Where and When is the Inflationary Impact of Tariffs?

Tariffs are in the news, but will they have no to little impact on inflation? What can we expect in the next 90 days?

Calculating the Short-Term Stakes

Taking a Stoic’s approach, the overall immediate impact of tariffs on inflation is likely manageable. Imports were 14% of U.S. GDP in 2024. If the current average tariff rate on imports is sustained at 18% and there is no substitution or reduction in demand, the tariffs would only add 2.5% to inflation. More advanced economic models predict tariffs will add only around 0.6% inflation in the current year. Other models predict a larger impact. Either way, this is likely to be a manageable inflationary pressure with contractionary monetary policy, a policy currently employed by U.S. central bankers.

This is a hypothesis to which I can work with regarding a three-month prediction.

The impact of tariffs on inflation is even more manageable if companies continue to absorb the costs, as some have called them to do. Many companies have, to date, not increased prices commensurate with input cost inflation. An optimistic consumer may expect that to continue, and hence the contractionary monetary policy may be relaxed as some have called for.

This is a hypothesis to which I cannot accept regarding a three-month prediction.

Executive Engagement

After reviewing three years of Pricing Spineometers, one identified common concern of CEOs, CFOs, and others in the C-Suite regarding pricing is inflation. The question shareholders and the C-Suite both ask is: Is the company raising prices with or ahead of cost inflation? Those that don’t, those that raise prices well after cost inflation, later express regret.

Losses and lost profits resulting from absorbing inflation can never be “made up”. It is like a hotelier practicing yield management with perishable inventory; once the night is over, a lost sale due to lack of demand or lost incremental revenue at a higher price due to higher demand is lost forever.

Ford generated losses of $36 million after paying $800 million in tariffs. Estee Lauder reported sales fell 12% due to lower consumer demand and is forecasting a $100 million tariff cost for 2025. Others are in the news with similar challenges.

The markets are holding the C-Suite accountable for their response, and executives across the board are working overtime addressing tariffs. So what accounts for the delay in response?

Two well-documented sources are creating market tension today. Economists call them Menu Costs and Relative Price Volatility.

Menu Costs

Changing prices comes with a cost, a cost economists call “menu costs” after the costs incurred by restaurants in updating menus. While the name stuck, the management implications are far wider than restaurants.

Unless your price structure is Index-Based Pricing, Yield Management, or Supply-Demand Matching Algorithms, it will take work and time for companies to get new prices in the market. And if you are using one of these three price structures, you already know the work required for dynamic price management is significant, and you have likely invested heavily in your pricing capability.

For businesses to implement a price change, consider what must occur. They must change list prices, socialize the changes internally to create buy-in, negotiate with customers to accept new prices, and then they can take purchase orders and invoice at the new prices. A 90-day price change process on this for every SKU at a company like Stanley Black & Decker, Generac, or Kohler is a Mercurian sprint.

Relative Price Variability

Once a company raises prices due to input cost inflation, but another doesn’t, the market receives confusing price information. Customers are likely to purchase from the lowest-priced competitor even if that competitor is the least efficient. Economists deride this as a market failure, as they hate inefficiency.

Yet for executives, the question of who moves first with higher prices into the market is a fraught decision. If they move quickly, they are likely to remain profitable but lose market share. If they move slowly, they will gain market share but at the loss of profits or even incur heavy losses.

Overall Small. Specific Large

Yes, consumers will see the impact of tariffs on specific items, but the overall direct impact on U.S. inflation is manageable.

And yes, well-run companies will be passing through input costs via price increases in the next 90 days. Markets demand it, but it takes time and effort.

Perhaps those CEOs and CFOs should have invested more in their pricing function already.