Our analysts Michael Zezas and Erik Woodring discuss the ways
tariffs are rewiring the tech hardware industry and how companies
can mitigate the impact of the new U.S. trade policy.
Read more insights from Morgan Stanley.
----- Transcript -----
Michael Zezas: Welcome to Thoughts on the
Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed
Income and Public Policy Research.
Erik Woodring: And I'm Erik Woodring, Head of
the U.S. IT Hardware team.
Michael Zezas: Today, we continue our tariff
coverage with a closer look at the impact on tech hardware.
Products such as your smartphone, computers, and other personal
devices.
It's Thursday, April 17th at 10am in New York.
President Trump's reciprocal tariffs announcements, followed by a
90 day pause and exemptions have created a lot of turmoil in the
tech hardware space. People started panic buying smartphones,
worried about rising costs, only to find out that smartphones may
or may not be exempted.
As I pointed out on this podcast before, these tariffs are also
significantly accelerating the transition to a multipolar world.
This process was already well underway before President Trump's
second term, but it's gathering steam as trade pressures
escalate. Which is why I wanted to talk to you, Erik, given your
expertise.
In the multipolar world, IT hardware has followed a China+1
strategy. What is the strategy, and does it help mitigate the
impact from tariffs?
Erik Woodring: Historically, most IT hardware
products have been manufactured in China. Starting in 2018,
during the first Trump administration, there was an effort by my
universe to diversify production outside of China to countries
friendly with China – including Vietnam, Indonesia, Malaysia,
India, and Thailand. This has ultimately helped to protect from
some tariffs, but this does not make really any of these
countries immune from tariffs given what was announced on April
2nd.
Michael Zezas: And what do the current tariffs –
recognizing, of course, that they could change – what do those
current tariffs mean for device costs and the underlying stocks
that you cover?
Erik Woodring: In short, device costs are going
up, and as it relates to my stocks, there's plenty of
uncertainty. If I maybe dig one level deeper, when the first
round of tariffs were announced on April 2nd, the cumulative cost
that my companies were facing from tariffs was over $50 billion.
The weighted average tariff rate was about 25 per cent. Today,
after some incremental announcements and some exemptions, the
ultimate cumulative tariff cost that my universe faces is about
$7 billion. That is equivalent to an average tariff rate of about
7 per cent. And what that means is that device costs on average
will go up about 5 per cent.
Of course, there are some that won't be raised at all. There are
some device costs that might go up by 20 to 30 per cent. But
ultimately, we do expect prices to go up and as a result, that
creates a lot of uncertainties with IT hardware stocks.
Michael Zezas: Okay, so let's make this real for
our listeners. Suppose they're buying a new device, a smartphone,
or maybe a new laptop. How would these new tariffs affect the
consumer price?
Erik Woodring: Sure. Let's use the example of a
smartphone. $1000 smartphone typically will be imported for a
cost of maybe $500. In this current tariff regime, that would
mean cost would go up about $50. So, $1000 smartphone would be
$1,050.
You could use the same equivalent for a laptop; and then on the
enterprise side, you could use the equivalent of a server, an AI
server, or storage – much more expensive. Meaning while the
percentage increase in the cost will be the same, the ultimate
dollar expense will go up significantly more.
Michael Zezas: And so, what are some of the
mitigation strategies that companies might be able to use to
lessen the impact of tariffs?
Erik Woodring: If we start in the short term,
there's two primary mitigation strategies. One is pulling forward
inventory and imports ahead of the tariff deadline to ultimately
mitigate those tariff costs. The second one would be to share in
the cost of these tariffs with your suppliers. For IT hardware,
there's hundreds of suppliers and ultimately billions of dollars
of incremental tariff costs can be somewhat shared amongst these
hundreds of companies.
Longer term, there are a few other mitigation strategies. First
moving your production out of China or out of even some of these
China+1 countries to more favorable tariff locations, perhaps
such as Mexico. Many products which come from Mexico in my
universe are exempted because of the USMCA compliance. So that is
a kind of a medium-term strategy that my companies can use.
Ultimately, the medium-term strategy that's going to be most
popular is raising prices, as we talked about. But some of my
companies will also leverage affordability tools to make the cost
ultimately borne out over a longer period of time. Meaning today,
if you buy a smartphone over two-year of an installment plan,
they could extend this installment plan to three years. That
means that your monthly cost will go down by 33 per cent, even if
the price of your smartphone is rising.
And then longer term, ultimately, the mitigation tool will be
whether you decide to go and follow the process of onshoring. Or
if you decide to continue to follow China+1 or nearshoring, but
to a greater extent.
Michael Zezas: Right. So, then what about
onshoring – that is moving production capacity to the U.S.? Is
this a realistic scenario for IT hardware companies?
Erik Woodring: In reality, no. There is some
small volume production of IT hardware projects that is done in
the United States. But the majority of the IT hardware ecosystem
outside of the United States has been done for a specific reason.
And that is for decades, my companies have leveraged skilled
workers, skilled in tooling expertise. And that has developed
over time, that is extremely important. Tech CEOs have said that
the reason hardware production has been concentrated in China is
not about the cost of labor in the country, but instead about the
number of skilled workers and the proximity of those skilled
workers in one location.
There's also the benefit of having a number of companies that can
aggregate tens of thousands, if not hundreds of thousands of
workers, in a specific factory space. That just makes it much
more difficult to do in the United States. So, the headwinds to
onshoring would be just the cost of building facilities in the
United States. It would be finding the skilled labor. It would be
finding resources available for building these facilities. It
would also be the decision whether to use skilled labor or
humanoids or robots.
Longer term, I think the decision most of my companies will have
to face is the cost and time of moving your supply chain, which
will take longer than three years versus, you know, the current
presidential term, which will last another, call it three and a
half years.
Michael Zezas: Okay. And so how does all of this
impact demand for tech hardware, and what's your outlook for the
industry in the second half of this year?
Erik Woodring: There's two impacts that we're
seeing right now. In some cases, more mission critical products
are being pulled forward, meaning companies or consumers are
going and buying their latest and greatest device because they're
concerned about a future pricing increase.
The other impact is going to be generally lower demand. What
we're most concerned about is that a pull forward in the second
quarter ultimately leads to weaker demand in the second half –
because generally speaking, uncertainty, whether that's policy or
macro more broadly, leads to more concerns with hardware spending
and ultimately a lower level of spending. So any 2Q pull forward
could mean an even weaker second half of the year.
Michael Zezas: Alright, Erik, thanks for taking
the time to talk.
Erik Woodring: Great. Thanks for speaking, Mike.
Michael Zezas: And thanks for listening. If you
enjoy the podcast, please leave us a review wherever you listen
and share Thoughts on the Market with a friend or colleague
today.
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