11 Tariff Mitigation Strategies

Tariffs imposed by countries worldwide to protect domestic industries and respond to unfair foreign trading practices pose challenges for any company that conducts business across international borders. Those businesses may have to raise domestic prices as tariffs boost the cost of imported raw materials, parts, and finished goods, and export sales may be affected if foreign countries institute retaliatory tariffs of their own.

By using effective tariff mitigation strategies, however, businesses engaged in international trade can continue to produce distinctive, high-quality products, develop new markets, and potentially boost their profits.

What Are Tariffs?

Tariffs are taxes that governments impose on imported or exported goods. Most often, governments apply tariffs to imported goods, but they will sometimes impose them on exports, too—for example, to discourage companies from selling strategically important products to foreign buyers. A tariff is usually calculated as a percentage of the value of the goods and is, therefore, known as an ad valorem tax.

11 Tariff Mitigation Strategies for Businesses

With careful thought and planning, businesses can often reduce, delay, or avoid tariffs. Here are 11 ways businesses can mitigate their exposure to tariffs.

1. Reclassification and valuation: For starters, effective tariff mitigation requires companies to correctly classify all raw materials, components, and finished products in its supply chain according to the international Harmonized System (HS). Overseen by the World Customs Organization, HS is a global system of nomenclature applied to most world trade in goods. Incorrect classification can result in significantly higher costs for businesses. Classifying a product for tariff purposes considers several factors, including the product’s description; its ingredients or component parts, and the percentages of each; the main use of the product; and its commercial, technical, scientific, or common name or designation. Using inventory management software integrated with an enterprise resource planning (ERP) system’s central database, businesses can maintain complete records of product inputs and inventory, in real time, which helps ensure that tariff classifications are correct and up to date.

2. Supply chain optimization: Many of the same approaches that optimize a supply chain for resilience can also mitigate the impact of tariffs. Diversifying supply chains, for example, can reduce reliance on products or their components from countries that are, or could be, subjected to high or volatile tariffs. It can also fortify a business’s ability to take advantage of special programs, quotas, and other governmental tariff-reduction facilities. For example, US businesses facing higher tariffs on Chinese imports could divert their supply chains to replace them with parts and raw materials from countries with which the US has free trade agreements (FTAs). In supply chain management, diverting is like diversification except that it’s usually tactical and temporary, executed rapidly in response to sudden changes in conditions.

   Optimizing supply chains to mitigate tariff exposure hinges on two information flows. First, businesses need to know which countries their products, and all those products’ components, come from. Moreover, if tariffs on input products have not undergone a significant change for the country from which they’re sourced, then the importer may also need to know which additional countries, if any, its ingredients or component parts come from. That calls for a precisely tuned supply chain management system. Second, businesses must comprehensively understand the landed cost of each imported product they buy—that is, the total cost of the product, including shipping, customs, taxes, insurance, and any other fees, as well as tariffs. This requirement makes integrated accounting and inventory management systems essential.

   Where tariffs are a significant contributor to landed costs, businesses may be able to increase profitability by shifting to suppliers in countries subject to lower tariffs. Alternatively, businesses can offset the costs of tariffs by improving supply chain efficiency—for example, reducing shipping costs by shortening supply chains. It’s wise to include tariff mitigation within an overall supply chain management strategy.

3. Free trade agreements (FTAs): Businesses can lower or eliminate their tariff exposure by organizing their supply chains and sales strategies to take advantage of FTAs, which are treaties between two or more countries to reduce barriers to trade among them—including, but not limited to, tariffs. The countries that sign the treaty collectively form a free trade area. The US, for example, has FTAs with roughly 20 other countries. So, to mitigate the effects of tariffs, US businesses can source raw materials and intermediate parts from countries with which the US has FTAs.

   Businesses can also reduce or eliminate tariffs on exports by selling to countries with which their country has FTAs. For an export to qualify for a lower or zero tariff under an FTA, it must comply with the rules of origin as defined in the FTA. Rules of origin are designed to prevent products fabricated in countries that don’t have FTAs from being routed through countries with FTAs to avoid tariffs. Exporters must be able to prove that a sufficient proportion of the components and raw materials from which a product was made was sourced within the free trade area. The rules of origin in the FTA determine what constitutes “sufficient.” For simple products, it’s typically 100%, but for complex products, such as cars, the proportion may be less.

   Even when an FTA doesn’t fully eliminate tariffs, it can still be advantageous. FTAs typically harmonize regulations among countries, thus reducing administrative paperwork and intrusive checks. There may be other benefits, such as intellectual property protection.

4. Supplier management: Businesses can mitigate the impact of tariffs by renegotiating supplier contracts or moving to lower-cost suppliers. Obtaining better prices and terms can pass some or all of the cost of import tariffs to suppliers. Technically, switching delivery terms to “delivery duty paid” shields businesses from changes in import tariffs and duties because they become the responsibility of the seller, but suppliers might charge higher prices for bearing all the costs and risks associated with international goods delivery. Diversifying suppliers also can be a good way to reduce input costs. But aggressive cost-cutting in supply chains has a possible downside: It can reduce supplier loyalty and increase a business’s vulnerability to supplier defaults. Often, businesses need to compromise with suppliers to effectively share tariff costs. Thus, tariffs should be considered part of a business’s overall procurement strategy.
5. Local manufacturing and assembly: Manufacturers whose production is partially or wholly overseas can reduce tariff exposure by reshoring—i.e., reestablishing domestic production facilities. This is the case even if they still import some or all of their product inputs, because tariffs are typically lower for ingredients and component parts than for finished goods. However, the costs of premises, plant, overhead, and labor may be higher domestically, so businesses must weigh whether the potential benefits from tariff reduction are sufficient to justify the higher cost of domestic production. An alternative is to shift production to lower-cost countries with which their nation has FTAs. Any of these decisions to shift production requires cost-benefit analyses based on total landed costs and pricing strategy. Businesses can use predictive analytics and what-if scenario planning to understand the effects on costs and profitability of shifting production to various locations.
6. Tariff engineering: Another way to mitigate the cost of tariffs is to change a product’s design or composition so that it qualifies for lower tariffs. The changes must be genuine amendments to the product, not temporary features added or removed for the purpose of evading tariffs. Tariff engineering can be as simple as replacing parts from suppliers in countries subject to high tariffs with similar parts from suppliers in low-tariff countries. Or it can involve a major redesign of the product to use completely different parts and materials. A well-known example of tariff engineering involved a sneaker manufacturer in an Asian country that added a layer of fuzzy felt to the sole, reclassifying the sneakers as slippers for export to the US and thus subjecting it to a 3% tariff instead of about 40%. However, ill-considered tariff engineering can have costly consequences. A car manufacturer devised a scheme to avoid a 25% tariff on light trucks imported to the US from Europe by modifying them to classify them as passenger cars, on which it paid a tariff of only 2.5%. It then converted the cars to light trucks immediately after they cleared customs by removing passenger-related features, such as rear seats, rear seat belts, and side windows. The manufacturer had to pay penalties and interest, and it now manufactures light trucks within the US.

7. Bonded warehouses and FTZs: Free trade zones (FTZs) are designated areas within a country where imported goods aren’t subject to customs and border regulations. In the US, they’re called foreign trade zones and are supervised by US Customs and Border Protection (CPB). Goods imported into FTZs are deemed to be outside CPB territory. No tariffs or duties are payable while they remain in the zone. However, tariffs and duties become payable if the goods leave the zone and enter CPB territory. Businesses may be able to avoid tariffs by exporting goods directly from the FTZ to other countries or by manufacturing finished products with the goods while still inside the FTZ.

   Bonded warehouses are secure facilities where businesses can store goods free of tariffs and duties until they’re needed. In the US, where they’re also regulated by CPB, they’re sometimes called customs warehouses. Businesses can store goods in bonded warehouses for up to five years. Bonded warehouses can be a good option for storing goods that may not be needed for some time. They’re particularly useful when a business has imported products it intends to use in the future but has yet to confirm tariff classifications or countries of origin.

   For both FTZs and bonded warehouses, keeping track of the movement of goods is essential. Businesses can use an ERP system with integrated manufacturing and inventory management software to control the use and movement of goods in FTZs, and to record and manage goods held in bonded warehouses. Knowing exactly which goods are held where helps business managers decide how best to deploy inventory to minimize tariffs and other costs.

8. Temporary import bonds: Businesses can temporarily import goods tariff-free by posting a bond for twice the value of the expected tariff. To avoid the tariffs becoming payable, the goods must be exported or destroyed before the bond matures. This can be a useful approach for goods businesses bring into the US for repair, alteration, or reprocessing, provided they immediately export the goods once the work is completed. As with bonded warehouses, keeping track of the movement of goods is essential, and time limits need to be adhered to. A professional services system that tracks warranties, repairs, and returns can help businesses manage tasks and timescales to help ensure that work is completed and the product is exported before the bond matures.
9. Duty drawback programs: Businesses may be able to reclaim duties, taxes, and fees paid on imported products if they can show that the product has been either exported with little or no modification or destroyed (because of a defect, for instance). Keeping complete and accurate documentation of product movements is essential for successful claims. An inventory management system can help businesses maintain the required documentation.
10. First sale rule: When businesses buy products from foreign intermediaries, they may be able to reduce tariffs by using the first sale rule. Using the US as an example, this rule allows a business to base the value of a product for tariff purposes on the price paid for the first sale of the product. If the first sale was from a manufacturer to an intermediary, the price for tariff purposes, therefore, excludes the intermediary’s markup or fee. Because there must be a clear intent to export to the US from the beginning of the chain for the first sale rule to apply, the US business must be able to prove that the first sale was a genuine arm’s-length transaction and that the product was always destined for export to the US. The business also must declare use of the first sale rule when it imports the product. Using the first sale rule can deliver significant cost savings for businesses. However, it’s important to maintain accurate and complete documentation, as use of the rule can be subject to legal challenge.
11. Price adjustments and cost absorption: Businesses may be able to mitigate the impact of tariffs on their bottom line by passing on the cost to customers. However, their ability to do so depends on the nature of the market, the sensitivity of customer demand to prices, and the intensity of competition. To minimize tariff impact in a volatile environment and adapt quickly to changes in customer demand, businesses need to develop pricing strategies, which necessitates that they know their production costs, total landed costs, and break-even points. They also must establish the sensitivity of product purchases to changes in unit price, which is known as the price elasticity of demand. Businesses can then use predictive analytics and what-if scenario planning to understand the likely sales impact of passing on costs to customers versus absorbing them. These analyses can help determine whether a price increase is right for the business and, if so, what size of price increase will maximize profits while maintaining customer loyalty.

Navigate Tariff Complexity with NetSuite

Tariffs can be as complex as the classification systems on which they ‘e based. Businesses need to understand which goods from which countries incur tariffs, how large they are, how the tariffs are calculated, and all the associated rules. With NetSuite’s integrated supply chain and inventory management systems, all the information that businesses need to navigate tariff complexity is readily available on a single platform. NetSuite’s planning tools and predictive analytics, with embedded AI capabilities, support strategic decision-making, while features for comprehensive documentation, detailed reporting, and audit trails help ensure completeness and demonstrate compliance.

Adapting to an environment of higher and/or more volatile tariffs may require businesses to reconfigure their supply chains, renegotiate contracts with existing suppliers, and even redesign their products. Effective management of tariff exposure is key.

Tariff Mitigation FAQs

How to overcome a tariff?

Businesses can mitigate the impact of tariffs by diversifying their supply chains, sourcing materials and parts from countries not subject to tariffs or subject to lower ones, or respecifying products to avoid using materials and parts on which tariffs are payable.

How can a company avoid tariffs?

Businesses can avoid paying tariffs by taking advantage of government-authorized exemptions, quotas, and special programs; using free trade zones, bonded warehouses, and import bonds for goods intended for re-export; trading with countries with which their country has free trade agreements; and claiming refunds on re-exported or destroyed goods.