Applying operational PDCA to trade and tariff risk

The Trump administration is pursuing its balanced and fair trade agenda on several significant, parallel fronts: 1) negotiations on the North American Free Trade Agreement (NAFTA) with Mexico and Canada, 2) tariff response to the Section 301 investigation related to unfair Chinese intellectual property and other technology transfer infringements, and 3) the Section 232 investigation of the national security implications of all automobile and automotive part importation.

Because of these many moving pieces, taking an operations approach with the tried-and-true method of plan-do-check-act/adjust (PDCA), made popular by W. Edwards Deming and Toyota, might be the best way to coordinate the numerous business function areas involved. Such an approach also will help you marshal required resources to mitigate final market uncertainty, production and capital investment cost risk, and supply chain disruption danger.

The NAFTA negotiations

Recap: The United States, Canada, and Mexico continue to negotiate new terms for the 24-year-old NAFTA agreement. With the May 17 deadline set by U.S. Speaker of the House Paul Ryan come and gone, the negotiation strategy took a bilateral direction with the United States and Mexico negotiating major automotive terms, including domestic rules of origin, content labor rates, sunset clauses, and dispute resolution. The Office of the U.S. Trade Representative (USTR) announced on August 27 that “a preliminary agreement in principle, subject to finalization and implementation” had been reached with Mexico. This preliminary agreement will be the basis for the negotiation with Canada.

The President has informed Congress that he intends to pursue this trade agreement with Mexico and that Canada may also agree to the provisions. This satisfies the required 90-day announcement window. The next deadline is Sept. 30, 2018. The U.S. Congress requires a 60-day window to review the final trade text, and this allows resolution before President-Elect Andres Manuel Lopez Obrador takes office on December 1.

The USTR reported that the Mexican deal requires a domestic content level of 75 percent, an increase from 62.5 percent, from U.S. and Mexican sources to qualify for free trade. New to the automotive provisions is a labor value content rule stipulating that 40 to 45 percent of that automotive content must be made by workers earning at least $16 per hour to be counted. Given that the wage provisions are new, and given the 20 percent increase in domestic content, there may be grow-in provisions over a number of years.

Section 301 investigation on Chinese practices and response

Recap: On March 22, 2018, the USTR issued the following: “The investigation of China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation addresses four categories of acts, policies, and practices of the Government of China that unfairly result in the transfer of technologies and intellectual property from U.S. companies to China. These policies harm U.S. businesses and workers and threaten the long-term competitiveness of the United States.”

In response, the United States placed a 25 percent tariff on $34 billion of imported goods. On August 23, an additional list of $16 billion of imported Chinese goods received incremental tariffs of 25 percent. Lastly, Sept. 17, 2018, the USTR released on a list of 5,745 products worth approximately $200 billion that will be subject to a 10 percent tariff starting on Sept. 24, 2018. Companies need to carefully review the third list, since it’s slightly changed from the original list that served as a precursor to three days of public hearings. The list is comprehensive and includes a wide range of intermediary goods, such as electronic chips, and items used in production, such as milling, tapping, drilling, and turning tools. In addition, the tariffs on these goods will rise to 25 percent on Jan. 1, 2019, if the original anti-competitive findings of the 301 investigation aren’t resolved. As the President announced these additional tariffs, he emphasized that up to an additional $267 billion worth of Chinese imports could come under increased tariffs if the Chinese retaliate.

The automotive Section 232 investigation

Recap: U.S. Secretary of Commerce Wilbur Ross announced on May 23 that the United States will initiate a Section 232 investigation under the Trade Expansion Act of 1962 to determine whether automobile and automotive part imports threaten to impair national security, as defined in the legislation. While Commerce Secretary Ross first stated the investigation will likely be completed by the end of August, in recent interviews, he has implied that the negotiations on NAFTA and other trade issues may be taking higher priorities than the completion of the automotive Section 232 investigation. Delaying the report, and the subsequent deadlines for the president’s response, gives the administration more time for trade talks with Canada related to NAFTA and to the European Union, as it relates to the broad range of reciprocal tariffs on the original steel and aluminum tariffs earlier in the year.

Plan-Do-Check-Act/Adjust: A framework for response to trade-related factors

Given how interrelated and fluid these negotiations are, companies are best to set up processes to monitor U.S. government actions and the reciprocal actions of countries on the other side of the table. Official statements, lobbying offices, trade associations, press reports, and the like are all good resources. Companies also need to monitor how competitors and suppliers are responding, and consider other elements of the value chain like changes to transportation logistics availability. One way to constantly monitor, develop contingency plans, and respond as needed to these political, competitor, and supplier actions and reactions is to set up a PDCA process within your organization.

    a. Plan: Every functional area should create an action plan related to the enacted and proposed tariffs and quotas by the United States, reciprocal action by trading partners, and outcomes of the NAFTA negotiations. Companies might think of stress testing their operations. What happens if NAFTA rules of origin rise to 75 percent? Will my customer drop me if my component misses regional content levels or is hit with a 25 percent tariff? What happens when South Korea hits its steel quota level? This gaming involves purchasing, finance, marketing, operations, labor relations, legal, and government and community relations.
    b. Do: Plans should consider proactive actions such as speaking to customers about potential mitigation paths even before tariff costs take effect, prepping manufacturing sites for product moves and, perhaps, even taking on costs of preparing production part approval process (PPAP) validations. While companies may not need to use these plans, the preparation can be considered an insurance policy against future supply chain or manufacturing disruption. Definitive actions should take place immediately, like applying for tariff exemptions, ensuring all imported materials are classified accurately, and triggering any physical or financial hedges.
    c. Check: With timing and actual tariffs of the United States and its trading partners uncertain, and customer, supplier, and competitor reactions varied, companies need to check their plans against the current situation and intended and unintended consequences. This is especially true since procedural changes continue, such as the posting of a second interim final rule on the exclusion of products from the steel and aluminum tariffs that includes a rebuttal process to challenge exclusions that were denied. Companies should look at these activities not as one-time costs in reaction to tariffs but as actions to harden their supply chains and customer relationships.
    d. Act/Adjust: The market environment will remain fluid as products that are approved for exemption, and potentially new products, are added to tariff lists. Companies will need to react to competitor and supplier actions to safeguard their market position, cost competitiveness, and supply allocations. The political environment will be equally fluid through the November, mid-term elections, lame-duck period, and initiation of the new Congress. And, while we’ve discussed U.S.-centric trade activities in this piece, don’t forget there’s likely to be equal uncertainty with actions and reactions with trading partners, beginning with the roll-out of Brexit as well as free trade agreements negotiated between regions and countries well outside the U.S. borders.

Timeline: The knowns and unknowns

Below is a brief timeline of what we know today:

• September 17: Release of Section 301 Chinese List 3 – $200 billion of goods with a 10 percent tariff. The posting in the Federal Register is forthcoming.
• September 24: Section 301 Chinese List 3 tariffs go into effect.
• December 18: Deadline for exemption requests to the Chinese List 2 Section 301 Chinese tariffs
• January 1, 2019: Section 301 Chinese List 3 tariffs rise to 25 percent.

We’ll continue to keep you informed. In the meantime, if you have questions, feel free to give us a call.