Supply Chains Explained: How They Work and Why Tariffs Can Strain Them

Supply chains are critically important to domestic and global commerce. Explaining and understanding them isn’t so simple. The Darden Report took a deep dive on supply chains with Associate Professor of Business Administration Vidya Mani, an expert on supply chains, to learn more about how it all works. For those who prefer to get the highlights and save the fuller report for later, find an AI summary of the main points at the top.

Vidya Mani, Associate Professor of Business Administration.

• A supply chain is a series of connected processes transforming raw materials into finished products and distributing them to consumers.
• Companies optimize costs by sourcing parts from suppliers rather than making everything in-house.
• Tariffs disrupt global supply chains by increasing costs for imported goods.
• Trade conflicts can lead to increased consumer prices, loss of market share, and job losses in supply chain-dependent industries.
• Higher tariffs can raise costs for companies, leading to higher prices for consumers.

What is a supply chain and how does it work in basic terms?

A supply chain is a series of linkages from raw materials to final product for end use and back to raw materials after use. Each stage of the supply chain involves a transformation step through a manufacturing or a service process and a network of people, companies, organizations and governments.

For example, if you look at a car, you have the motor assembly, which includes gear boxes that contain clutches, whose parts include pressure plates made from steel blanks, produced from steel, which is made from minerals. At each stage, a manufacturer could choose to make the complete product or buy its parts from suppliers who make them and assemble it to sell to the next stage.

The supply chain is built by picking the next link upstream that offers the least cost while maintaining quality standards. After World War II, global commerce flourished due to interconnected shipping and flight routes. That meant a company could look for the least cost option across the globe, not just in-country. This gave rise to global supply chains where different countries had advantages on scale and specialization in different parts of the supply chain.

Why would high tariffs or a trade war affect a supply chain?

When you have a global supply chain, the flow across country borders is governed by rules of import and export as set by the countries in the chain. This is why tariffs are impactful.

For products and components that we have no or very little capability to build within the U.S. and are sensitive to price, high tariffs will significantly impact the supply chain. Each company in this scenario will have to weigh major questions:

• Can I afford the tariff and still continue with the existing sourcing arrangement?
• Can I source from an alternate country not subject to next round of tariffs, that has the capability to manufacture at a viable cost?
• Can I make it in-house?
• Or should I change the technology altogether to use other components that are not subject to the high tariff (a very long-term undertaking)?

What are some of the side effects that could occur, the unintended consequences?

Tariffs would lower the operating margin for companies and they will pass along some of those price increases to the consumer if tariffs are one-sided. There could be a loss in sales and market share for companies that sell in markets for countries that respond with similar hikes in tariffs. The bigger impact that affects societies is the loss of livelihood for people working upstream in the supply chain.

Many of the fledgling democracies specialize in a few commodities at the low-end of the value chain. Free-trade agreements, duty-free access to U.S. markets and other incentives were a way to allow these emerging economies to develop their way out of conflict and poverty. However, these economies don’t just make finished products and directly sell in U.S. markets. A major part of their economy is the production of semi-finished products like metals. These metal products are sold to manufacturing hubs in China, India and Mexico (subject to the high tariffs) to be made into components that then feed into the supply chains coming to U.S. markets. Losing this access due to the high-cost implications from tariffs puts these societies in grave danger. Unlike developed countries, these countries do not have Social Security, unemployment benefits, and other safety nets, so we are literally looking at loss in livelihood. This can lead to an increase in conflict and destabilizing of democratic institutions.

Are you seeing such disruption now or expecting it soon?

Changing the supply chain in response to high tariffs is a massive undertaking and lasts beyond any one administration. The current response is to build buffers against this disruption. We saw a pile-up of inventory, especially in the retail sector, before the tariffs and the “de minimis” rule removal went into effect. We are also seeing Chinese manufacturers ramp up production in other low-cost places like Vietnam to allow for a way around the tariffs. The rhetoric around tariffs and unfair trade practices has been around for a while and spiked in 2016. So, Chinese manufacturers had time to invest in other countries that allowed them to create alternative manufacturing locations should such a scenario arise.

Currently, given the wide range of industries that would be affected by the high tariffs, many companies are in a wait-and-see scenario, believing that there would be an agreement at the end of day that would alleviate government concerns. Some of the trade agreements are due for review and renewal in the near term.  For instance, USMCA that allows duty free access to U.S., Canada and Mexico markets for a wide range of products, including autos, is up for review in 2026. The African Growth and Opportunity Act (AGOA) is due to expire in September. Some of the back-and-forth on tariffs may be a way to get some leverage at the negotiating table when these trade agreements are renewed. Companies are building buffers for critical products, passing along some of the costs in terms of price increases, cutting down on expenses and exploring other options. But, if the U.S. imposes high tariffs on Mexico, China, India and the European Union, and cuts off aid to major resource economies in Africa, there isn’t much room left for the global supply chain to move.

Does anyone have oversight of supply chains?

Global supply chains are governed by country rules of trade through which they pass. Historically, from 1995-2005, through the World Trade Organization, we saw numerous changes to country trade policies such that they could be standardized across the globe and allow for a common platform for the supply chain to function. Specifically, this means lowering tariffs for input goods, reducing import and export controls, creating a harmonized system to track goods and services, and creating incentives for sustainable operations through adoption of labor, environmental, intellectual property standards. China joined the WTO in 2002 and from then on has gone to become a manufacturing hub that is integral to many global supply chains. Around the same time, in the Americas, and the focus of much of the current tariff in news, the U.S. negotiated free trade agreements with Mexico and Canada (NAFTA in 1994 and then USMCA in 2016) and with Central America (CAFTADR in 2006 with Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua).

The global financial crisis of 2008 gave one shock to the global supply chain. Post 2015, countries have moved away from the WTO consensus-like process to negotiating individual trade agreements (which reduce tariffs for member countries) and imposing tariffs or sanctions on specific products and countries to meet their national objectives. This has escalated into the kind of tit-for-tat trade war post the COVID-19 pandemic and what we are seeing in the news right now.

However, one thing to remember is that the countries and products are not treated the same everywhere. For example, if we look at auto imports, traditionally, the U.S. will levy only 2.5% tariffs, while it was 6.5% in Canada, almost 30% in Mexico and 10% in China. The United States also has a lot of Free Trade Agreements with many countries and blocs that allow for 0% tariffs if certain rules are met. With the rise in geopolitical tensions, the U.S. government raised the tariffs on Chinese made EVs to 100% while the EU raised it to 45.3% last year and negotiations continue to take place at government and industry levels around both these measures. In general, trade agreements, tariffs and sanctions all serve to provide an incentive to either increase manufacturing, increase or restrict the flow of products outside the country, and increase or decrease market access.

What are some examples of things Americans buy that are very exposed to supply chain disruptions?

Apparel and automobiles are two good examples.

We import a majority of the apparel, including China. We have very limited production in the U.S., and even though the U.S. has FTAs with Mexico, Canada and Central America to allow for import with zero tariffs under certain conditions, this has not stopped us from importing a major percentage of apparel from China. We do not have access to raw materials and have limited processing capacity in this sector. The cost differential makes it cheaper to continue to import from China even if we raise the tariffs to 10% or more (the market mediation effect). Unless there is a ban, like the UFLPA, it will be very difficult to effect significant change from tariffs on this supply chain.

We produce more than half of the passenger cars that we drive within the North American region (U.S., Canada, Mexico). The existing USMCA agreement allows for zero tariffs on imports if certain rules are met (called rules of origin). However, to meet those rules, 75% of the value of the car must be made within the region. If not, they pay a 2.5% tariff. Depending on the access to components to produce the car, this production can happen in Mexico, Canada or the U.S. and we saw some shift in manufacturing to the U.S. after the tightening of rules under USMCA because of the cost difference. A potential 25% increase will now make cars more expensive because we do not have the manufacturing capacity to produce everything here.

There is much debate around how access to U.S. markets has traditionally been with low tariffs but the same is not true for other global markets. For example, China may charge as much as 40% on certain U.S. vehicles. As consumption picks up in emerging markets, companies have managed their supply chains by keeping sourcing and manufacturing close to these markets to take advantage of low prices and market access incentives. This has led to the call for “reciprocal tariffs” in recent months. A change in tariffs, especially the lowering of import tariffs in major markets can lead to consolidation in the global supply chain that allows it to respond efficiently.

Are there other unintended consequences?

If we are not careful we can end up with completely unintended consequences. An easy example is food production. We grow most of our food in the U.S., so one might expect that this sector would be insulated from the tariff shock. Not entirely, because the agricultural machinery, the fertilizers, the seeds, may all come from countries that are part of the tariff escalations and if these costs go up significantly, the food prices will also increase. This is the impact of a global supply chain that supports a national supply chain on the surface.