On Aug. 1, 2019, President Trump tweeted that the U.S. will impose an additional 10% tariff on $300 billion of goods imported from China, including major tech products such as smartphones, notebooks, servers, storage devices, printers, wearables, tablets, and videogame consoles. This comes on top of the 25% tariffs already imposed on about $250 billion of goods, which include tech products like hard disk drives, routers, switches, modems, motherboards, and other computer parts.

S&P Global Ratings believes the proposed 10% tariffs on another $300 billion of Chinese imports, if passed, would have a much larger impact on the U.S. tech sector than the current 25% tariffs on $250 billion of China imported goods. Not only would the proposed tariffs significantly raise costs for manufacturers and prices for consumers--much more than the current tariffs--but they include a broader scope of major tech products that represent a higher proportion of overall U.S. information technology (IT) spending and include more finished goods, which are more expensive than intermediate goods and therefore subject to higher tariffs.

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We have observed that the impact from the existing tariffs has so far been relatively muted for U.S. tech companies. Tech companies have been able to reallocate certain manufacturing activities to where there are existing facilities and skilled labor. For example, hard disk driver vendors Seagate and Western Digital reallocated some of their China-based manufacturing to their existing facilities in Thailand and other countries. Additionally, some tech firms have been able to pass along the higher costs to customers without significantly affecting demand. For example, Cisco Systems and Juniper Networks increased prices on their networking equipment to offset a portion of the higher costs due to the tariffs.

However, despite our belief that many tech companies have already planned to invest in new manufacturing facilities in Southeast Asia, Mexico, and other regions to offset any business concerns as a result of rising U.S.-China trade tensions, we expect their ability to use the same playbook to mitigate the higher costs of tariffs on the proposed new list of tech products imported from China will be more difficult over the near term. Manufacturing and assembly for Apple's products such as iPhones, Macs, iPads, and wearables are well established in China due to the complex supply chain, with parts and components suppliers concentrated there and skilled labor trained over many years to manufacture the company's products at the highest quality and lowest cost. While Apple, through its contract manufacturer Hon Hai Precision Industry Co. Ltd (also known as Foxconn), plans to manufacture more of its products in India and elsewhere--mainly to diversify its manufacturing base and develop a strategic presence in emerging markets with stronger growth prospects--it would be difficult to reallocate much of its manufacturing production from China over a short period of time without compromising execution.

Meanwhile, according to Nikkei Asian Review, Dell and HP Inc. are both looking to move up to 30% of their laptop production out of China. While this is possible, they would only be able to avoid tariffs on a portion of those products subject to them, plus there would be costs associated with the move. Additionally, given the relatively low product margins on servers and PCs and the availability of close substitutes, Dell and HP would have limited flexibility to absorb the higher costs from tariffs and instead have to raise prices, which could in turn lead to longer customer refresh cycles and lessen product demand.

Furthermore, while the tariffs would likely hurt original equipment manufacturers' (OEMs) sales and margins, part suppliers, contract manufacturers, distributors, and value-added resellers would not come out unscathed either. We expect some of the higher costs from the tariffs would have to be shared among the supply chain members, and their revenues would also be lower if end customer demand weakens.

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The revenue and margin impact on U.S. tech firms is difficult to assess because most companies do not disclose how much of their products are manufactured or assembled in China and imported directly to the U.S. However, we believe most OEMs have a significant manufacturing and final assembly presence in China due to supply chain efficiencies and the availability of skilled labor.

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To be sure, we believe this latest announcement will weaken global business confidence and could compound decelerating U.S. and global investment growth and economic prospects if it goes into effect on Sept. 1 (see "Global Trade At A Crossroads: Tariff Tweet Adds Heat To U.S.-Sino Dispute," published Aug. 2, 2019). Given recent events, it appears that U.S.-China trade tensions will continue. Key topics such as China's "unfair trade practices" related to technology transfers, intellectual property, and innovation continue to be sticking points. We've also seen U.S. protectionism in the face of rising security threats, as seen in the situation with Huawei. The U.S. added China-based Huawei Investment & Holding Co. Ltd. and its affiliates--which rely on U.S. companies for certain components for major products--to its restricted entity list for fear that the Chinese government could use Huawei's equipment to spy on the U.S. and other countries, effectively cutting Huawei out of markets.

U.S.-China trade tension has certainly escalated since early 2018 when the two countries began imposing tariffs on certain products imported from each other. Positive developments could happen, such as the 90-day reprieve the U.S. Commerce Department offered to mobile phone companies and internet broadband providers less than a week after the Huawei ban announcement to work with Huawei to keep existing networks online and protect users from security risk. Also, following the G20 Summit in Japan where President Trump and China's President Xi Jinping met in late June, the U.S. Commerce Department confirmed that licenses will be granted to U.S. companies to sell to Huawei where there is no threat to U.S. national security. Conversely, we are also wary of further actions by both countries, such as even higher tariffs imposed on each other's imports, or by their consumers, such as boycotts of goods made by each country.

We have seen pockets of weakness in global IT spending so far in 2019, such as slower enterprise IT spending by certain large tech companies and elevated semiconductor inventory levels, especially in memory, which lead us to now expect the global semiconductor market to decline in the mid-teens percent area in 2019 versus our prior expectation in February 2019 for a 7% decline. We also now expect overall IT spending growth to lag that of global GDP growth versus our prior expectation in November 2018 for IT spending near global GDP. While we have not made any rating changes to U.S. tech companies arising from continued trade tension between the world's two largest economies, we recognize that any escalation will undoubtedly add to global economic uncertainty and further increase downside risk to the tech sector.

Related Research

• Global Trade At A Crossroads: Tariff Tweet Adds Heat To U.S.-Sino Dispute, Aug. 2, 2019
• Bans On Huawei Will Hit Tech Harder Than Telecom, But Not Enough To Move The Ratings, June 12, 2019