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May 6, 2020
by Brooks Hamilton

This article first appeared on Industrial Distribution.

 

We can learn a lot from history. The economic impact of tariffs on products and raw materials over the years can be easily measured and enlighten us to possible outcomes from today’s tariffs. We can review past market reactions to tariffs and understand the implications for businesses today. More importantly, we can see with 20/20 hindsight, learn from our mistakes and decide where to where to make improvements.

 

In particular, the past five years have seen a significant shift in foreign trade policy between the U.S. and huge trade partners like China. With the U.S. imposing a 25 percent tariff on a broad range of products (including imported steel) as well as a 10 percent tariff on imported aluminum and trading partners retaliating, B2B businesses must equip their pricing teams with the knowledge and tools to react quickly, or risk losing valuable margin, revenue and competitive advantages.

 

How well B2B businesses have responded to these cost increases in the past can reveal important insights about missteps to avoid and the opportunities to leverage modern tools and technology, like data and analytics, artificial intelligence, and central data repositories to mitigate revenue and volume loss as the result of higher tariffs.

History can teach us what to improve, but technology can show us how.

 

Taking a look back to understand the way forward 

 

Tariffs have been an important part of U.S. foreign trade policy since the late 18th century. During an especially protectionist period in the late 19th century, the U.S. saw an average tariff on imported manufactured goods of between 40 and 50 percent. Compare this to the average tariff in European countries of between nine and 12 percent during roughly the same period, and it’s safe to say that the U.S. has been no stranger to high tariffs at various points during its history.

 

In 1949, Lloyd Metzler, an American economist, noted the significant impact of tariffs on domestic prices, relative to international demand. In sum, he reasoned that if demand remains constant on certain goods, then we can expect an increase in the domestic price of imports. For other products, the opposite is true to startling results. When tariffs are imposed on these price sensitive products, demand substantially decreases. So much so that domestic prices may end up lower than before the tariffs were imposed. This is why precision pricing strategies are so important when examining how a business should respond to the resulting market implications of tariffs.

 

The 2002 George W. Bush-era tariffs provide an illustrative case. In an effort to improve the U.S. steel industry’s competitive advantage against international players, the administration imposed a tariff that increased the cost of imported steel by as much as 30 percent. There was an unforeseen consequence. The manufacturing sector that consumed that steel reported at that time that the tariffs “raised their costs, cut their profits and forced them to delay expansion,” according to a 2003 New York Times article. Indeed, data from the U.S. Department of Labor found that motor vehicle parts prices were 3.4 percent lower than pre-tariff prices, and machinery and equipment prices were 3.8 percent lower. Ultimately, intense competitive pressure forced steel consumers to reduce prices in an environment of increasing costs, but they struggled to exact higher prices from customers in the face of soaring steel costs.

 

So what happened to those producers’ margins? To their revenues? To their competitive advantage? Foreign producers of steel-manufactured products developed a cost advantage over U.S. producers, giving them a competitive edge that drove customer orders out of the U.S. and into the hands of foreign manufacturers.

 

During the Bush-era tariffs, the vast majority of B2B companies lacked the right data, analytics and pricing technology to effectively react. Today, these companies have a better way to manage pricing strategies in these environments – one that takes a more dynamic and granular approach to price strategy, providing the levers to maximize revenue or margins in any market environment.

 

How technology is changing the game for pricing strategies in the face of tariffs 

 

When tariffs are imposed on raw materials like steel and aluminum, manufacturers have limited options to absorb the higher costs. The easiest way to deal with tariffs is to pass the cost on to the customer. However, this general price hike can sometimes backfire if certain considerations are not accounted for.

 

How will customers react to the price increase? Will it be too high, such that they take their business to your competitor? As history has shown us, finding the right balance between maintaining margins and volume can be tough, but it bears taking a closer look at the role price elasticity can play.

 

In other words, what is the price-volume relationship within each micro-market that exists for a business. Many different factors are at play when differentiating the price elasticity of various customers, including geography, industry, customer size, order size, competitor pricing, and more. Each micro-market has varying degrees of price elasticity, meaning a customer segment where price elasticity is low is less likely to change their purchasing pattern and may absorb all of the price change resulting from cost increases, while a customer segment where price elasticity is high may be more sensitive to price hikes, and thus, may reduce their volumes. The key differences between practices in prior tariff actions and today are knowing which micro-segment is highly sensitive and which is not and managing different price changes across thousands to millions of micro-segments.

 

This can be accomplished by utilizing advanced pricing science to examine and predict the profit and revenue impacts of new pricing strategies on various customer micro-segments before they go into market. Quantifying customers’ price response allows for better decision-making about where to be more aggressive with price increases and where to be more conservative. By comparing traditional methods of pricing responses (such as passing on most or all of the tariff costs to customers across the board) to a more granular response that strikes a balance among customers who can and can’t tolerate certain price increases, B2B companies can better maximize their revenues and profit margins against the alternative consequence of losing customers or volume.

 

Price optimization software, as outlined above, is game-changing in its ability to make accurate predictions about the business impact of cost changes on each segment and provide multiple options or levers to pull when uncertainty arises. Moreover, the leading platforms in this space can utilize data from multiple, unlimited sources, so teams can quickly import and process important tariff and product data to eliminate the cumbersome processes and inform pricing strategies.

 

The best defense to mitigate the impacts of tariffs is to put in a place a robust pricing tool set that allows companies to react quickly and with precision as market triggers, such as tariffs, arise. Where history taught us about the impact of high tariffs on product demand and prices, we can thank our modern technology for giving us a better, more scientific way to understand the micro markets for our business and make more intelligent and precise decisions that positively impact margins and revenue.

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