Tariffs in Supply Chain Planning

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Understanding The Tariff Turbulence

Now that the initial shock of recent tariff shifts and the wild claims about tariff solutions have somewhat abated, it’s time to apply some rational thought to the topic and how it may or may not impact supply chains in general and specifically, supply chain planning. It’s important to understand what tariffs are, how they are applied and in what sphere of concern they reside. It is equally important to understand how technology may or may not be able to address the core truths and impacts of tariffs.

The foundation of tariffs begins with the simple definition we all know. Tariffs are a fee or surcharge levied by governing bodies for the privilege of bringing some product manufactured in a different sovereign nation into the nation levying the tariff. This becomes a part of the overall cost of the product.

We have always had tariffs of some type. They are not new. What is new is the size and volatility of the tariffs.  These fees historically are only a small part of the overall cost of importing a product and as such, did not require any specific considerations from a planning and supply perspective. In our current reality, tariff application is broader and much more substantial than before, in many cases equaling or exceeding the actual acquisition cost of the product. Part of the dilemma facing companies as it applies to tariffs is the volatility and instability of the tariff structure. How long are we going to have them in their current state? Are they going to go away? How often and how large are the changes going to be? Currently, tariffs pose a significant threat to margins and profitability and so the simple tariff has become a disruption to continued business for many companies.

If we can agree that tariffs now present themselves as a potential disruption to existing supply chains, we should probably talk about disruptions in general. Disruptions are any internal or external action or event that disturbs the demand/supply balance and inhibits the ability of a company to profitably deliver to customers on-time-in-full. Supply chain disruptions are not new, they are an inevitability. Some are small, some large. Some are local and some are global. Some are self-imposed/self-inflicted, and some are totally outside of a company’s control. Regardless of size, scale or scope, disruptions are inevitable. Today’s tariffs are just another disruption.

So, what mechanism exists to deal with disruption? Wild and varied claims have been touted about newly developed capabilities that have been magically built overnight or that by sprinkling a little AI pixie dust on tariff volatility somehow the dilemma is solved. Taking a deep breath and stepping off the hype train, and then applying just a little critical thought one quickly realizes that those claims are just that, claims, and that those claims don’t really pass the sniff test.  The planning framework that has historically been used to understand the impact of disruptions to a business is a process known as S&OP or Sales and Operations Planning. S&OP is, by definition, a collaborative, iterative, alignment process, aligning a company’s resources to achieve company goals. It may also be known by its more mature name, Integrated Business Planning (I generally use those names interchangeably).

One of the main tactical goals of S&OP is to help a company fulfil its obligations to its customers at the lowest reasonable price, preserving margins and protecting market share. One of the ways that it does that is through a planning activity often called scenario planning, also known as what-if planning or simulations. It takes the existing business plan and, separate from that plan, allows planners and analysts to interactively change values that affect the business plan and measure and compare the outcomes on a variety of dimensions. An inconvenient truth is that AI cannot do that as there is no training dataset that can teach AI what to look at, what to change and what the decision tree looks like.

Now let’s look at tariffs specifically as a disruption. As previously mentioned, tariffs are not new. What’s different is that, historically for the most part, tariffs have been a relatively small part of the overall cost of a product and, as a cost element, did not figure into disruptions. In today’s volatile and unpredictable arena, tariffs have become a major consideration and, in many cases, exceed the total cost of the product itself. This forces companies to examine their plans and consider sourcing alternatives. The way they systemically do that is by creating scenarios in their S&OP or IBP process that incorporate tariffs as a decision lever and then analyzing and comparing those scenarios. This is a cost and profitability approach that provides baseline data for decisions but is not the only dimension that needs to be considered.

Configured correctly, optimizers can scrutinize a company’s digital twin and using Machine Learning logic (OK, I concede certain AI tools can be effectively used) can rationalize the supply plan based on cost. Tariff relevant values can be changed in separate scenarios and then optimized and the then results compared. However, this is strictly a mathematical exercise.

Once the cost impact is known, a company must determine and decide whether to absorb the tariff, resulting in a hit to margins and profitability or increase selling prices to protect margins. Perhaps the decision is a little of both, hedging short term profitability to retain market share. They must also recognize and model the possible impact to overall demand as prices may push customers to not buy or to delay buying. Threats to market share and company image and reputation must also be represented in the scenario process. These are qualitative decisions, not necessarily quantitative and as such require human wisdom.

In the near-term, there is another dimension to planning that must be included in this process. How does any of the scenarios modelled impact your suppliers.  In this area we all may need to change our way of thinking a little. All our suppliers have capacity limitations themselves. Our suppliers also have history with us, and they allocate some of their capacity to our historical demand and/or forecasts that we provide. As we model different scenarios with tariff-driven outcomes we need to have the ability to digitally connect with our suppliers and quickly and iteratively send them potential forecast(s) and receive their soft commits in return – not in a point-to-point manner, or through even more cumbersome methods such as email.  The velocity and volume of these data exchanges requires a one-to-many digital business network to succeed. Those soft commits will either validate or invalidate those scenarios and become a part of the decision process. This positions our trading partners as an integral part of our planning process.

Finally, in the frenzy to react to these financial pressure points caused by these extreme tariffs it is necessary to acknowledge that permanent solutions cannot be quickly achieved. These are strategic, capital planning level alternatives that need to be modeled and compared in scenarios. These alternatives may include options to onshore or nearshore to a more favorable tariff source, to build internal capabilities or to refurbish existing capabilities. All these options carry significant risk and expense and given the volatility and unknown future of the tariffs, create tough decisions for companies.

In simple summary, the ability to easily create alternative options through the use of imbedded scenarios, leverage algorithmic machine learning logic to perform the complex mathematical calculations, and compare the outcomes of those scenarios in an easily consumable manner are the keys to resilient supply chain planning and getting our companies through this latest disruption to our carefully laid plans. Contact your SAP representative to explore SAP solutions that assist in weathering the Tariff Turbulence.