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10% Tariffs Were Manageable. At 25%, Businesses Are Squirming.

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08/12/2019 | 11:33am EDT

By Chao Deng

ZHANGJIAGANG, China -- When the U.S. raised its tariffs on Chinese imports in May, Harlan Stone knew his U.S. vinyl flooring importing business had to move fast.

He got on the phone with his main customer, Home Depot Inc., to update it. Soon he was on a plane to China, prepared for tough conversations with suppliers.

Mr. Stone cajoled his Chinese suppliers not to let the now-25% tariff deter them from the American market. He worked across time zones to see if Home Depot would absorb part of the added costs. He tried to time ocean shipments so that some might not be subject to the punitive levies. And his U.S. team looked at rejiggering transport and packaging costs for more savings.

"It comes down to every little thing," said Mr. Stone, wearing sneakers and a Yankees cap as he moved between meetings in the Yangtze River port city of Zhangjiagang. "We find every quarter-point we can. If you have 10 quarter-points, then you have 2 1/2 points."

When the Trump administration first imposed 10% tariffs on many Chinese goods about a year ago, suppliers, importers, distributors and retailers worked together to defray the cost and try to avoid passing it on to consumers for fear of losing sales. Mr. Stone and his Chinese partners initially ate most of the vinyl flooring tariff cost, passing just a tad on to retailers.

Tariffs at the 25% level are quite another matter. They are upending cost projections and business models and straining relationships built up over decades. For operations such as Mr. Stone's, the math is painful. He and others are trying to figure out how much of the new expense can be dispersed throughout the supply chain, how much should be passed to customers, at what potential cost in lost sales, and how much they must swallow.

These tit-for-tat tariffs, at their new higher levels, are forcing businesses into tortuous calculations and negotiations. How these ultimately turn out will have ramifications throughout the U.S. economy, determining how the higher costs get distributed and what effects they may have on sales, as the U.S. and China dig in for what is becoming a protracted trade battle.

"This is a chaos moment. If I pay the tariffs, I don't have any money," said Mr. Stone.

The 61-year-old has been buying goods from Asia since the 1970s, first from Taiwan and later mainland China, having followed his father into the vinyl flooring business.

The product, often made to look like hardwood flooring or stone, was one of the largest categories of Chinese exports on the U.S. target list for tariffs. The U.S. vinyl flooring market was worth about $3 billion last year, with most coming from China, according to Stifel Equity Research Group. High-end flooring, the kind Mr. Stone imports and sells through his wholesale and distribution business, makes up most of that market and is growing roughly 25% annually.

Mr. Stone's Chinese suppliers, partners for decades, were shellshocked by the latest tariffs, fearing they and their thousands of workers would face canceled orders from American customers. Some smaller Chinese suppliers began offering discounts to European buyers to unload inventory.

On his trip to China, part of a multipronged search for tariff solutions that has absorbed him for months, Mr. Stone acted as a cheerleader, trying to rally his partners.

"Do not stop production. Do not let your workers go home. Finance yourselves locally," he instructed managers at Zhangjiagang Elegant Home-Tech Co., a family business started by a Chinese factory worker-turned-entrepreneur and now run by that man's Canada-educated son.

Mr. Stone and his Connecticut-headquartered HMTX Industries LLC wanted a commitment from Home Depot to absorb some of the higher tariff. A Home Depot spokesman declined to share details about the retailer's approach, saying only that its strategy varies across vendors and products and that it makes "every effort to lessen the impact on the consumer."

HMTX, which Mr. Stone said has about $700 million in annual revenue and a net profit margin in the mid-single digits, has a wholesale division that sells to other regional distributors in the U.S. That division decided to raise prices by nearly 20% on flooring. Wholesalers in general have raised prices of luxury vinyl flooring by as much as 50 cents a square foot, or close to 25%, according to estimates from industry executives.

The 18 Flooring Liquidators retail stores in California carry Chinese-made products from HMTX, among others. The chain has raised prices for some products because of the tariffs. Tiles for a living room, dining room and hallway space can run up to hundreds of dollars more than before.

"You can't have a 25% increase and not have an effect on retail prices," said Stephen Kellogg, president and owner.

As for other tariff-hit household goods, such as washing machines and furniture, FFO Home in Fort Smith, Ark., is raising prices on couches and dining-room sets with parts from China. Store owner Larry Zigerelli said some items have already gone up by 10% because of the tariffs imposed last year, and he expects to raise prices more as manufacturers pass on the 25% tariff.

For now, consumer spending in the U.S. is solid. By economists' estimates, it will take three to six months for some portion of the tariff costs to be fully reflected in consumer prices.

On average, an American household will pay about $770 more each year under the 25% tariffs the U.S. has imposed on $250 billion in Chinese goods, according to Trade Partnership Worldwide, a Washington-based consulting firm working with industry groups. Consumers' costs to are likely to rise more if President Trump carries through with 10% tariffs he announced this month on the roughly $300 billion in annual Chinese imports not yet taxed.

"There's certainly going to be people who just can't afford the same good," said Katheryn Russ, an economics professor at University of California, Davis.

CFL Flooring, one of the largest exporters of flooring from China to the U.S., with around 2,600 workers at factories in Jiaxing city south of Shanghai, sees the tariffs as a portent of permanent change. CFL decided last fall to set up factories in Taiwan and Vietnam and started shipping goods from those sites in March.

"The desire to not be dependent on China is here to stay," said Thomas Baert, a CFL co-owner. "Whatever happens with tariffs, certain customers have made up their mind that they want to be out of China for X% of their business."

Mr. Stone thinks most manufacturing of vinyl flooring will remain in China. Since he began purchasing the product in China in the 1980s, he said, the country has developed a deep pool of skilled labor and quality manufacturers that would be hard to replicate.

Hundreds of Chinese factories compete for business, investing in new technologies to improve costs and products. Chinese suppliers, Mr. Stone said, have led the way in producing a thinner but stronger and more affordable form of vinyl flooring in recent years.

When he started working with Zhangjiagang Yihua Plastic Co., the company was still state-owned. The government assigned a demobilized military officer, Sun Yonghua, to run the company and he later privatized it, retaining Mr. Stone as a customer.

In May, over a dinner of crayfish, beef hot pot, fish and red wine, the two men discussed the tariffs and what to do about them. Mr. Sun said he was confident his company would get support from big Chinese banks, and that would help him weather the tariffs.

Mr. Sun bellowed that their more than 30-year partnership would survive. "Under your leadership, we aren't afraid of the trade war," he said, raising a toast to Mr. Stone. The two exchanged pictures of their grandchildren.

Throughout his trip, Mr. Stone took care to project optimism with Mr. Sun and other suppliers. Fresh designs were in the pipeline, he reminded them, and a new digital printing method from Italy would allow them to adapt designs more quickly. American customers would see that their offerings were higher-quality and pick those, Mr. Stone said.

He reminded them, too, that Home Depot hadn't canceled any orders and was prepared to fight the tariffs too. Still, the lack of a firm deal with the retailer, at the time, nagged him.

Over the following weeks, there were emails, phone calls and texts with the Home Depot team. Mr. Stone's colleagues made trips to the chain's Atlanta headquarters. Their pitch was that Home Depot should share the tariff burden, otherwise HMTX and its manufacturers wouldn't have money to invest in designs and processes to remain competitive.

"All that costs money," Mr. Stone recalled saying. "I've built warehouses, I've stocked them, I have robots taking orders. If I don't keep doing this, we'll both lose."

Home Depot's argument for footing less of the bill, according to Mr. Stone, was that with this type of product, raising retail prices risked driving away customers. Unlike fixing a leaky roof or replacing a broken washing machine, homeowners could put off buying a new floor.

Home Depot set up what employees called a "tariffs war room" to analyze products and costs and devise pricing strategies, Mr. Stone said. In late June, Home Depot's chief executive told CNBC it was working with suppliers to offset tariff costs, although part of the 25% would be passed to consumers.

A few weeks later, according to Mr. Stone, after six different offers and multiple revisions, he and Home Depot reached an agreement that will last until February. Without providing specifics, he said it was "in the spirit of half-half." His Chinese partners, he said, were relieved.

(MORE TO FOLLOW) Dow Jones Newswires

08-12-19 1132ET

Stocks mentioned in the article
ChangeLast1st jan.
KELLOGG -0.02% 63.73 Delayed Quote.11.79%
THE HOME DEPOT, INC -1.51% 224.67 Delayed Quote.30.76%
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