How to Manage Price During a Trade War
The trade war initiated in 2018 is impacting business. Economists warned that trade wars do more harm than good, but their voices went unheeded. For executives in businesses, people who are accountable for their business decisions in response to changing government policies and trade wars, the urgent and pertinent question is how to manage the turbulent changes imposed by the new tariffs.
Tariffs Are the Weapon of Choice in the Current Trade War
The weapon of choice for the current trade war has, mercifully, only been tariffs. Yet the number and breadth of companies impacted is staggering. For just a short list of goods impacted by tariffs imposed and retaliatory tariffs enacted or under consideration, we have seen:
- U.S. placed tariffs on steel and aluminum in June 2018, impacting various market opportunities for U.S. firms in steel and aluminum, as well as cost structures of U.S. firms from the auto industry and construction to consumer packaged goods canning operations.
- China and Mexico placed retaliatory tariffs on U.S. meat in July 2018. By August, as record levels of beef, pork, and chicken were coming to market, Tyson, Pilgrims Pride, and Sanderson Farms all reported pricing pressures as a “meat glut” threatens.
- A retaliatory E.U. tariff made U.S. kidney beans 25% more expensive in Europe. As of August 2nd, 80 containers of beans valued at $2 million were stuck in warehouses as E.U. ordered dried up.
- U.S. is preparing a 10% tariff on fish from China. Unfortunately, an estimated $900 million of this fish originates in the U.S., is shipped to China for processing and packaging, and then returned to the U.S. for consumption.
- E.U. Canada, Mexico and China have all launched retaliatory tariffs on U.S. cranberries. About one-third of the U.S. production of cranberries were destined for export. As a result, prices have fallen below production costs, 15% of last years crop and potentially 25% of this years crop is being “disposed.”
- 659 U.S. goods face Chinese tariffs in industries including agriculture, energy, chemicals, medical devices, commercial jets, and many more.
Managing in a Trade War
Executives in industries impacted by the tariffs, retaliatory tariffs, and threatened future tariffs must react. The playbook for executives in this trade war will vary. Key dimensions to consider include short-term and long-term expectations, and the specific nature of the impact on their business relative to their industry.
We can categorize the impacts on business into two broad considerations:
- Input costs have change.
- Market access has changed.
Changing Input Costs Due to Tariffs
A slew of manufacturers and producers will be impacted by a change in cost structure, and usually for the worse. Managing prices in reaction to a changing input cost will strongly depend on the direction of the input cost change, and the breadth of competitors impacted by the cost change. See the Tariff’s Cost Impact Reaction Matrix.
If the cost change impacts all relevant competitors in the industry relatively equally, then managers should anticipate competitors feel the same pressure to act in the same manner.
For cost increase, managers should swiftly seek a highly publicized price increase. This prescription has been well documented across many pricing strategy texts. It rests on the assumption that (1) the cost change has a similar impact on all competitors and therefore all competitors have a similar incentive to react in the same direction and (2) communicating the price increase broadly to the market will make competitors aware of the potential to quickly follow price leadership upwards.
For cost decreases, managers should reluctantly allow price decreases. This prescription too has been well documented across pricing strategy texts. It rests on the assumption that (1) price deceases always reduce profits and hence should be done only reluctantly and, as such, (2) said price reduction should be in response to a competitor’s move, and when anticipated to be necessary according to a competitive price reaction matrix.
If the cost change impacts companies within the industry unequally, then the prescribed reactions become more nuanced, but can still be calculated according to the competitive price reaction matrix.
For costs changes that disproportionately improve a company’s competitive advantage, executives have an opportunity to attack with a price reduction and take market share, or ignore the impact and pocket windfall profits.
For costs changes that disproportionately harm a company’s competitive advantage, executives must either (1) mitigate the potential market share loss associated with maintaining higher than industry norm prices by communicating its superior value proposition and offering benefits, (2) lower prices and accept lower profitability and potential short term losses, or (3) accommodate competitor encroachments into their market share and aim to survive the current turmoil to compete again under a changed circumstance.
Changing Market Access Due to Tariffs
An overlapping slew of manufacturers and producers will be impacted by changes in market access, and usually for the worse. Managing prices in reaction to a changing market access will strongly depend on whether the tariffs increase market captivity, or decrease market accessibility.
If the tariffs increase market captivity, executives have an opportunity to raise prices. This prescription rests on the understanding that industry level elasticity is always lower than company level elasticity. As such, when competition has been reduced, elasticity decreases by approaching that of the industry rather than any single firm. Microeconomics strongly demonstrates that reduced market elasticity implies a potential to increase prices to maximize profits.
If the tariffs decrease market access, executives are facing a damaging crisis. In these cases, current product must be sold prior to expiration to a smaller market, future production must be curtailed, and some product may have to be destroyed.
The decisions and actions of executives should also take into consideration two pertinent time horizons: short term versus long term expectations.
In the short term, prices may go haywire as competitors rush to dump product on the market, miscalculate their response, or otherwise make adjustments to accommodate the newly altered competitive position imposed by tariffs. The above matrices can help executives anticipate needed price moves, but not all producers are rational.
In the long run, firms will adjust and industry composition will be altered by these tariffs. Production will move, be reduced, or be increased in depending on how the tariffs favor or disfavor a particular industry in a particular country. Price levels in industries impacted by the tariffs are unlikely to return to pre-2018 status—unless the tariff is swiftly reversed, which is unlikely. Instead, prices will increase or decrease depending on whether the tariffs favor market captivity—or disfavor access due to the tariffs’ impact on cost structures.
Many executives impacted by this trade war, even if the tariffs are eventually reversed, will experience irreversible damage done to their company.
Decision Making in Turbulent Times
Trade wars impose turbulence on executives and the businesses they manage. Moreover, the uncertainty created by the trade war and the potential for continued escalation of tariffs and retaliatory tariffs and policies, make planning and investing perilous.
As the above decision matrices demonstrate, the proper response to a tariff is highly dependent on its specific impact on a company.
We cannot accurately predict if or when the trade war will be resolved. We can fortunately calculate decisions, which are most likely to either improve performance or reduce the negative impacts of a specific tariff on a specific business.
While a handful of businesses may enjoy a windfall, most executives must reduce, but cannot eliminate, the negative impacts of the trade war. Times like these calls for cooler heads and rational business decisions.