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Latest tariff hikes to test retailers' resolve on price increases

The Market Intelligence Platform


Latest tariff hikes to test retailers' resolve on price increases

U.S. President Donald Trump's latest round of tariffs on $550 billion worth of Chinese imports will force several U.S. retailers to raise prices in 2020, despite their reluctance to pass the burden on to customers, analysts said.

"They can only order and store so much inventory ahead of tariffs. If a company faces [an] increase in costs with no way to mitigate it, then it will have to raise prices eventually," said David Swartz, equity analyst at Morningstar, in an interview.

Trump on Aug. 23 said he would raise taxes on a number of Chinese imports in retaliation to China's announcement that it plans to impose additional tariffs of 5% to 10% on $75 billion worth of U.S. products and raise auto tariffs to 25%.

Tariffs on $300 billion worth of Chinese imports were raised to 15% from 10%. The first tranche of taxes went into effect Sept. 1, while the second tranche is scheduled to be implemented on Dec. 15. The Trump administration also raised existing tariffs on $250 billion worth of Chinese imports to 30% from 25%, effective Oct. 1.

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The latest tariff hikes target a variety of consumer products including clothing, footwear, toys and electronics. Experts said they will hurt U.S. retailers, particularly smaller operators like Macy's Inc. and Kohl's Corp. that are heavily reliant on China for their products and cannot immediately diversify their supply chain.

The top product categories subject to the Sept. 1 tariffs include apparel imports worth $38.8 billion and television and monitor imports worth $8.55 billion in the 12 months ended June 30, according to Panjiva, a business line of S&P Global Market Intelligence.

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The Dec. 15 tariffs include imports of toys and games worth $21.3 billion, apparel worth $11.9 billion, phones worth $39.9 billion and laptops worth $39.1 billion in the 12 months ended June 30, according to Panjiva.

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Certain consumer electronics and some footwear and clothing products that involve complex production techniques and processes that are well established in China and cannot be easily replicated in other countries could see the biggest price increases, experts said.

Catch-22 for retailers

Amid the escalating trade war between the world's two largest economies, several retailers, including Kohl's, Macy's and Walmart Inc., in recent earnings calls expressed hesitation at increasing prices as they look to strike a delicate balance between preserving profit margins and the value proposition they offer to their customers.

"Today's customer doesn't have much appetite for price increases," Macy's CEO Jeffrey Gennette said Aug. 14.

Even before the Aug. 23 hikes, Kohl's expected the earlier tariffs to contribute to a 35 to 45 basis points drop in gross margin from 36.4% of sales in the prior year, compared to previous estimates of 20 to 30 basis point drop. Kohl's revised outlook also reflects the retailer's first half performance.

While Macy's did not include any potential impact from tariffs in its full year adjusted EPS guidance, which the retailer cut Aug. 14 by 20 cents, it said that tariffs could deal a 5 cents hit to its updated fiscal year earnings guidance.

Analysts believe some smaller retailers have significant exposure to China, and with earlier tariffs already squeezing their margins, the new set of taxes will make it harder for them to keep prices low.

Kohl's has been trying to reduce its exposure to China in recent years but still sources over 20% of its products from the country, according to statements from company executives during earnings calls for the past two quarters.

Macy's also sources a bulk of its products from China and is not "as nimble" with its supply chain compared to other retailers, according to David Zoba, chairman of the global retail leasing board at retail and leisure real estate consultancy JLL.

"I think these tariffs are going to hurt Macy's," Zoba said.

Shifting supply chain

Reorganizing the supply chain and negotiating terms with vendors and suppliers in China are among the strategies that companies affected by tariffs are using.

Best Buy Co. Inc., whose top products including televisions, phones and smartwatches are subject to the Sept. 1 and Dec. 15 tariffs, said Aug. 29 that many of its vendors are already shifting their production out of China to avert the impacts of tariffs. CEO Corie Barry said the retailer is also taking other mitigating steps including stockpiling ahead of the tariffs, evaluating its vendor and product assortment, and analyzing its pricing strategies.

While large retailers like Walmart, Target Corp. and Best Buy are able to swiftly diversify their supply chains, a lot of the smaller retailers lack "the financial flexibility to regenerate a supply chain or to transform a supply chain or even to diversify," Moody's retail analyst Charlie O'Shea said.

Neil Stern, senior partner at retail consultancy McMillanDoolittle, said the larger retailers are also better positioned to negotiate with their suppliers to share the burden of the tariffs.

"When you become J. C. Penney Co. Inc., your sales are declining, you're becoming obviously less important overtime to those suppliers," Stern said.

Walmart, Macy's, Kohl's and J.C. Penney did not respond to S&P Global Market Intelligence's requests for comment. Target declined to comment.

Uncertainty adds to complexity

Although officials from the U.S. and China are scheduled to resume talks in October, the uncertainty surrounding the trade negotiations is making it difficult for retailers to effectively employ mitigation strategies.

"They can't plan because they don't know exactly what's going to happen and the plans have already been changed multiple times. They've already had to alter their strategies. That doesn't help," Swartz said.

Target CEO Brian Cornell expressed concern during an Aug. 21 earnings call that persistent instability caused by the trade dispute "will present an additional layer of uncertainty and complexity as we plan our business."

The ongoing trade dispute also creates uncertainty about consumer behavior, Best Buy executives said on the Aug. 29 call.

"It is hard to predict how, at the macro level, consumers will react to higher prices resulting from tariffs," CEO Barry said.