Planning Inventory While Accounting for Tariff Costs

Making Changes When Nothing Changes

Here we are, two years since the tariff battle began, and the back-and-forth isn’t letting up. While both the United States and China have reduced the tariffs on certain subsets of goods imported on either side, other tariffs have been implemented and expanded. These include tariffs on goods that use steel and aluminum — not just steel and aluminum themselves. While deals have been negotiated and progress is being made, the situation doesn’t show any sign of letting up anytime soon — making it difficult for companies that are accounting for tariff costs to make certain strategic decisions.

For manufacturers and distributors, the tariffs have become a guessing game. Should companies scale up inventories despite potentially lower consumer demand in the event that the tariffs conclude and demand returns? Or should companies scale inventories down, preferring instead to risk low stock, service issues, and customer frustration in an effort to save on costs? Whichever route a company chooses, how can it be done efficiently to minimize the impact? When the tariff battle concludes, how can inventory be scaled back up?

Let’s Recap Our Previous Recommendations

Recently, we explored the concept of accounting for tariff costs through efficient inventory descaling. This descaling isn’t accomplished through inventory itself, but rather by identifying reductions in variable costs and fixed costs. While the latter is often difficult to reduce and later reinstitute because they deal with longer-term needs (like buildings and employees), variable costs present a faster solution in that they are tied to sales and production. When production and sales are down, reorders of specific materials and other expenses like advertising can be reduced as well. These are often much easier to reinstitute as well, though, when it comes to certain parts and supplies, advance planning is necessary as they may take some weeks or even months to arrive.

While this approach does provide some relief for manufacturers and distributors, inventory strategy itself must still be addressed. Even if a company decided to scale its inventory up or down, some long-term approach is required to keep the company going. Ideally, organizations would take our recommended inventory approach by purchasing lower volumes of components, parts, or products at a more frequent rate.

The thinking behind this strategy is that the benefit of not being overly invested in inventory in a low demand environment outweighs the short-term downside of higher transactional and per-unit costs. If companies were to scale inventories up, they run the risk of sitting on that inventory for a long time. By buying less but more frequently, companies can better match inventory to existing demand. Margins will shrink some, but this is still preferable to sitting on inventory that simply isn’t moving out the door.

Accounting for Tariff Costs in the Long Term

Since we seem to be in a never-ending tennis match, it’s now important to take this strategy a step further. These recommendations still hold their own, but as the headlines are proving with each passing day, the tariffs are going nowhere. So how can companies hedge against what they think will happen versus what might actually happen? In such an uncertain tariff environment, what matters most is that companies place themselves in a position to protect what margins they can while maintaining service.

Let’s jump back to our recommendation of buy-fewer-more-frequently. While this will shrink profit margins due to the absence of price breaks that come with larger orders, existing demand can be satisfied. Service levels can still be maintained because parts or products will still be coming in, though at more frequent intervals. Conversely, by buying more products or parts as a reaction without demand, precious resources are tied up in the warehouse. And because orders aren’t being replenished as frequently, service issues could arise. Either the demand won’t be there to consume inventory, or inventory will be consumed with far too much time between now and the next restock to maintain service.

Pay Attention to the News

Another consideration here is that the drawn-out nature of these negotiations means that companies must pay close attention to global matters. While many tariffs have already been implemented or expanded, as recent headlines have proven, any other type of tariff could become a reality in little to no time. That means companies must monitor market headlines and start accounting for tariff costs in their planning.

For example, if it starts to appear that a tariff on a specific material or good will not be decreasing from its current level, companies must be prepared to take action immediately. If the tariff were to increase unexpectedly, the financial impact to a company could be severe — and virtually immediate. In this situation, it might benefit a company to increase its inventory at the current tariff price rather than after the tariff increase. A tariff increase could reduce demand further but make it even more difficult for a company to replenish as that inventory ships out over time. It would be better to stock up ahead of the price increase to ensure sufficient supply, that service levels could be maintained, and to preserve the margin that currently exists on the part or product.

Conversely, if it appears that a tariff on a product or material will be decreasing, it makes sense to hold off on ordering new inventory to avoid paying the current price. However, there is a key strategic consideration here. With the tariff decrease could come an increase in demand from competitors for the same products or goods that a company is looking to reorder for its customers. This will put strain on the supplier and could result in each company that placed an order experiencing a delay, which could further impact sales and service. What companies decide to do in this situation should take their inventory levels into careful consideration. Companies should consider their runway for their existing inventory: will it last long enough to eventually place a reorder at a lower price? Or do we need to reorder now and accept the existing tariff price in order to meet demand?

Consider Other Sources of Supply, But…

Another consideration for companies in this situation is to start evaluating other sources of supply. Perhaps another provider has solutions and processes for producing the goods needed at lower price points regardless of the tariffs. Not only might the per-unit price drop, but it might reduce enough to justify a reorder at the current tariff level, allowing companies to replenish inventory, meet demand, and preserve service. However, there is a dangerous pitfall here that is important to keep in mind.

With every new supplier comes costs beyond unit production costs. It will take the supplier some time to produce the new products, particularly if their production environment isn’t already set up to produce it (e.g., if a mold needs to be built for manufacturing). It will also take some time to set up the distribution network between the company and their new supplier, which also adds to the lists of new costs incurred as a result of a new relationship. Any organization considering a supplier switch should conduct a cost analysis to determine if the lower part/product price is worth the time and cost of switching — and what the payback period or break-even point on the move will be.

Use Our Expertise for Peace of Mind

We hope you have enjoyed our series on the tariffs and the recommendations we’ve made throughout each post. As a refresher, you can read our recommendations on efficient descaling here as well as our thoughts on the buy-fewer-more-frequently inventory strategy here. If any of the points, challenges, or recommendations expressed throughout these three posts have connected with you and your organization’s inventory management challenges in light of the tariffs, know that River Rock Advisors is here to help.

We have worked with numerous global organizations to help them solve their most pressing and complex inventory management challenges. Through our unique approach, we can develop strategic recommendations that not only put your organization in a stronger position to succeed in the long run but also give you key advantages over your competitors. All it takes to get started is a conversation.