The Startup CPG Podcast

Aaron Alpeter
Foreign. When you go back and you take a look at what had to happen in order for these tariffs to come through, because keep in mind we have a free trade agreement with Mexico and Canada. This should not be allowed to happen. But there is language in the USMCA that says when you are facing a national emergency, you can put tariffs in place of a temporary basis. One of the first executive orders that Trump signed on January 20th was declaring an emergency around fentanyl and the migration crisis. And so that was the first kind of domino that fell. This appears to have been something that was always the plan. And I would be surprised if it's something that only happens for a weekend and then is rolled back. The reality is that this is going to hurt the American consumer.

00:48
Aaron Alpeter
It's going to hurt the Republican base dramatically. But I think what they're gambling on is that the pain will be so much worse on the other sides of the border than in the US Border, and it'll happen there sooner. They'll get what they want before it actually comes through. So I could imagine a situation where these tariffs threats are always kind of extended. A month out, two months out, six months out, and more things are happening until they become appeased with what they need. What's the deal with these tariffs?

01:15
Daniel Scharff
I don't know, but the implications are going to be massive. So I wanted to record a podcast today with Aaron Alpeter, who's a supply chain expert. He's scaled a bunch of supply chain companies just to kind of get us all on the same page. What does it mean if you're a brand based in the US what does it mean if you're a brand based in Canada, Mexico, China? If you source ingredients from one of these places? If you co pack in one of these places. So honestly, things are changing so fast, this might even be outdated within a day or two. We know, for example, since our recording earlier today that there was already a stay of execution on the tariffs in Canada.

01:47
Daniel Scharff
But we really think it's important for everybody just to understand what the ramifications would be in all of these different scenarios. So I recommend giving this bonus episode a short listen. All right, enjoy. All right, welcome everybody. Today we've got Aaron here. Aaron, do you mind just introducing yourself to get us started?

02:07
Aaron Alpeter
Yeah. I am a supply chain guy. So first off, Daniel, thanks for having me. I'm a supply chain guy and the founder of isba. We are an end to end supply chain consultancy that helps brands prepare to exit.

02:17
Daniel Scharff
All right, so Aaron, I was very Glad to try to get you on the podcast today to talk about an issue that is very pressing and interesting and confusing and scary for a lot of brands who are in different situations right now, which is the subject of the tariffs. And I really wanted to bring you on because I feel like you're somebody who can explain this to me. Like, I was an eight year old, which I feel like I am in this sort of scenario. It's very confusing. So what I'd love to do is just ask you a series of questions about, hey, if I'm this kind of a brand, what does it mean for me? Does that sound good?

02:48
Aaron Alpeter
Sounds great.

02:49
Daniel Scharff
Okay. And I know we have to acknowledge that this is as of the recording moment, which usually we don't like to time date these podcasts, but Today is Monday, February 3rd. It's 2:30 Eastern Time. There's a lot happening even today. Like, you know what we heard this morning that Trump was meeting with Mexico and making changes already and putting a stay on the tariffs. He's meeting with Trudeau later today, so that could also get updated. But we're just going to do our best, basically. Right? Like, hey, here's the information that we have today. Here are some scenarios just at least to keep everybody kind of informed about what is happening now and, you know, what kind of situations they should plan for. Does that sound about right?

03:26
Aaron Alpeter
Yeah, absolutely. This is changing so quickly. And it's one of those things that we know that these tariffs are going to come through in some way, shape or form. Even the Mexico piece was a stay of execution for a month. We don't know if that means that something's going to be different or what, but let's just try to keep as generic as possible.

03:40
Daniel Scharff
Yeah. And I mean, I don't know, you know more about this than I do, but I mean, I could see a scenario where even he could decide not to do it. If he gets some major concession that he wants from Mexico, from Canada, he will know how to spin something into a win in terms of what his objectives were. So maybe that's actually a good place to start. What do you think the objective of the tariffs or what is it stated to be?

04:03
Aaron Alpeter
Yeah, so I spent a good chunk of the weekend going through the executive orders, reading the actual language, and the executive orders are pretty clear about why these are in place. And that's because of fentanyl. And so just to throw some statistics at you, this is obviously a growing issue. It's something where there is an enormous amount of precursor or ingredients that are being produced in China, in most cases, shipped to Mexico, processed into fentanyl, and then smuggled up to the southern border. This is killing tens of thousands of people a year in the U.S. And so this is what they've talked about for why these are here.

04:35
Daniel Scharff
And how does a tariff impact the trade of fentanyl?

04:39
Aaron Alpeter
Oh, it doesn't. It does. I mean, you're not taxing illegal goods coming across the border. But what this is trying to do is it's trying to make so much pain and so much outcry that it one either bends those governments to the will the Trump administration has in terms of border security, going after the cartels, things like that, or it starts to give those politicians cover in their own country to do things that are unpopular. So a good example of the current Mexican government has historically, and this is going back to the previous president, not just Claudia Schambaum, but they have historically signed a truce with the cartels. And it used to be maybe early 2000s, there was a war on the cartels with a different political party that was in. In power.

05:19
Aaron Alpeter
And that caused a lot of bloodshed, a lot of difficulty and pain in the Mexican society as they were going out and trying to kill these cartels. Well, the last 10 or so years, it's been a little bit more stable. And so now I'm imagining one of the things that Mexican government had to give up was going after these cartels and trying to shut down the fentanyl production.

05:37
Daniel Scharff
Okay, so this is something to punish the governments or the countries that. That our government believes are responsible for a lot of fentanyl coming into our country because they're not doing enough, basically, to stop it from entering their country or being processed in their country or leaving their country for the U.S. Exactly.

05:56
Aaron Alpeter
And I think, like, fentanyl is what the excuses, although I don't know if that's the actual reason. And so here's my thought on this, is that Canada is kind of dragged into this. We know that there's a fentanyl problem with ingredients coming from China and being produced in Mexico. And it's true that there have been some super labs that have been popping up in British Columbia, but by and large, the problem is on the southern border, not the northern border. And so then I kind of go through and ask myself, what are some of these other reasons, some other objectives that the Trump administration may have? And I think it could be as simple as wanting access to the Arctic.

06:29
Aaron Alpeter
And you hear about all these 51st state jokes and buying Greenland and understanding that as the Arctic thaws, there's enormous amount of resources and shipping lanes that will become more navigable. And if Russia makes a pass, Canada can't defend itself because it's so vast. So maybe there's something there. Perhaps it's something as petty as Trump doesn't like Trudeau, and we know that there is an election happening in Canada probably in October, and so he's trying to pull the strings to make sure that there is a sympathetic ear in Ottawa. So there's all these different things that are going on. I think the key thing I want to point out is that this is a multifaceted problem.

07:02
Aaron Alpeter
And tariffs are a blunt instrument that may be used to solve the fentanyl problem, but also half a dozen other things that they may want to be doing. Yeah.

07:10
Daniel Scharff
So the way you're phrasing it makes sense. And then it does make you wonder, okay, is that going to be something that is put into place over the long term, or is it just temporary to try to get the changes in place that the government wants to see? Right. Like, okay, so they did a stay does that. Because when Trump talked to Mexico that they made some capitulations or they're going to agree to certain changes, and if they continue to agree to do those things, then maybe he won't actually implement it, or he's going to implement it, but maybe he would take it away later. Right. Verse. This is just the new reality, and everybody needs to completely change their businesses and face it.

07:43
Aaron Alpeter
Yeah. I mean, we're two weeks into this. Right. I think the thing that was striking to me as I was digging into it is that this appears to have been the plan all along. When you go back and you take a look at what had to happen in order for these tariffs to come through, because keep in mind, we have a free trade agreement with Mexico and Canada. This should not be allowed to happen. But there is language in the USMCA that says when you are facing a national emergency, you can put tariffs in place on a temporary basis. Well, one of the first executive orders that Trump signed on January 20th was declaring an emergency around fentanyl and the migration crisis. And so that was the first kind of domino that fell.

08:19
Aaron Alpeter
And then you look at all of these other people that needed to be confirmed in order to do something like this, whether it be Secretary of Homeland Security, secretary, Treasurer, Secretary of Commerce, all of these sorts of people have either been confirmed or have passed a major hurdle and will be confirmed this week. And so this appears to have been something that was always the plan. And I would be surprised if it's something that only happens for a weekend and then rolled back.

08:41
Daniel Scharff
But you could see a world where it might be in place for six months and then rolled back or a year or then rolled back.

08:46
Aaron Alpeter
Absolutely, absolutely. I mean, I think that the reality is that this is going to hurt the American consumer. It's going to hurt the Republican base dramatically. But I think what they're gambling on is that the pain will be so much worse on the other sides of the border than in the US Border, and it'll happen there sooner, that they'll get what they want before it actually comes through. So I can imagine a situation where these tariffs threats are always kind of extended. A month out, two months out, six months out, and more things are happening until they become appeased with. With what they need.

09:14
Daniel Scharff
Okay, Aaron, let's get into some tangible examples because that's the best way for me to try to understand this now, knowing that these things could change. Let's just take the example right now of a, hey, I'm a US Brand and I just have some ingredients that come from Canada, Mexico or China. What is actually going to happen to my cost of those ingredients?

09:37
Aaron Alpeter
Yeah, so the way that the executive order is written is that it, anything coming that is a product of one of these countries will have an incremental tariff added on top of whatever else was there. So if I'm sourcing in agricultural good or packaging from China, you'll see a 10% increase on the cost of those items coming in 25% for anything coming from Mexico or Canada.

09:58
Daniel Scharff
Okay, so let's take, hey, I'm a. If you have a beverage company, maybe you're sourcing cans if they happen to come from abroad directly, maybe Instead of paying 12 cents a can, you might be paying 13.2 cents a can. Let's take the example of a beverage company. Let's say you are sourcing your cans currently from abroad. Let's say they're coming from Mexico. If you're paying currently $0.12 a can immediately now you're going to be paying over 15 cents a can because you're going to be incurring a 25% tariff on those if it's coming from there or from Canada. And if it's coming from China, it'll be a 10% increase. Same if you have any ingredients that are coming from any of those places, it would be a similar increase.

10:40
Aaron Alpeter
That's right. The executive order doesn't make Any distinctions? Usually what you'd see in these is a list of HTS codes that are impacted. And as of the recording, the customs hasn't released the technical guidance on what it is. And so it's assumed to be a broad based tariff on absolutely everything.

10:54
Daniel Scharff
On absolutely everything. So any kind of ingredient that you're getting, any kind of packaging, any kind of secondary packaging. Okay, now what about there are some brands that actually co manufacture in Mexico or Canada because maybe it was cheaper or there's a better quality plant there. And in that case they're probably sending a, even if they're based in the US they might be sending a bunch of ingredients there from different suppliers and then having the product made there and then potentially sent back to them in the U.S. What would the impact be for that kind of a company?

11:22
Aaron Alpeter
Yeah, so let's suppose I have all of my ingredients coming from the US but I'm having it produced in Mexico. Let's make the example easy. So as of right now there are no retaliatory tariffs of products coming from the US into Mexico. But that doesn't mean that they couldn't be there very quickly. And that was actually one of the things that was being threatened before they got the state of execution this morning for a month. But let's just assume that's the way it is. That means all of your goods would flow down into Mexico at the current price. And then because they are being produced in Mexico, even though it's a hundred percent U.S. Products, U.S. Ingredients, those would now be subject to a 25% tax coming back into the U.S. Okay, so.

11:56
Daniel Scharff
That would be a tax on, let's say for beverage, for simplicity's sake, let's say the overall cost to me of making one can is $1 and that is the can, it's all of the ingredients. It's also the tolling for the co manufacturer. And at the end of the day that thing totally cost me about a buck and it's getting sent back to me. Does that mean it's going to be like a buck 25, meaning I'm just paying an extra 25% in a tariff to the government now to get that product back? Or does it mean I'm just paying a 25 cents on the tolling or what is it?

12:26
Aaron Alpeter
Yeah, great question. So the price today and then a month from now, because it's probably different, but today your CO man will give you an invoice for a dollar and then you'll take that invoice to customs. You'll try to clear and customs will say cool to have that dollar, we're going to charge you a 25 cent ransom. And so it's a buck 25 to get that product in. That is the easiest way to think about it. What's likely going to happen though is because there's so much interconnectivity is that even though the cost of production and the goods still made that dollar, your co man may come to you and say actually that price is now A$10. My costs have gone up elsewhere. Maybe it's machinery, but it's other parts like that.

13:01
Aaron Alpeter
And so the increase in cost is likely going to be higher than just 25% because you're putting all of this friction into the ecosystem. And so you know, with the 25% tariff you probably would expect 35 to 40% increase in costs long term.

13:15
Daniel Scharff
Yeah, that's pretty tough. I mean so like if it were just on tolling it would almost be more manageable. Tolling by the way is just basically the margin the service is charging you. So the co manufacturer that's like accounts for all of their labor and machines and all that stuff. So let's say your actual cost of ingredients and packaging is 60 cents. Maybe they're charging you 40 cents to put all the stuff together and all that stuff. If it were just on that would be more manageable. But now if you're just paying on the overall value of your whole product, all of the ingredients that are in it, plus how much it costs for them to make it for you, that's going to be unsustainable for almost anybody. Right?

13:50
Aaron Alpeter
Yeah. The interesting thing here is that this also presents an opportunity to raise prices. And so let's suppose you were really good at negotiating prices with your co man and their margins are not where they wanted to be. Well now they have a really good excuse to raise prices back to the margin level that they would prefer to have. And that would be something that would be super helpful from that point of view. So customers are going to do this. Comand's brands are all going to do this. And so it's almost one of these things where you try to be as competitive at price as possible. When the bottom falls out and everybody's costs are going up, that's where you look to capture as much margin yourself.

14:21
Daniel Scharff
Now I think you're talking about us based comands, right? Because they're about to see a lot more demand coming in that might have previously been outsourced and they're going to be ones who are going to be probably raising prices as well, Is that right?

14:31
Aaron Alpeter
I think certainly. And then that'll just be simple supply demand. But I think when it comes to the Mexican commands or the Canadian commands, in most cases they are not sourcing everything, absolutely everything from their country. There's some cross border pieces that are going through and so it is possible that'll happen. But the other part of this is that as tariffs really kick in, that's going to drive demand down, that's going to push the currency down. So these products may actually get cheaper from a dollar perspective just because of currency manipulations.

14:57
Daniel Scharff
I mean, it's kind of hard for me to believe that the biggest companies in the US that do this kind of manufacturing, whether it's automotive companies, food companies, whatever, aren't going to be able to have some kind of an impact to at least make this a little bit less painful than it will be if it's the full value of the goods. But we'll see. But it sounds like at least one takeaway immediately is hey, if you are a US brand using US comands, it might be time to get maybe some kind of a longer term schedule with your coman and just try to make sure you're good on your pricing.

15:27
Aaron Alpeter
Well, there's three reasons why you would renegotiate a contract. The first one is that your contract expires. The second is that there's a fundamental change in your business. And the third is there's a fundamental change in the market. And so even if you have a contract that looks like it's ironclad and says hey, this is your price for the next 10 years, this is such a large force majeure sort of event that it likely is going to cause a renegotiation with those comands.

15:52
Daniel Scharff
All right, okay, so now I think we've covered then if you're getting ingredients from abroad or if you are using a coman abroad, if you're a US based brand. Now let's take the perspective of a foreign brand. We have so many awesome brands from Canada, from Mexico, many other places in our community. And what's going to be the impact for them? Let's take like Midday Squares for example. A brand that a lot of people love is based in Canada. I think their market is about 10% of the US market. So for them obviously it's really important as a fast growing brand to have that distribution in the US they launched with Target nationally, I think all this stuff. So what is likely to be the impact for them at this point on their US Business?

16:32
Aaron Alpeter
Well, it's really going to depend on where they're manufacturing. If they're manufacturing in Canada, then they'll see that the cost to import that product in the US will go up by 25%. However, if they have manufacturing in the United States, there'll be no impact to them.

16:45
Daniel Scharff
Okay. In their instance, they self manufacture which capital investment that they made and build up that capability. So basically at this point, I don't even know how much they charge on shelf, but let's say they are, you know, selling to like the distributor for buck 50 plus distributor margin, plus target margin, whatever, selling on shelf for three bucks or something. Now all of a sudden, immediately that cost is going to go up to let's say a buck 85, buck 90 or whatever, and then you're going to be adding margin on top of that. So maybe at the end of the day it could increase their shelf price by 50 cents. A dollar or something like that could be okay. So probably it'll hit them on sourcing ingredients as well, I'm guessing. I don't know where all the ingredients in the world come from.

17:28
Aaron Alpeter
So the key thing here is that right now, as of this recording, the tariffs are only goods coming into the United States. And so there's nothing about chocolate coming from Ghana into Canada or, you know, obviously if they're sourcing dairy from Canada, there's no cost there. If they were to source, say, dairy from the US which they typically don't do, there could be some sort of punitive charge that the Canadian government puts on their retaliatory tariffs they're going to put forward. But realistically, the costs will not change if decoupled. Right. So it's really just the actual product being produced. Again, the US Wants to export as much as possible, and so there are no cost controls or tariffs on those exports. It's really the imports.

18:10
Aaron Alpeter
And so again, going back to the example, even if they sourced 100% of all of their agricultural ingredients from the United States, shipped them to Canada, made them in day square and then sent it back, that would now be 25% more because those jobs are in Canada, not the U.S. Okay.

18:26
Daniel Scharff
So, yeah, I mean, I think I had read that there were some kind of retaliatory tariffs that they were considering immediately, like Florida orange juice, you know, Kentucky peanut butter. Just some basic stuff like that. Hard to imagine in the long run if there are tariffs this way, that there wouldn't be that way on more goods but they won't have any kind of an impact on them sourcing products from Mexico or from China. So who knows if there are retaliatory tariffs, it could probably shift some of their sourcing away from the US Then.

18:55
Aaron Alpeter
Yeah. And the interesting thing here is again Mexico and Canada are going to be hurt a lot more by this than the U.S. Even the retaliation they're going to do. And so the intention is to cause pain with the most vocal groups in the United States. That's going to be your dairy lobby, your agricultural lobby, could be Home Builders association, things like that. And so what Canada has announced that they would do or they say they threatened to do and they haven't done it again as of yet is they have said that they are going to put tariffs on American goods where there is a easy non American alternative. And. Right. So clothes, you can get those from anywhere, you don't have to get them from the U.S. Right.

19:31
Aaron Alpeter
Chocolate, alcohol, you can get from other parts of the world, you don't have to get them from the US So that's what they're trying to do to punish the US but also try to not hurt the Canadian consumer as much. Mexico's taking a different tact where they've talked about how they'll just rotate which items are on tariff on their side and the thought is just to cause uncertainty in those trade flows to make more people upset and complain. And even third, the China took the perspective of saying we're going to file a lawsuit with the WTO and say you can't do this. Okay.

19:56
Daniel Scharff
So Aaron, from everything that I've heard you say so far, it sounds like the biggest red flag would be if you are a US based brand and you are currently co manufacturing in Mexico, Canada or China. Right?

20:07
Aaron Alpeter
That's right. And you don't have to be just a US Brand. It's anybody who's producing anything outside of the United States that sells into the United States.

20:14
Daniel Scharff
Okay. So definitely everybody will be impacted who is a foreign producer of goods. But especially if you are a US based brand, just because a lot of our community is that would be kind of the first thing where what would you say to them like hey, immediately you should looking for alternative ways to manufacture your product in case this doesn't go away.

20:31
Aaron Alpeter
Yeah. So I think it's really important that you try to keep as cool ahead as possible. Again, we don't know how long these are going to be in place. We don't know if they're going to get bigger. They're going to get smaller. And changing your manufacturing, flipping your supply chain is a big endeavor. It's a decision you have to live with for years. And so what I've recommended is that there's three short term things that a brand should do and two long term things that they should do. And so I just walked through those quickly.

20:51
Aaron Alpeter
The first thing is you take a look at tariff engineering and what I mean by this is you need to go through and try to understand are there changes you can make to the product so that qualifies for one HTS code versus another which may have a lower duty rate or can you change the assembly?

21:05
Daniel Scharff
What's HTS code?

21:06
Aaron Alpeter
Yeah, Harmonized Tariffs code. Basically it's like the Social Security number of the product coming in. And that's what customs knows. This beverage has this ingredient. So we're going to tax at this rate versus this other ingredients. We tax it that rate. So the first thing is we'll see if you can change the product or you can change the assembly to try to make it something other than one of these impacted countries. That's the first thing. The second thing is to start doing some pricing and cost sensitivity analysis and you want to understand how elastic or inelastic is your product with your consumers. This will let you know to what extent you can raise prices and pass along any of these increases versus there's a million alternatives out there and you're going to have to eat these and survive on lower margins.

21:46
Aaron Alpeter
Then the third part you have to do is really try to figure out how you're going to save money elsewhere. There's a lot of other parts of the P and L other than just the manufacturing piece that you can do to offset some of these costs. Looking at fulfillment, parcel, workflow, automation, streamlining, you know, getting rid of some SKUs or channels that maybe aren't as profitable. These are the sorts of things that you can do today that will give you a relief today that benefits you even if these tariffs come off next week.

22:10
Daniel Scharff
Okay, perfect. Aaron, thank you very much for giving us this analysis. I feel like I at least have a entry level understanding at this point after you explaining it to me. So thank you very much and I imagine we will be back with some more content on this topic. Things are going to evolve, we're going to learn more and we'll try to help everybody learn alongside us. So Aaron, thank you so much. Any last words?

22:31
Aaron Alpeter
No. I appreciate you having on and I think we will make it through this. I think it's going to get crazy and more hectic before it gets better. But just hang in there.

22:38
Daniel Scharff
All right. Thank you Aaron. Thank you everybody.

22:44
Speaker 3
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