Traditional Risk Models Don't Apply During Tariff Uncertainty

When U.S. President Donald Trump announced significantly increased tariffs on Liberation Day (April 2, 2025), the general expectation was that the shock to global trade would be short-lived. Either by being perceived as an initial offer to eventually settle on lower rates after concessions were made, or by a collapse of the tariff-intensive trade policy.

Since then, the shocks have continued to hit the supply chains of American and global manufacturers, either in the form of delays to the introduction of announced tariffs, sudden announcements of added new tariffs even on America’s strategic partners or in changes to the magnitude of the tariffs.

In addition, the government shutdown starting on Oct 1, 2025, has reduced visibility as vital federal statistics to gauge the health and direction of the U.S. economy (e.g., labor reports) are no longer being published. In supply chain terms: The changes in tariff applicability and levels are more frequent than the replenishment cycles.

Today, manufacturing and supply chains operate in an unpredictable world of trade friction, and traditional measures of risk modeling are difficult to apply. Traditionally, risk is modeled by the suddenness of the disruption, its magnitude, duration, speed of recovery and level of the new normal after recovery. Implicit assumptions are that the disruption is related to external factors—without a deliberate intent to cause or sustain the disruption.

For example, natural disasters occur but do not change in their occurrence, and all stakeholders’ efforts aim to jointly overcome the disruption. However, in the case of Liberation Day, an underlying, deliberate attempt to sustain the disruption through actively changing timings and magnitudes of the tariffs can be assumed.

Previous approaches to build resilience into the supply chain are unsuccessful because the cost of materials is no longer constant. Stockpiling inventory has turned out to be a promising strategy only to address short-term tariffs, not continuous ones. And while large corporations may lobby for favorable exemptions, most companies in America are exposed to uncertainty on the applicability of tariffs: on parts, components or finished goods; country of origin or considering upstream countries of origins; product type; industry; etc.

In this article, we discuss mitigation options (real options) every supply chain manager can take despite the limited predictability of what will come next. These options focus on the basic trade-offs and related business characteristics. We will illustrate the application of real options to guide decision making along distinct aspects.

Operationally, options must be assessed against the combined impact of

• Holding cost
• Tariff cost
• Selling price increases

Stockpiling raw materials to fix the input cost may be a beneficial option if tariffs are expected to increase in the short-term but are expected to return to manageable levels mid- or long-term. Overall, logistics providers have been indicating for several months that warehouses show higher fill rate than usual. And, on the demand side, it has been reported that Walmart’s decision to expedite shipments in May unfroze trade after the initial shock of tariff announcements on April 2, 2025.

Alternatively, if the tariff cost of raw materials is estimated to stay lower than the cost of a competitor’s imports of finished products, the domestically assembled product remains competitive.

The counter example is automotive, for which imported steel and electronics components for domestic assembly are tariffed higher (as of this writing) than an imported car fully assembled overseas. This assumes however, that the government shutdown which took effect on Oct 1, 2025, will not cause additional delays due to lack of documentation and inspections staff.

On the other hand, if demand is inelastic to price changes, the excess tariff costs can be passed on to consumers/customers, especially if the competition is expected to act the same. Several industries have since stated their intentions of passing on tariff costs through price increases, while in the case of some machinery and heavy equipment, manufacturers suspect their own suppliers to do so quietly, without announcements.

However, for consumer products, the strain on credit card repayments (number of credit card customers with unpaid bills for more than 3 months) and growth in buy-now-pay-later schemes and cash advance apps indicates that there are limits to what the consumer may be able to absorb. As an extension, it may be beneficial to speculate on temporary reduction of consumer/customer demand and adjust supply accordingly, to preserve cash flow for other purchases or investments, as well as to prepare for the time consumers/customers have used up their buffers and must replenish their warehouses.

However, in this scenario, the delay of purchases may strain the suppliers, especially the lower-tier suppliers, requiring more sophisticated contract mechanism designs to mitigate risk of losing (sub-)suppliers. Similarly, some companies have decided to absorb at least part of the tariff cost in the automotive industry, as well as selected companies in other industries the authors of this article work with.

Companies in the engineering industry and furniture industry employ a different approach. They reassess the HS (harmonized system) code classifying imported products for tariff calculations.

Attempts to reroute input materials and add-value in lower-tariffed countries is often not feasible for smaller manufacturers. Trans-shipments are targeted despite generally clear country of origin (COO) rules, and as the new trade regime takes hold, more countries try to regulate the flow of trade.

The simultaneous suspension of the de minimis rule for customs exemption of goods shipments below $800 has closed the option to ship direct to consumer (D2C) as an effective way to avoid the cost of tariffs. A strategy that was employed by e-commerce companies like Temu, She-in, and many others. While courier services have resumed shipping to the U.S., all parcels will be processed at any value.

This leads to several industry characteristics that must be considered in the short-term:

• Is the supply chain strategy anchored around cost efficiencies or product excellence?
• Are raw materials perishable, e.g., due to expiry or obsolescence, or can they be stored for long periods of time without deteriorating?
• Is the product a price leader and sensitive to price changes, quality leader, or an aspirational product for which price increases do not affect demand?
• Is demand for your product subject to seasonal changes?
• Are alternative products available domestically or internationally to substitute for your product?
• Are supply chain partners financially healthy, or will you need to support them to last through the tariff crisis?

Answering these questions offers short-term options to respond to the tariff crisis at hand. However, medium-term a more holistic approach is required. Over the medium-term, all domains of supply chain management must build flexibility into supply chain and manufacturing operations to remain competitive under these ever-changing conditions.

For the medium-term, these domains center around flexibility in:

• Product design emphasizing dual/multi sourcing and utilization of substitutes
• Product demand by introducing demand management techniques to sales and order taking
• Manufacturing flexibility to reduce lot sizes and fulfillment times from sales order creation to closure in full
• Decision-making through incentives alignment, decision options, and visibility/ data availability
• Decision execution through clarity of responsibilities and transparency to control and adjust

We presented a dual approach around short-term options to mitigate the impact of tariffs after Liberation Day and the need for activities to build flexibility over a mid-term horizon. This reflects the unique nature of the current situation in its intentionality of disruption. This situation is unique and not covered by traditional risk models, because the disruptions are expected to continue to persist and fluctuate. The dual approach considers that building flexibility is always lagging, and the short-term need is to keep operations afloat.

While we do not aim for completeness of mitigating options (nor the covered scenarios), we illustrate a potential approach to mitigate the impact of the uncertainty of tariffs for supply chains to regain the ability to make decisions based on real and achievable options.

A key area that has not been assessed yet is the country of origin and size of the company under consideration. We expect U.S.-headquartered multi-national corporations to have more influence on the direction of tariffs, compared to non-U.S. entities or small and medium enterprises.