Big Data, Plainly Spoken (aka Numbers Rule Your World)

Who pays the tariff?

In a previous post, I covered how tariffs affect the cost of goods sold, and how they should flow into prices. There continues to be myths spread around in the media that a 10% tariff should increase prices by 10%. (For example, this article.)

I hate to say any vendor raising prices by 10% because of a 10% tariff is doing dirty by the customers.

Let's review the tariff math again. We were talking about a $1,600 iPhone, for which Apple pays manufacturers $700. The other $900 covers Apple's profits but also a host of other costs like staff, marketing, etc. 

Tariffs are levied on the cost of goods sold so a 10% tariff on $700 adds $70 to Apple's cost. If Apple completely absorbs the tariffs, it would keep the iPhone price at $1,600. In this case, the tariff reduces Apple's profit per phone sold by $70; in effect, Uncle Sam took $70 from Apple for each phone sold. Apple's stock price should fall in order to reflect this transfer of wealth from shareholders to the government, which is why Apple's management isn't going to like it. The net profit margin per phone expressed as a percentage of the selling price is reduced. The total profits earned from all phones sold is also reduced while the number of phones sold should not be affected.

In case Apple decides to increase the list price by 10% (the rate of tariff), the new selling price is $1,760. Of the extra revenue of $160 Apple gets from selling each phone, only $70 goes to paying the tariff to Uncle Sam. The other $90 represents additional profit extracted from customers. This is because the tariff is levied not on the selling price but on the cost of goods sold.

What's the impact on Apple's financial metrics? The net profit margin per phone expressed as a percentage of the selling price remains the same as pre-tariff since each component rises proportionally. The total profits earned from all phones sold will also increase because Apple effectively extracts more from each phone - however, this increase is not assured because higher list prices may cause demand to fall. If demand falls, the total profits may drop even if the profit margin is maintained.

If Apple wanted to pass the full cost of the tariff to the customer, it should increase the price from $1600 to $1670, which is a 4.4% increase, not 10%. In this case, the profit per phone that the vendor earns remains the same since the customers pay the tariffs. However, the net profit margin expressed as a percent of the selling price is reduced because the selling price has increased. The total profits may drop if the increased price causes demand to fall; if demand does not fall, then the total profits stay the same as pre-tariff.

Why would the vendor want to increase the list price by 10% instead of 4.4%? One possibility is general inflation. The vendor might argue that all other costs like staff, marketing, etc. will also rise as an indirect effect of tariffs. Another possibility is the supply-demand curve. If the 4.4% hike in list price causes a drop in demand, the vendor may try to increase prices further to maintain total profit. This move can trigger demand to drop further, so it's a delicate balance.

In the end, the key question is if the vendor is willing to share in the suffering. If the vendor insists on earning the same amount of profits post-tariff, then the list price would surely go up and beyond the direct impact of the tariff.

 

P.S. [5/8/2024] Minor rewriting of a few sentences for clarity.

 

 

Illusion of perfection

Automated detection technology has been invading the sports world. From the "out" call in tennis to the "offside" call in football (soccer), technology is gaining traction and replacing human judges who have traditionally made these calls.

Here is an example of an "out" call in tennis. The technology collates video footage to reconstruct the landing location of the ball. The simulation is animated and shown to spectators as evidence of an "out" call.

 

In football, a scoring player is judged "offside" if s/he is positioned behind the last defender (excluding the other team's goalie) when s/he receives the ball from a teammate. A goal is annulled if it is scored from an "offside" position. The spirit of the offside rule is to disencourage teams from parking an attacker in front of goal at all times. The "offside" call has an outsized impact on match results since football is a low-scoring game. It's a hard call, requiring accounting for the positions of three players - the attacker who scored the goal, the player from whom s/he received the ball, and the last defender. We freeze frame the moment the pass to the attacker is made, then a "calibrated line" is drawn to show the edge position of the last defender, finally, the attacker is called offside if any part of his/her body is over the line.

Defenders often move up and down as a unit, and so the positions of multiple defenders may need to be examined to find the last defender. Unlike the tennis line calls, in which the ball is found next to the line, there may be considerable distance separating the scorer from the last defender.

***

The advantages of using technology are clear. Technology applies a consistent, repeatable, testable process to come to decisions; and thus can be considered fairer. Vendors suggest that technology is also more "accurate". For example, the creator of Hawk Eye technology claims that a tennis ball's location can be determined to within 4 millimetres (the ball is about 67 millimetres in diameter). [link]

Nonetheless, some players have doubts about its accuracy. A few days ago, the German tennis star, Alexander Zverev, questioned a ball judged to be "in" by the automated detection technology. He pulled out his phone, mid-game, to take a picture of the mark on the ground, and later posted it to social media.

Because the tournament is played on clay, each ball leaves a mark on the ground. So in theory, every call made by the technology can be checked against ground truth. Zverev offered up an example of an error as the mark showed clearly that ball landed out.

This type of reality check is not possible on surfaces other than clay.

***

How does the margin of error factor into these calls?

The short answer appears to be it doesn't. The margin of error is treated like it is in a poll, and not like in air travel.

The animation shows a single ball location, without indicating the margin of error. Think of this circle as the technology's guessestimate for the true landing spot of the ball (such as that given by Zverev's snapshot). The "out" decision is based on the estimate while the margin of error adds information without threatening the decision. That's also how poll results are reported in the news media. Trump's approval rating would be reported as under 50%, even if it were at 49% with a margin of error of 3%.

In other scenarios, decision-makers let the information about the margin of error change their decision. Think about how airlines show the flight time to fly from one city to another. We all know it's heavily "padded". An hour-long flight may be shown as requiring two hours. One can use the margin of error around the average flight time to decide how much extra time to add. One would add some mutliple of that margin, calibrated to achieve a certain probability of coverage.

When applied to the tennis calls, one can add some multiple of the margin of error as another circle that envelopes the inferred ball location. If any part of the augmented ball touches the line, the ball is considered "in".

***

How to accommodate measurement uncertainty also troubles offside calls in football. Watching a bit of football lately, I am amazed at how many goals are overturned because the VAR says a finger or a toe was in an "offside" position.

Here is an example:

A goal was scored, but the striker was judged offside because according to the VAR, part of his ankle was beyond the last defender.

It's hard for me to believe that the VAR technology is capable of making such fine distinctions. Remember we are looking at a reconstruction of the scene, a composite image formed by fusing many images from different cameras. There are no sensors pasted to the fingers or toes of these players.

For me, these toetip decisions don't align with the spirit of the offside rule. Some type of margin of error should be incorporated into the decision rule. How much depends on whether they want more scoring or less.

Charging more for less, and less for more

There is this coffee shop near me that makes good coffee and provides a nice environment for doing some work. The other day I ordered a small iced latte with less ice.

Oops, I forgot about their $0.75 fee for "less ice". The small drink rings up to $6.80. It's $5.50 for the hot latte, $0.50 extra for ice, and $0.75 extra for less ice.

One time, I asked them why they charge more for less ice. They said less ice means they have to give me more coffee.

I don't know why that sounded sensible at the time. Because it doesn't make sense.

I should have asked them why they charge $0.50 for ice in the first place. By their own logic, the iced coffee has less coffee than the hot coffee, thus shouldn't there be a deduction for making it iced?

 

 

 

Doing tariff math right

The Trump tariff mayhem has spotlighted innumeracy in the U.S. media.

I'm not talking about the numbers coming from the U.S. administration - I didn't care to write about those because they are intended for laughs.

Unfortunately, the math emanating from the other side is also riddled with errors. I'll focus on one particular talking point that's been bugging me.

***

Many journalists want to tell us the dire effect of Trump's 25%, 125%, 145%, etc. tariffs on the prices U.S. consumers pay for common purchases. Here is a typical example from CNET (link), which focuses on Apple's iphones. The key sentence is this:

If Apple passed the China tariff costs on to customers, the iPhone 16 Pro Max with 1TB of storage could increase from $1,599 to nearly $3,600 -- assuming that the previously imposed 20% tariff was already incorporated into the current price.

3600/1599 is 2.25 so they added 125% on top of $1,599, suggesting that Apple pays about $2,000 of tariff for each iPhone. This calculation sounds reasonable but that's not how the math works.

A tariff is an import tax that importers are required to pay to the U.S. government in order to accept products from overseas. Apple imports the iPhone from a Chinese manufacturer, and pays any tariffs. The tariff is based on the value of the imported good, in this case, it is the cost that the manufacturer charges Apple for each iPhone. And that cost is much lower than the retail price of the iPhone.

The people at this website (link) estimates that Apple pays the manufacturer about $700 for each iPhone 16 Pro Max. Thus, a 125% tariff on this cost is $875, much smaller than the $2000 from the prior calculation.

If Apple passed the entire tariff onto the customer, the new retail price should be $1,599+875 = $2,474, which is a 55% markup, much lower than 125%.

***

What would Apple do?

Charging the entire tariff onto the customer preserves Apple's profit per unit sold. Before the additional tariffs, the (gross) profit per unit was $1599-$700 = $899. After the price hike, the profit per unit would be $2,474-$(700+875) = $899. This just embodies the idea of passing the pain to the customer.

It's hard to imagine that Apple would do such a thing. The problem is a 55% price hike might cause demand to collapse. So while Apple would still earn $899 per unit, the total profit would plunge as the number of units sold would drop sharply. (For those paying attention, the gross profit margin, expressed as a percent of revenues, would be hit hard even though the profit per unit is unchanged.)

On the other extreme, Apple might absorb the entire tariff. In this case, the new profit per unit would be $1,599-$(700+875)=$24. In this case, iPhones would immediately turn from a driver of huge profits to a money-losing product overnight. (Apple share price should crater if this materialized.)

The $24 is not pure profit for Apple. It goes into paying for all of the overhead costs, like marketing, brand advertising, engineering, R&D, administrative costs, etc. There surely would be nothing left for pure profit.

This shows the insanity of this magnitude of tariffs, and why the business community was so alarmed by it. (Apple's profit margin is very fat by industry standard; imagine you're selling trinkets for laser-thin profits.)

The number of units sold would at best stay constant, but more likely, it would also drop because the general economic outlook has soured. The drop in this case would be much less severe because the retail price did not change.

***
Realistically, Apple would have to pass some of the tariffs on to consumers while also suffering a decline in profits.

What happened to the $875 tariff? It went to the U.S. government. So effectively, the tariff functions as a massive corporate tax hike. Apple has been forced to transfer a huge chunk of profits from shareholders to the U.S. government.

The tariff rate is so high that Apple won't be able to pay them in full from existing profits so part of the tariffs also is a tax on Apple customers through price hikes. The price hike would not be as high as the tariff rate. It's definitely not going to be 125%.