Tariffs have dominated headlines since March 2018, when the U.S. first announced the beginning of a series of tariffs affecting several industries, sectors and countries. Since then, “on again off again” signals have besieged the marketplace, leaving many businesses to contend with rising prices and a sense of whiplash.
At a basic level, a tariff is a tax—a surcharge a country pays on goods it sells to another country. The intent is typically to level an unequal playing field, and as a result, there are practical as well as political aspects to consider when trying to understand tariffs. Nevertheless, the net effect is that prices will be higher for suppliers impacted and, if passed on, could be higher for distributors, retailers and consumers—potentially dramatically so.
With the possibility for new tariffs still on the horizon, those responsible for setting and executing pricing policies, strategies, tactics or activities are eager to anticipate these changes. At Nielsen’s Sales Effectiveness Practice Area, we devote ourselves to understanding manufacturer, consumer and retail impacts due to pricing (and promotion) dynamics, including the effects of tariffs. Based on our research, we’ve identified three underlying elements of tariffs. At their core, tariffs are:
- Uncontrollable, for retailers, consumers and manufacturers;
- Often larger than usual price fluctuations; and
- Political in purpose.
Some of these are known factors. We understand how other uncontrollable events (like weather changes) or large price increases can affect product volumes, and this knowledge could help us anticipate the effects of tariffs. But given the political element of tariffs, they may be somewhat unique from other price increases.
We’re currently conducting an empirical study to investigate how expected and actual tariffs affect the marketplace, but we’ll need more time to determine if the long-term effects of the current tariffs will be a composite of known dynamics or something special. Yet, by exploring the implications of these underlying elements, businesses should be able to better position themselves to react to the turbulence tariffs are creating in the marketplace now and in the future.
ANTICIPATE ALTERNATIVES TO THE UNCONTROLLABLE
A tariff can be controlled in the sense that the country executing the tariff can decide not to do so. However, for most manufacturers, retailers and consumers, a tariff is uncontrollable, like a weather induced supply disruption. The good news for brands is that consumers and retailers tend to be relatively understanding of such uncontrollable events, and sometimes there is even a surge in purchasing (even with a price increase) for fear of “doing without”—particularly for necessity items.
So what can we learn from weather-induced disruptions? They typically tend to produce relatively modest effects despite an abrupt increase in price. We believe this is primarily because consumers and retailers realize that no one is at fault in the price increase. Second, the fear of not having the product spurs demand. Third, category sensitivity pales in comparison to product sensitivity. The key though is that the weather induced event affects all key products—if some manufacturers can change their supply chain, they will tend to reap this demand “dividend.”
Thus, a critical factor of the effect of uncontrollable factors that interfere with the supply chain is whether they do in fact affect the total category/segment/sector or whether they’re more circumscribed. For example, if France had a country-wide drought or an abnormal crop freeze, all French wine would be affected equally. However, if I had a mango sorbet product that used mangos sourced from India and these mangos were affected by an infestation, my product may be more at risk because my competition may source their mangos elsewhere (or I’ll need to take time and money to adjust my sourcing).
To that end, a fundamental dynamic when prices rise (due to uncontrollable factors or not) is whether there are suitable alternatives. Let’s go back to our French wine example, which is particularly pertinent given the recent tariffs imposed by the U.S. on some European products including still wines from France. While all French still wine is being tariffed equally, U.S. consumers have lots of options for premium wine, including domestic wines as well as imported wines from other countries not subject to these new tariffs.
As a result, loyalty (or disloyalty) also plays a key role in determining the impact of these uncontrollable price increases. If tariffs were levied only on French table wine, these products would be substantially affected, but other premium and imported wines would likely offset most of this volume shortfall, because wine has relatively lower brand loyalty levels than some other alcohol categories. Comparatively, a product-specific tariff on something like bourbon, with higher loyalty levels, would be less impacted.
For tariffed brands, this means that if reasonable alternatives do not face the same tariffs/pricing pressure, there will be a much stronger impact on sales. Therefore, it would be especially important for these brands to engage in offensive (e.g., brand support such as advertising) and/or defensive (e.g., public relations explaining tariffs) activities to blunt the impact of the tariff.
But this also points to opportunities for products that aren’t tariffed. An adjacent brand can attract volume from tariffed products by expanding their consumer or usage target. And by absorbing some of the tariff themselves, they may be able to turn a loss into a win, proving to consumers and retailers that they deeply care about the marketplace.
PREPARE FOR PRICE AND VOLUME CHANGES
A tariff is usually a large tax—for example, tariffs on Chinese goods are currently averaging around 20% and the tariff on French wines that we mentioned previously is 25%. As a result, tariffs often result in a hefty increase in everyday price. But not all categories and products are equally affected by price increases. Not surprisingly, the more a product is considered a ‘necessity,’ the lower its sensitivity to pricing changes. In other words, necessity products are less price sensitive than discretionary ones.
While it’s easier said than done, marketers facing tariffs can try to position products as a necessity (critical for a special evening, for example), not as discretionary. This may be done by targeting key consumers, who might be most open to finding alternatives. However, it’s crucial that brands and retailers understand consumer impacts, and then market accordingly. How consumers think of “necessities” isn’t always intuitive.
While there aren’t many examples of previous tariffs for us to study, the U.S. has implemented taxes on specific products in the past. And a study found that when a cigarette tax was implemented, heavy smokers, for whom cigarettes would be viewed as more of a necessity, were more affected by the tax than light smokers, for whom cigarettes would not be viewed as a necessity. This was probably because heavy smokers could save more money from reducing smoking (because these consumers purchase a great deal of this product).
A key concept to measure sensitivity to price is a product’s elasticity. This is a summary statistic of how much volume changes with a price change. Usually, we recommend using our price elasticity models for + or – 10% changes, but tariffs could result in much more significant price increases than this. As a rule, we don’t recommend making such “out-of-range” predictions (that is, making predictions of a large price increase from a dataset that did not include large price changes).
Elasticities are non-linear, meaning that a hefty price increase is expected to have a flatter curve than would a substantial price decline. But, given the dearth of experience, we aren’t positive that this is how the elasticity will play out in the marketplace. There might be additional factors that are “extra-elasticity” drivers that need to be understood.
One of these additional considerations when it comes to price may be a product’s price threshold—when tariffs cross a key price point, or a threshold, a disproportionate impact can occur. For example, a common threshold in wine is $10, and in premium wine, it’s $20. If a price increase resulted in an $18.99 wine now being priced at $24.99 (or more), we would expect a substantial volume decline.
Using an elasticity designed for a small price change to predict volume change from a precipitous price change is certainly risky, but if there is no ability to conduct better research, it is probably better than nothing (as a worst case scenario). But the bottom line is to plan for significant volume loss, unless the entire category is exposed to the tariff.
EXPECT A POLITICAL ELEMENT
There is an important political element to tariffs. Back to our wine example, for a while, the U.S. was discussing exacting an even higher tariff of 100% on French wine. While this has been delayed for now, if it were to go through, some U.S. citizens may have felt it was their patriotic duty to avoid this product. This could even cause a triple-whammy—the substantial price increase, the arousal of patriotism (and tribalism), and perhaps a chiseling away of this product’s equity (the brand may not be as special because they or their country are engaging in what some might perceive as unfair activities). Most challenging is that these dynamics could unfold rather abruptly and unpredictably.
A related dynamic would be that the “tariffed” county may retaliate (such as China or France exacting tariffs to U.S. goods). This not only reinforces the aforementioned patriotism/tribalism, but may reflect other dynamics as well (e.g., animosity toward the product/country).
PREPARING FOR TARIFFS
We were up front that we don’t know whether a tariff is a special circumstance or can be reduced to known dynamics. Tariffs seem to have some factors that should diminish the negative impacts of a large price increase (e.g., consumer/retail forgiveness of something beyond the manufacturer’s control or an entire sector being affected), but they also may involve factors that exacerbate the price impact (loyalty, tribalism and even animosity to the tariffed product/country).
Ultimately, we think the severity of the effects of the current tariffs or any future tariffs will come down to whether there are reasonable substitutes for the tariffed product. So while some products have much to lose with tariffs, others can capitalize on such a dividend. With potential new tariffs looming, how can brands prepare for this? Understanding the pricing landscape is crucial—will you cross pricing thresholds? Will competition be more or less affected? What adjacencies might seem attractive to your current consumers (and can you position yourself against such competition)? Additionally, removing the political component as much as possible, through public relations and other communications vehicles, could also help reduce the effects. But it’s just as important to continue building your brand to drive loyalty and equity, reinforcing that other products aren’t simple substitutes for yours.