A New Proposal
A week after withdrawing the US from the Trans-Pacific Partnership (TPP) agreement and several weeks after his inauguration in late January, President Trump announced his proposal for a 20% border tax to be implemented for US companies on all imported goods. The policy’s objective was to jump start US based manufacturing, create new job opportunities for blue collar workers, and generate an estimated incremental $10 billion a year in tax revenues that could be used to finance a number of initiatives in the years to come.
Upon hearing the recent news, Michael Smith, a senior manager on Target’s global sourcing team, began modeling the financial impact of the policy changes on the company’s profits. A single bead of sweat rolled down his furrowed brow as he came to his startling conclusion. Without a large corporate tax cut, Target, a $70 billion mass market retailer, may not survive this latest proposed border tax.
As Michael modeled his predictions on the impact of a border tax he had to consider the current sourcing and production for many of Target’s highest margin products. Like many other mass market retailers, Target generated profits primarily from high margin apparel and home goods and only sold lower margin commodity goods such as groceries or household essentials to drive traffic to its stores. These apparel and home goods, which generated roughly 40% of Target’s total revenue and an even larger percentage of total profits, were primarily sourced from foreign countries (China, Vietnam, India, etc.) where labor rates were significantly lower than in US.2
In 2016, Dan Panzica, chief analyst at HIS Markit Tech’s Manufacturing Service estimated labor rates inclusive of employee costs beyond wages to be “$2.50 an hour for Vietnam with Bangladesh being around $1.80 an hour”. By comparison, IHS’ analysts calculated the labor rate in the US at $25-$30 per hour.3 Since the primary cost of manufacturing these items is labor (as opposed to materials) the overall reduction in price compounds. Furthermore, the abundance of willing laborers (workforce size) and factory efficiencies gained over years of global manufacturing further lowered the costs overseas. Lower labor costs and favorable currency exchange rates in these countries, enabled US-based mass market retailers like Target to sell these items at increasingly lower prices to consumers while still maintaining high profits.
The implementation of a 20% border tax would significantly impact Target’s bottom line, shareholders, and consumers. Target and similar retailers, who historically operate at razor thin net margins of 3-5%4, cannot afford to absorb a 20% increase in cost on the majority of their profitable items without going bankrupt. An alternative to absorbing the costs would be to pass them along to the consumers. That said, with increasing globalization and ever higher consumer expectations, an increase in prices for consumers would likely render Target uncompetitive and in the long-term, out of business. Either way, an employer of 350,000 people nationwide would no longer be able to properly serve the American public as a result of a policy whose main goal is to do just that. This left Target with one option; to fight the policy. As Michael reached this conclusion he realized that this task was far above his paygrade, so he sat back and waited as Brian Cornell, CEO of Target, sprang into action.
Target’s short-term response came swiftly and was backed by many of the other major US retailers. CEO Brian Cornell began releasing interviews with major news outlets on the dangers of the policy and even flew to meet with the Trump administration several times over the next few weeks to explain the potential impact. In the midst of uncertain future trade policies, Target began developing sourcing contingency plans for the long-term future based on all foreseeable options for changes in the trade policy, resulting in significant increases in workload for sourcing managers like Michael.5 Additional long-term solutions involved political lobbying with the controlling parties in Washington.
One thing I would suggest that Target implement is a larger investment in manufacturing technology. Technology can be utilized to reduce the price of manufacturing domestically and an early investment in a lower cost US manufacturing solution may serve as an excellent contingency plan in the future. Another suggestion I have is to begin contingency planning with the countries of production themselves. This may enable working relationships to continue even in the event of an unfavorable policy change.
- How can countries incentivize development and investment in domestic manufacturing without negative effects on the standard of living for citizens?
- How can companies in developed countries with smaller workforce pools compete with companies based in larger countries (or countries with lower costs of production) in an increasingly global market?
- 2017. http://www.bbc.com/news/business-32498715.
- Target Corporation. 2016. “10-K Annual Report.”
- 2017. http://www.businessinsider.com/how-much-products-would-cost-if-made-in-us-2016-11/#jeans-2.
- Yahoo! Finance
- Interview with Michael Smith (name hidden), Sr. Sourcing Manager at Target. 2017. Interview by Kamau Massey. Phone Interview.