The Impact of Isolationist Trade Policies on Retailers and the Communities they Serve

From the critically acclaimed author of “Type B at HBS” comes the compelling story of Michael Smith, a senior sourcing manager at Target struggling to navigate the uncertain and ever-changing landscape of international trade policies. This piece explores how isolationist policies impact retailers, their employees, and the communities they serve, offering an intimate and personal narrative on how a large retailer and its leadership has reacted to policy change.

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.

Michael’s Conclusion

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 Response

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.

Key Considerations

  1. How can countries incentivize development and investment in domestic manufacturing without negative effects on the standard of living for citizens?
  2. 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?

Sources

  1. 2017. http://www.bbc.com/news/business-32498715.
  2.  Target Corporation. 2016. “10-K Annual Report.”
  3. 2017. http://www.businessinsider.com/how-much-products-would-cost-if-made-in-us-2016-11/#jeans-2.
  4. Yahoo! Finance
  5. Interview with Michael Smith (name hidden), Sr. Sourcing Manager at Target. 2017. Interview by Kamau Massey. Phone Interview.

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19 thoughts on “The Impact of Isolationist Trade Policies on Retailers and the Communities they Serve

  1. Thanks so much for this, Kamau! To me, this piece helps highlight one of the most fundamental tensions that exists between economic theory and economic reality. There are few concepts that economists more strongly agree upon than the idea that free trade is a good thing; by allowing each party to specialize in producing those goods for which it has a comparative advantage (that is, for which its opportunity cost of production is lower than the other party’s), all parties should end up unambiguously better off.

    The issue in implementation, however, is that those benefits don’t accrue evenly to individuals within a particular country, and in fact, can distort existing inequalities even further by rewarding the owners of capital. And often, those who are harmed the most (in the US case, those in labor-intensive industries) are able to generate significant political influence to defend their own wellbeing. The challenge, then, is first, to help individuals understand the benefits of free trade – e.g., the availability of lower-priced goods at Target – but second, and more difficult, to figure out schemes to reallocate the benefits reaped from free trade to those groups whom it made seemingly worse off. This latter piece is, in my opinion, one of the biggest economic and political challenges nations (the US in particular) face today – and, to an economist, it is devastating that political realities force us to be unable to fully realize the utility gains of free trade. In the meantime, this example from Target shows us at least one immediate consequence of trade barriers to all parties (and potentially even more so to the groups who resist trade the most) – a higher near-term price on what we’ve come to know as low-cost products.

  2. Great article Kamau! I loved to read it, it feels like a short HBS case!

    It was both interesting and striking to see how a 20% border tax could affect and destroy an established player like Target. I fully agree with the contingencies you propose: qualify and develop new local suppliers and invest in manufacturing technology. The latter is in my opinion a potential solution to approach the key considerations you raised at the end of your article. You mentioned the cost of labor as key differentiator for production facilities outside the US, particularly in Asia. Assuming that this difference in labor cost will remain in the foreseeable future, the only way to be competitive is to reduce to a minimum the amount of human labor required in manufacturing. Today’s technology advances allow to design manufacturing plants that are (almost) fully automatized and will ultimately help the US strengthen a competitive advantage through manufacturing technology, a field that is less attractive to invest in for Asian manufacturers benefiting from low cost labor.

  3. Thanks for sharing this article, Kamau. Echoing both TOM Lover and Pascal, I found your article extremely thought-provoking. I definitely share the concerns that have been expressed and agree that US investment in manufacturing technology is one potential solution. My concern with the need for moving manufacturing to the US is the time required to get factories setup and labor trained. Assuming however that Target is successful in setting up US manufacturing facilities, I could see how the tax adjustment could leading to significant US-based job creation. Unfortunately, in reality I think that it is unlikely that these jobs will be created in time to combat the rising costs to Target, should this tax be implemented. In my opinion, the only way for this 20% tax to not destroy companies like Target, would be for enough jobs to be created and wages to increase so that the company is able to pass through their added costs to consumers but I am skeptical that this happens successfully.

  4. Thanks for sharing, Kamau! As you alluded to at the end, one of the levers Target and other companies have is to leverage technology to reduce costs. The irony of that is the cost reduction from technology would be to cut labor. Cutting headcount overall is something else Target can do, which undermines the entire policy’s goal of increasing American competitiveness. I highly doubt regulators have thought about many of the unintended consequences of some of the suggested policies…

  5. Adding to Jen’s comment, there is quite a bit of risk in both investing in manufacturing technology and also not investing in technology. In the scenario that the tax is implemented, Target, if they are going to have any chance at combating price increases, must invest in technology NOW due to the length of time it would require to get technologies online. However, the investment would be irrelevant (and quite a waste of capital) if lobbying is successful and the tax is not implemented. To Jen’s point, if Target waits to invest, they may be too late – consumers may not abide higher prices. On the optimistic side, if Target’s competitors are all equally affected and prices rise across the board, consumers may have to abide higher prices to a certain extent (even though demand must inevitably go down due to higher prices).

  6. Thank you Kamau for a great article! I really enjoyed reading it, particularly the dramatic description of our protagonist Jihone Du. Echo the comments that technology is a key lever to reducing labor costs. However, it would take years for U.S. retailers to rebuild supply chains devastated by sudden tariff hikes and develop technology to displace human workers. All this comes at a cost that retailers may choose to pass on to consumers. In the meantime, foreign countries can impose retaliatory tariffs that further hurt US consumers. Retailers may have solutions for this in the long term as case alluded to, but it’s a gloomy outlook for short term.

  7. Thanks, Kamau! Similar to what jgrchild mentioned, my concern would be how we tackle these issues in the short term. While Congress typically moves at a snail’s pace, it seems likely that something like a 20% tax would come before Target had time to react. I imagine that many companies are starting to plan infrastructure now in order to take a proactive instead of reactive stance.

    I also found your first question interesting in this sense: if we move our manufacturing out of these other countries and back into the US, will that negatively affect those countries? Will another company just move in their manufacturing or will Target’s suppliers train this people to move to other jobs?

  8. I also found your first question interesting in this sense: if we move our manufacturing out of these other countries and back into the US, will that negatively affect those countries? Will another company just move in their manufacturing or will Target’s suppliers train these people to move to other jobs? While Trump’s administration is not necessarily as concerned about the affects these moves will have on the rest of the world, many consumers probably will be.

  9. Thanks for sharing Kamau! I had not realized how thin Target’s margins are and it was interesting to hear what Target has been up to in regards to combating the 20% proposed border tax. I would question the US hourly figures as well as the supply of willing manufacturing workers in the US a little bit: GE Appliances recently brought jobs back to the US and pay around $16/hour average. In addition the job website signups fill up very quickly every time they set out to interview for hourly assembly positions (never a lack of people who want to work). This could be due to the region of the country though and this situation calls into question the issue of minimum wage in the US and what is enough to be considered a living wage.

  10. An essay fit for HBS; well written and presents a compelling logical argument and a clear problem position.

    I would like to focus on your observation that passing on the cost to the consumer would render Target uncompetitive and put it out of business. In the broader context, Target’s main competitors all face the same problem in the current political climate and all struggle to find a solution. I absolutely agree that political lobbying is one of the necessary actions to be undertaken, but given the irrationality of the current administration I fear this route will have limited tangible effects. As such, if this proposal persists I believe the ultimate outcome would have to be rising prices across the board given this is one of the only options left to prevent bankruptcies of this kind of business. Target would not necessarily be put in an disadvantageous situation given prices would rise across the board to its consumers, and the ultimate loser would be the American public. Perhaps this third-order negative effect on the average citizen might be necessary to raise awareness that the public policies voted into the White House were sold on false premises, and as such ensure that this protectionist agenda will be rather short-lived in power.

  11. I agree with Simon, I think that prices would rise across the board. This will lower aggregate demand for the amount of products provided though, so I do think it would hit Target and the industry pretty hard. There would be an overall contraction as the industry adjusts to lower levels of demand at the new higher prices.

    To the question of impact on US society – there are certainly many negative impacts on consumers. However, one positive thing to think about is the impact on consumeristic culture & the disposability of cheap items. Reduced access to low cost goods may increase the longevity of products (e.g., clothing, furniture) which could help reduce waste.

  12. Very nicely written article Kamau. You bring a compelling argument against isolationist trade policies. However, I feel it would be difficult to make breakthrough technological modifications to drastically reduce manufacturing cost in the US, given the scale of cost difference in labor rates: $25 per hour in US vs $2 in Bangladesh/India. This can result in premium prices being passed on to consumers, and from a macro context, the extra value generated by in country manufacturing is being actually paid for by the American middle-class consumers. This can be a good argument to present in front of the government.

    Also, another key stakeholder in these isolationist policies is the government of the sourcing country. Isolating trade can severely impact foreign policy and strategic relations between large nations. For example, the Prime Minister of India, has taken up the issue of visa for Indian immigrants, and impact on US proposed policies on limiting outsourced services (specially I.T) and manufacturing in India, in his several meetings with the U.S government officials and has asserted confidence in the interactions thus far. The source company governments will also lobby against these regulations and political decisions on protectionism and trade isolations will have to factor potential relation and strategic tensions between nations.

  13. Great article, Kamau – I had no idea that Target was navigating a difficult situation of this nature. I’d like to build on Simon’s point about Target’s competitors: although the dilemma Target faces is less than ideal, I would imagine that all of their competitors are grappling with the same issue.

    I wonder if this particular situation lends itself to cooperation with competitors. While Target is a large corporation on its own, I imagine that it could more successfully lobby the government with the support and resources of other corporations. This represents a rare situation where the incentives of direct competitors are aligned, and I can imagine corporations taking steps to “lay down their arms” to convince the government of the adverse effects of this policy, from corporate health to the workforce development issue that Angel raised. I’ll stay tuned to this issue in the news to learn how the situation progresses.

  14. Kamau – I have learned more from/about Target this semester than I ever expected. Thank you for flagging another interesting challenge!

    I agree with you and some of the previous comments that technology is key here. To push back on some other comments, I think investment in tech will be costly but absolutely necessary for the long-term future of Target (whether or not Target seeks and puts into place other near-term solutions more immediately). I agree that Target will have to outsource some of its production (especially the labor component) to lower cost markets in the near-term but by investing in tech now, Target will make possible US manufacturing in the future which will create other US jobs (development and conception of tech solutions, tech implementation, management of factories, etc.). The market for global production and manufacturing likely will look dramatically different a few decades from now and Target should anticipate that change and make investments in tech now to ensure their long term sustainability.

  15. Speaking with Trump is a step in the right direction to bring make manufacturing domestic again. Government policies will have to change for this Target’s manufacturing to come to the U.S. As technology continues to develop, labor will slowly be replaced with machines and robots, which will reduce labor costs and bring manufacturing back to the U.S.

  16. Great work Kamau! You followed the assignment, but worked it flawlessly into story form—such a fun read. I think the problem of investment in domestic manufacturing without negative ripple effects is a question that the US wishes they had the answer to right now. As you touched on, due to the low cost of labor and materials in other countries, there is an incentive to move manufacturing offshore, but putting in trade policies to counteract the problem can often have side effects that weren’t understood when the policy was enacted. As the shift toward globalization continues, it’s important for policy makers to understand and keep in mind that tariffs and other artificial blocks to globalization and free trade have other effects that often leave the people they were trying to protect worse off.

  17. Kamau, this was very interesting to read! It brings me back to the idea of comparative and absolute advantage. In international trade, nations benefit from producing those products in which they have a comparative advantage. The tax leaves both the US and TPP countries worse off.

    A few years ago, Argentina imposed tariffs on electronics (including computers, tablets and TVs) to protect local manufacturing workers assembling these products. Accessing electronics became so expensive that Argentinians began to cross the Andes mountains to acquire these products in Chile. What’s even worse, a black market for Apple products emerged.

    When these protectionist measures are taken, it is important to evaluate the potential impact beyond the desired increase in local production and employment.

  18. What a great read, Kamau. Loved learning (even) more about Target! Frankly I was extremely surprised to learn that the TPP agreement threatened Target to the point of putting bankruptcy on the table. I had not previously considered that behemoths like Target were so affected by the TPP. Throughout your piece, I kept thinking about small & medium businesses (less than 500 employees) which comprise 99% of US companies [1]. Target, a company of 350,000 employees as you noted, had the political leverage and media access to attempt to influence the President. Their short & long-term actions involved media interviews, meetings with the President, and political lobbying in DC. Small business don’t have the resources or access to do so. This brought to mind the importance of considering unintended consequences as mentioned in many comments above as well as considering how to secure your supply chain against international shifts. I see your point on domestic manufacturing investment, but struggle to see how the economics will ever be equivalent. I do agree with aportland that in theory this is a macro trend Target’s competitors will also face and by all passing costs to consumers, isolationist policies can eventually be reassessed.

    [1] https://www.foreignpolicyjournal.com/2017/01/18/trump-china-trade-and-the-impact-on-us-small-business/

  19. Excellent article Kamau, and very well written! I really like your recommendation around investing in manufacturing technology to lower Target’s overall cost of production. I think this is the only real solution in the long run and one that Amazon has demonstrated really works. For example, Amazon significantly expanded its army of robots in 2016 and now has 45,000 robots across 20 fulfillment centers (http://www.businessinsider.com/amazons-robot-army-has-grown-by-50-2017-1). While initiatives like these are usually capex intensive upfront, they give significant competitive advantage to companies like Amazon by reducing large operating costs such as labor. Target similarly needs to start investing in the future now to ensure that it remains competitive.

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