Supplement industry braces for impact as tensions with China mount

In August, Tyson Foods surfaced as the latest corporation to cry uncle over the trade tariffs emanating from the Trump administration. In advance of its third-quarter earnings release, the company cut its 2018 profit estimates, from roughly $6.70 per share to $5.70, for one reason and one reason alone. CEO Tom Hayes cited “the combination of changing global trade policies here and abroad, and the uncertainty of any resolution.” The stock promptly fell 6 percent and continues to languish near its 52-week low.

Tyson joins the ranks of such iconic U.S. brands as Harley-Davidson and Whirlpool in adjusting to the vicissitudes of the president’s protectionist stance on international trade. Even Coca-Cola announced price increases in response to China’s 10 percent retaliatory tariff on aluminum. These companies don’t sell dietary supplements, of course, but they do operate in commodity raw materials imported at scale from China. It should come as no surprise that experts in the supplement industry remain on high alert, waiting for the proverbial other shoe to drop somewhere closer to home.

The makings of a trade war

For now, Trump’s sights are set squarely on China, as tariffs with the EU stabilize and tensions there continue to de-escalate. Experts see this as a coordinated strategy, with China cast as the ultimate global trade villain by design. “The thinking seems to be that we’re in a trade war with China, and the administration expects Europe to have our backs,” says Dan Ikenson, an economist who serves as director of the Herbert A. Stiefel Center for Trade Policy Studies at the Cato Institute. “The EU needs to buy more liquefied natural gas and soy from us because China won’t. This recent détente with Europe arises from the administration’s belief in our commonality of interests with respect to China.”

But how did we get here? To get up to speed—and with an emphatic caveat that this only holds water as of press time—here’s a quick 2018 timeline of the tariff actions with respect to China, which are now reaching a more fevered pitch.

January:
• Trump imposes 30 percent tariffs on solar panels and 25 percent on washing machines.
February:
• Trump targets steel and aluminum.
March:
• Trump targets $50 billion in Chinese high-tech.
• China responds to steel and aluminum tariffs with $3 billion on U.S. goods.
April:
• China slaps 25 percent tariffs on wine, pork, some U.S. fruits and nuts.
• Trump adds $50 billion more on mostly tech, like flat-screen TVs.
• China retaliates with $50 billion on aviation, cars and soy.
July:
• U.S. begins to impose tariffs on $34 billion in Chinese goods.
• Trump threatens to target $500 billion, the entirety of our trade with China.
• Trump announces $12 billion in subsidies for U.S. farmers.
August:
• Threatened tariff rates begin to escalate from 10 percent to 25 percent.
• Trump’s tariffs on the next $16 billion go into effect.
September:
• Trump formalizes another tranche of tariffs on $200 billion, bringing the tariff total to half of the total trade volume.
• China responds, raising its tariff total to $110 billion out of a total of $130 billion in U.S. imports.

As with any good trade war, the rhetoric and table stakes continue to rise, with Trump threatening to slap tariffs on the full $500 billion and up the rates to 25 percent in early 2019.

After skirting direct impact in the early rounds, the supplement industry is now squarely on the tariff schedule with such mainstays as whey, ginseng, and fish oils clearly listed. Given the economic reality that China cannot outlast the U.S. in a strict tariff war—that $500 billion versus $130 billion noted above—trade experts are beginning to speculate about the additional moves available to China should President Xi decide to dig his heels in as deeply as Trump.

One go-to next step for China would be specific roadblocks and hurdles that target U.S. brands based in China (listen up, MLMs) with regulatory scrutiny, delays at customs, and outright boycotts orchestrated by the government. Any brand thinking of moving production to China as a hedge against tariffs should take note of these additional measures available to China once the billions in trade have run out.

The backdrop for all of this bluster and bravado around trade imbalances and tariffs is a simmering resurgence of nationalist pride in China that could pose the biggest threat to supplements in the long term. If the Chinese consumer’s appetite for U.S.-branded goods wanes, industry growth rates begin to tick down in meaningful ways. But is it all bad news? Is the future for supplements really this bleak? Or is there a subtext beyond the latest headlines that posits a brighter outcome?

Supplements just outside the crosshairs

The supplement industry has largely skirted disaster thus far, but proposed tariffs have brought certain key ingredients to the table. Foremost among them would be American ginseng, highly prized in China, with the vast majority of the U.S. crop exported to that market. There have been rumblings or outright listings of fish oils, amino acids, lactic acid, most of the major minerals, and even xylitol, not to mention CoQ10 and vitamins E, B2, and B12.

Goods subject to trade are categorized in detail by the U.S. International Trade Commission (USITC) according to the Harmonized Tariff Schedule (HTS), but many codes still leave wiggle room for interpretation. But trying to understand the nuances at play in those interpretations—and get up to speed on exactly what’s at stake—puts the supplement industry in a high-stakes game of catch-up. Think of it this way—negotiating terms with FDA and FTC are well-trodden terrain, but tariffs and trade wars are another, rarer beast entirely.

Beyond the ingredients mentioned above, trade organizations like UNPA have expressed concern over an early listing of “ferments, excluding yeast,” and CRN is investigating some wildcard packaging categories pointed out by its membership. “It’s a broad variety of ingredients on these lists, and it’s not just ingredients,” says Steve Mister, CRN’s president and CEO. “We’re even seeing potential tariffs on caps, closures, stoppers, and lids under a category called ‘handbags.’ A nice plastic case or little wooden box—some of the higher-end packaging you often see with MLMs—is potentially caught up by these tariffs, too.”

Regardless of the specific ingredients and HTS codes under scrutiny, the industry does speak with one voice in wholesale opposition to the approach. “This is the least desirable path forward,” says Mister. “We would agree that China is a problem for our industry from a trade standpoint, with policies and practices that often disadvantage U.S. companies, but starting a trade war is probably not the best way to handle that.” Ikenson stretches that argument still wider. “These are the same problems we’ve had with China for years,” he says. “But to stand up to China, you bring it to the WTO. Instead, we’ve chosen to become this international scofflaw.”

Primary perils

As the industry catches up to the realities of a burgeoning trade-war, several risks have risen to the surface as top concerns. First up? Getting squeezed from both ends.

“There’s strong demand in China for U.S.-made products,” says Mister. “You often see ingredients imported from China, manufactured here into finished products for a U.S. label, and then turned right back around for export to China, where a growing consumer base wants to use their newfound middle-class income to stay healthy.” The Chinese famously don’t trust China-made goods. “If this trade war escalates, we could see tariffs on these finished products going back to China too,” Mister warns.

Just to parse that a bit, Mister speaks of a double hit to the supplement industry from a trade war that impacts both exports and imports of economic relevance. Major ingredients and raw material sourced primarily out of China could easily fall subject to Trump’s tariffs on some future list, forcing U.S. manufacturers to scramble for alternative sourcing. As a meaningful share of these Chinese raw materials wind up in finished products sent back to China for export into a higher-growth market than Western Europe or the U.S., China’s retaliatory tariffs could also come into play. It’s a double whammy that many industries don’t face.

As a corollary to the first concern, industry is well aware of the ways in which it is held captive to cheap, Chinese supply of essential nutrients. In a trade war, manufacturers depend on elastic markets with readily available substitute suppliers, and that’s just not applicable for supplements.

In a July letter to U.S. Trade Representative Robert Lighthizer, Daniel Fabricant of NPA asks for clear exemption of 57 HTS codes representing hundreds of dietary ingredients. Writes Fabricant: “Any disruption of the raw material supply chain through tariffs on ingredients sourced from China will curtail innovation, decrease future sales, and flatten the expected CAGR for the dietary supplement and natural product industries. The 10 percent CAGR in the future global market over the next 10 years means that any proposed tariffs on dietary ingredients will lead to strong sales for the rest of Europe, South America, and Asia, and a lack of growth for the U.S. for the first time. It is an action which the U.S. dietary supplement industry may not be able to recover from.”

In that letter, NPA speaks loudly and clearly to the market reality that only China can supply at scale to feed our domestic manufacture of supplements. A desperate hunt for substitute suppliers that just don’t exist threatens to harm small- and mid-sized companies most of all, and ultimately drive manufacturing overseas at a net loss to U.S. jobs. Job loss is always a tough argument to stomach for a politician in an election year.

Death by percentage points

Ikenson sharpens the point, with particular attention paid to the escalating nature of the tariff rates. “As we talk, it’s $200 billion in Chinese goods on the list, with 10 percent tariffs for some goods and 25 percent for others,” he says. “At 25 percent, that can be prohibitive and trade could go to zero. At 25 percent, companies can’t hedge the risks anymore, and they need to change out their supply chains. The 10 percent tariffs can be less prohibitive. You can hedge your bets, come up with contingencies.”

Another concern, with longer-lasting impact, would be further damage to the innovation pipeline that fuels growth in the industry. “There’s a myth out there that reducing trade barriers benefits the big and rich companies,” says Ikenson. “It’s the complete opposite. Trade barriers are a much bigger deal to the challengers than the incumbents. It’s a much higher cost in comparison, and trade barriers foreclose opportunities for the small guys to innovate around sourcing and production.” Innovators depend on creative thinking and challenges to the status quo to differentiate. They build better mousetraps that incumbents can’t see or are too calcified to understand. Tariffs on raw materials at rates as high as 25 percent make all of that nimble maneuvering nearly impossible. “A trade war ultimately retards the ecosystem of innovation,” says Ikenson. “It benefits the institutional investors and the large companies.”

Do MLMs face fallout?

Given the rampant uncertainties at play, what’s a company to do? A smart first step would be to understand the true nature of the risks and face them head on.

“We import a lot more from China than we export to them, so this isn’t an even playing deck,” says Ikenson. “China will run out of cards, and then what? Do they go after U.S. multinationals operating in China? That’s another $550 billion in sales. It’s another likely target of Beijing as this escalates.” Which brings to mind the largest MLM brands, and the eerie lack of public concern coming from their leadership or the leading analysts covering their stocks.

NBJ combed through the most recent earnings calls with Herbalife, NuSkin, and USANA, and exactly zero Wall Street analysts asked about the impact of these tariffs or the impact of an ongoing trade war with China. Here’s the one mention we could find, this from Mark Lawrence, NuSkin’s CFO: “Currently, we do not anticipate the recently enacted tariffs to materially impact our operations or financial results. However, as a result of recent global trade disputes we have seen the U.S. dollar strengthen, which does negatively impact our reported results and is reflected in our guidance.” There was no follow up.

The MLM sector has a long-standing, tumultuous relationship with China, which could put them higher on the retaliation list. Just one year ago, a threatened crackdown on the sector by the Chinese government sent all three of the stocks listed above down 5-7 percent. As U.S. growth matures, China has become a significant part of each brand’s revenue mix, making trade tensions a much greater risk to the bottom line. At Herbalife, roughly 20 percent of revenue now comes out of China. It’s 30 percent for NuSkin, and a full 50 percent for USANA. While China-based manufacture of China-sourced ingredients might skirt these early salvos in the trade war, what happens if the battles escalate beyond tariffs alone? Experts speak of immediate concerns around an already challenging product registration process, and the fallout from any efforts to raise nationalist pride in China-made goods. The “Made in USA” supplement story has been a successful one, and global industry growth depends upon it.

Data presented at the 2018 NBJ Summit paints the best picture. Estimated consumer sales of supplements in 2017 ttribute 34 percent of the global total to the U.S. ($43 billion), 14 percent to China ($18 billion), and 13 percent to Western Europe ($17 billion). But China is the grower, at 8 percent annually, compared to 5 percent in the U.S. By 2021, China will see 15 percent of that global total.

Best case, worst case

Another way to prepare is to imagine the best- and worst-case scenarios playing themselves out and figure out a response to each. “If there’s any silver lining here, it’s that the Chinese are in a bit of a bind,” says Ikenson. “Their economy’s not great, ours is humming. Ours is bigger, ours is less dependent on trade. And Trump has scared them, so maybe there is some rationality behind his irrationality.” Ikenson sees the best-case moving forward as more clarification from the administration about its true goals here—what exactly do we want from the Chinese?—and Trump disabusing himself of his flat-earth, mercantilist myths about trade. “He can’t mandate a reduction in the trade deficit with China, and his advisors need to tell him that. Maybe this could all end with a PR win for him, a headline like ‘China buys another $150 billion in U.S. goods; trade war over.’”

CRN is focused on the known knowns. “The best case is the administration backs away from these tariffs,” says Mister. “That’s where we’re focused. The tariffs are a clear, defined flag in the sand we can argue against.” And a bright red flag to boot. The impact to U.S. consumers of dietary supplements stands to become significant if a 25 percent tariff lands on major ingredients from inelastic supply markets, so that manufacturers must pass costs directly on to consumers or risk shutting their doors.

Worst case? It’s pretty simple for Ikenson. “No one relents, and we end up in recession, then depression,” he says. Beyond this kind of macroeconomic malaise, industry experts are most worried about any sustained souring of trade relations with China. Prosperity for supplements in the future depends on China buying U.S. exports. This is a larger threat that could rear its head for years after the tit-for-tat of trade tariffs fade into the dustbins of so much weird history around Trump and his protectionist worldview on trade.

This article originally appeared in the October issue of the Nutrition Business Journal. Visit the store to purchase this and other issues.