DEEPER DIVES: War!

Good Evening,

First, as always, thank you for joining.

Another late delivery for DEEPER DIVES. Necessary to get you all of the information and insights about President Trump’s Executive Orders.

Originally I was going to do more than just tariffs in this edition, but given the amount of uncertainty and misinformation out there (and the fact that this will be everyone’s primary concern right now), I decided to make today’s newsletter all about the US tariffs.

Matt and I will also be talking more about this tomorrow morning at 9AM Eastern Time on Wake Up and Deliver (our 1x / wk podcast where we talk all things operations and supply chain - and where you can join the conversation!)

I’m also back in the GTA for a few days meeting with a number of people to help them improve in 2025. If you want to try to connect, send me a DM on LinkedIn - if we’re able to make the schedules work, I’m happy to.

Here’s what this issue brings:

• The tariffs are here. I’m going to give you an overview of the situation, from the top down to help you understand as much as possible. There’s already a lot of misinformation happening, I’ll do my best to keep it clear so you know what buckets things falls into.
  

The Border Isn’t The Goal. This Is About Another Kick At the Can

Everyone is talking about the new tariffs imposed by Executive Order by President Trump.

They are broad and will have a huge impact on industrial and consumer commerce.

We’re going to start and the top and work our way down.

While everyone is talking about the new tariffs, I haven’t seen too many people putting things into context.

To start off, let’s go back to Trump’s first term, and start with the USMCA.

The USMCA (which came into effect in 2020) replaced NAFTA as the primary trade agreement between the US, Canada and Mexico.

The goal of this agreement to promote freer markets, fairer trade, and robust economic growth in North America.

You may recall President Trump criticizing NAFTA saying it was “perhaps the worst trade deal ever made”. This criticism was a driving force behind his administration's efforts to renegotiate the agreement, leading to the creation of the United States-Mexico-Canada Agreement.

Here’s the TLDR on the USMCA:

• Elimination of tariffs: The USMCA eliminates most tariffs on goods traded between the US, Canada, and Mexico

• Rules of origin: The agreement includes stricter rules of origin for automobiles, requiring a higher percentage of North American content to qualify for duty-free treatment

• Labor and environmental standards: The USMCA incorporates strong labour and environmental protections, with mechanisms to ensure these standards are enforced

• Dispute settlement: The agreement includes a dispute settlement mechanism to address trade disagreements between the three countries.

• Digital trade: The USMCA includes provisions to facilitate digital trade and e-commerce

The objective of the new agreement was to create more balanced and reciprocal trade, supporting high-paying jobs for Americans and fostering economic growth in North America.

The President wanted to reduce the trade deficits and to create a trade environment that was more balanced than what he believed NAFTA created.

But that’s not at all what happened from his policy changes.

The U.S. trade deficit with Mexico grew to $152 billion in 2023. In tandum, the Canadian deficit increased to $72 billion over the same period. The combined deficit reached $220 billion, up from $85 billion pre-USMCA.

Canada's energy exports to U.S. significantly increased.

Mexican auto sector employment grew from 120,000 to 550,000 workers despite USMCA's wage provisions.

Companies leveraged USMCA to establish regional supply chains that reduced costs rather than bring manufacturing back home.

Not exactly the legacy he wanted.

In addition, Mexico became the number one US trade partner, over taking China. I shared last week the implications that had and what China has been doing on the world economic market since.

In order to address these same lingering issues, the President has taken a different approach.

They have declared illegal immigration and drug trafficking, particularly the spread of fentanyl, a national emergency under the International Emergency Economic Powers Act (IEEPA). To address this crisis, the administration is imposing additional tariffs on imports from Canada, Mexico, and China as leverage to pressure these countries into stopping the flow of drugs and illegal migrants

As of February 1, 2025 here’s where we are:

Canada:

• General Goods: 25% tariff imposed on most imports

• Energy Products: 10% tariff applied specifically to Canadian energy exports, including crude oil

Mexico:

• All Goods: 25% tariff imposed on all imports from Mexico

China:

• All Goods: 10% tariff imposed on all imports from China

And while the countries impacted by the tariffs are going to feel the impact, so too will Americans.

You see, Canada is the top import partner for 23 U.S. states. Mexico is the top import partner for 10 states, predominantly in the South (the country is the largest supplier of fruits and vegetables to the U.S.). China is the top trading partner for 9 states, including California and Florida (two of the largest economies in the country).

These tariffs will impact B2B and D2C business in different ways.

It’s important to understand how the tariffs are applied and what value is used to calculate them.

The tariffs are applied to the customs value of imported goods (the declared value at the U.S. border), not the sales value in the U.S. market.

The customs value for these shipments include things like: Cost of goods (production cost), Packing expenses, Transportation costs to the U.S. port of entry, Assists (materials, tools provided to producer), Royalties or license fees related to the goods.

The customs value is based on the transaction value and are sometimes switched when you are reading information about how these tariffs will apply.

(Transaction value serves as the foundation for customs value in most cases, but customs value might be determined through alternative methods when transaction value cannot be used)

eCommerce Context

The biggest (or maybe best said as the most apparent) impact to eCommerce in the short term will be to companies that are using the Section 321 program to ship product into the US from Canada or Mexico duty free.

Both Canada and Mexico allow for the product to be stored in warehouses, where they can go through a pick and pack process, and not pay any duties as long as that inventory is never indented for domestic sale.

This allowed retailers and brands to pay the same amount to ship product from overseas (it would have to get to NA regardless), manage their warehousing costs (that they would have had anyways), pay for their consumer shipments (that they would have had to pay anyways) but be able to benefit from avoid US import duties and benefiting from lower costs of labour and/or better transit times to fulfill orders.

This cost savings means millions (or tens of millions) of dollars depending on the size of your business.

Zone skipping and Section 321 Transportation options have popped up everywhere over the last few years.

Trucking thousands of packages a day and injecting that volume into the domestic US shipping market made all of these activities financially viable.

The 25% rate chosen by the US Administration was set because it’s basically higher than any of the import costs associated with these consumer goods.

Since the customs value of these shipments would have to including additional work and transportation in Canada and Mexico when tariffs are applied, the cost impact is substantial for direct-to-consumer shipments.

Industrial Context

Despite the USMCA goals, more businesses moved their U.S. manufacturing out of the US and into Mexico, while also taking advantage of cheaper Canadian energy to drive operational cost savings.

The 25% tariffs seems to also be in the right range to negative the benefits that American businesses have gained by moving their production outside of the US and buying more foreign products to lower their overall costs.

In my opinion, the entire goal is to force business to re-balance imports and exports and dramatically reduce the trade deficits that have ballooned since the start of the USMCA.

The unfortunate part about it, is that there seems to be misleading information about some of these numbers.

Without energy trade for example, U.S. actually has a $30 billion surplus with Canada.

Canada exports approximately 4.3 million barrels of crude oil per day to the U.S.. This represents about 60% of all U.S. oil imports, making Canada the largest foreign crude supplier - 6 times larger than Mexico, the next biggest supplier.

And while the U.S. does have their own oil reserves, the export volume is largely due to U.S. refineries specifically designed for Canadian heavy crude. The infrastructure and pipelines have been built over the last 70 years leading to discounted Canadian oil to the US based on the geographic proximity.

The tariffs are scheduled to take effect at 12:01 a.m. Eastern Standard Time on February 4, 2025. These tariffs will apply to goods entered for consumption, or withdrawn from warehouse for consumption, on or after this time. Notably, goods that were already in transit to the United States before 12:01 a.m. on February 1, 2025, are exempt from these tariffs.

Advice and Guidance

I’ll share some thoughts and perspective on how to review your operations here. I’ll focus predominantly on smaller brands and direct to consumer brands, however there is some general advice that applies to everyone.

• Short term you are going to absorb costs. It’s important that you are able to get an accurate assessment of your current state. Try not to lean on forecasts of planning models to estimate the impact. Use actuals and get up to date information on what you have been selling, what percentages, values, ABC costing, etc.

• Determine your key components, ingredients or sales units. The things that you sell the most will be where you can find ways to mitigate the cost impacts more quickly. Focusing on everything and all at the same time will make you move slower, costing you more money in the long run

• The De Minimus shipment changes are going to hurt. Short term I would recommend that you continue operating status quo. If you have a US facility already, you can start shipping secondary items from there (so that you don’t go out of stock too quickly on best sellers). Paying the tariff will be far less costly than moving to quickly with the wrong 3PL partner

  • If you have a Section 321 Warehouse in Canada, ask your provider to see what proper international shipping from Canada will do. I have seen very aggressive rates in the market and this could be a good stop gap if you had been using ground + US Domestic shipping via 321

• Look to implement stepped price increases to limit sticker shock from consumers. It’s better to have your community’s understanding versus creating confusion with overly aggressive price increases that may make them feel you don’t properly understand what is happening

• Look to create more value through bundles and additional services or subscriptions if possible

• If you had been running large ads selling on discount, I would stop these immediately

Information I have Seen I Do Not Believe Or Is Confirmed Inaccurate

1. [Not Accurate] 35% tariff on China
   Some people are posting that it’s a 25% + 10% additional on China goods. This is not true. 25% for Canada and Mexico, 10% on China
   

2. [Believed Not Accurate] Customs Value Versus Sales Value or Fair Market Value
   There is some uncertainty as to what the tariff will be based on. Since these are applied as a percentage of X, the base is important. All of the information I have seen and reviewed is making me confident at this time that the tariff is based on the Customs (Transaction) Value
   

3. [Believed Not Accurate] Section 321 Will Still Be Permitted From Canada Or Mexico Of the Country Of Origin for the Goods Is Not China
   Flexport CEO Ryan Petersen said this. I don’t believe it is true. Everything to this point that has been released has specifically called out the country of export, regardless of where the goods come from.
   
   I don’t believe this to be true as it would do two things. First it would create another loophole and an administrative nightmare to manage. And second, it would be taken VERY poorly by China. If the President wanted to impose harder conditions on them, you would be better off to have hit them with more than 10% than to hide it with a country of origin clause.
   
   Given what I shared about the US-China economic relationship, I do not see this actually being true.

That’s it for this week. Thanks for being here.