Tariffs and Supply Chain Diversification Under Scale Economies

The recent elimination of the United States de minimis exemption for import tariffs has been reported to have a significant impact on ultra-fresh fashion companies such as Shein and Temu. This article develops a game-theoretic model to investigate the impact of such tariffs. Specifically, we consider a model for a global ultra-fresh fashion supply chain with economies of scale under tariff hikes. Our model analysis reveals the following main insights. First, the ultra-fresh fashion firm would price in such a way to pass the entire import tariff onto customers in the tariff-imposing market, and tariff hikes in one market would reduce the firm’s product launch frequency and total product variety in all markets due to the supply chain scale economy effect. As a result, tariff hikes reduce the firm’s profit, with the loss amplified under greater supply chain scale economies. However, a higher demand from outside the tariff-imposing market helps soften the blow from tariff hikes, signifying the importance of the demand-side market diversification (a strategy termed as the “US Plus One” in this article). Moreover, we find that the firm would relocate its production for the tariff-imposing market if and only if the tariff rate exceeds a certain threshold, with supply chain scale economies serving as an “efficiency barrier” to counter-balance the supply-side production diversification. We also find numerically that the demand-side market diversification strategy can serve as a potential substitute for the supply-side production diversification strategy. Implications of tariff hikes for consumer surplus and the environment are further examined along with production relocation. Finally, we offer a general discussion regarding market competition and other relevant modeling considerations.