Why tariffs could really pinch retailers this time

Trump has proposed a universal tariff of 10% to 20% on all imports to the U.S. and a 60% or more tariff on goods from China. Somewhat confusingly, Trump has also separately threatened 25% tariffs on goods from Canada and Mexico and an additional 10% tariff on China over immigration and drug issues.

So while the ultimate shape of tariff policy under Trump’s second administration remains unclear, it seems likely that tariffs will be more punitive and wide-ranging than the previous round of Trump-era tariffs, which started in 2018 and were focused on China. Retailers diversified their supplier base as a result: China accounted for 26% of U.S. textile and apparel imports last year, down from 37% in 2017. Much of that has shifted to Vietnam, India and Bangladesh.

The tariff impact was clearest for retail categories hit in 2018. For example, a 20% tariff went into effect on imported residential washing machines in early 2018. In response, the price of washers rose by nearly 12% in the months following the tariffs, according to a 2019 study from economists at the Federal Reserve Board and the University of Chicago, implying that consumers absorbed most but not all of the tariff costs.

Contrary to what Trump contends, exporters didn’t bear those costs: A study from the U.S. International Trade Commission concluded that the cost of the 2018-2019 tariffs was borne entirely by the U.S. importers.

Other retailers were cushioned from the full force of those last tariffs because of the timing. For example, the first Trump administration tariffs on apparel items from China went into effect in September 2019. There is typically a six-month lead time to ship goods, so by the time companies were selling tariff-subjected items it was already early 2020, when the Covid-19 pandemic took over.

While retailers’ margins plunged with the demand shock from the pandemic in 2020, they rebounded strongly in 2021, according to data compiled by Dylan Carden, equity analyst at William Blair. Pent-up demand, stoked even further by multiple rounds of stimulus and supply-chain disruptions, meant retailers were able to raise prices easily. For apparel and accessory retailers, for example, operating margins averaged 12.3% in 2021, higher than the 9.5% in 2019.

Retailers might have less room to pass through the tariff costs to consumers this time around. This is especially the case for discretionary categories such as apparel, where retailers have less pricing power. While the postpandemic years were an exception, pricing for discretionary categories such as apparel and toys has largely been declining or flat since the 1990s. More recently, inflation-pinched consumers have been pulling back on discretionary categories and are focused on discounts. Companies including Vans, Birkenstock, Sephora and Ulta Beauty all put more products up for Black Friday sales online compared with last year, according to an analysis from BMO Capital Markets. The number of products on sale actually doubled for some, including Vans and Victoria Secret’s PINK brand.

It may be a different story for retailers selling necessities. Analysts at Evercore estimated that tariffs carry a risk of reducing earnings by a mid-single-digit percentage for the average retailer, but that retailers selling need-based categories such as auto parts and home products may see less of an earnings impact because they have stronger pricing power.

Already, operating margins for department stores and for apparel and accessory retailers were lower in the first half of 2024 than they were in 2019, according to a report from William Blair. “Combined with limited pricing power, all else equal, incremental tariffs would result in even greater margin pressure in a space that has limited capacity to give," the report noted, referring to apparel retail.

The National Retail Federation said in a report that Trump’s proposed tariffs would be too large for U.S. retailers to absorb. The trade group estimated that they would raise costs across six retail categories—including apparel, furniture and household appliances—by $362 to $624 per household every year. One offset could be Trump’s proposed corporate tax cuts, which could benefit all U.S. companies’ bottom lines.

Retailers got used to raising prices without much pushback over the past few years. Some will do so again, to the detriment of consumers. Others may have to eat more of the costs themselves, harming their profits and shareholders. Ultimately, someone has to pay.

Write to Jinjoo Lee at jinjoo.lee@wsj.com