A border tax would throw a wrench into retail's price wars

Shoppers at a Target store in Chicago.
Jim Young | Reuters

Retailers' heated price wars may get doused with a bucket of cold water.

As companies like Target and Wal-Mart go head-to-head on value, a House bill proposing a tax on imported goods threatens to undermine any progress they make.

While the specifics around potential legislation remain fuzzy — as well as its odds of passing — the current version being pushed by the GOP calls for a 20 percent tax on products coming into the U.S.

Given that the majority of apparel, footwear and consumer electronics sold in the U.S. are manufactured abroad, retailers have frequently, and vociferously, asserted that such a tax would wipe out their profits and force them to charge more.

That rhetoric stands directly at odds with their promise to offer low prices every day, underscoring just how tightly they're being squeezed as they compete for penny-pinching shoppers' dollars.

"In the long-run, it's not sustainable to absorb these costs," Johan Gott, a principal at strategy and management consultant A.T. Kearney, told CNBC. "Retailers don't have very large margins to play with."

Yet the very real possibility of being forced into price increases hasn't stopped retailers from promising more consistent deals. At its recent investor day in New York City, Target said it would dial back its use of one-off coupons in favor of everyday low prices — a phrase that's become synonymous with Wal-Mart's strategy.

Like Target, the world's largest retailer over the past year has been looking at its cost structure to systematically lower prices. And on a call with investors earlier this month, a Costco executive said the club retailer, too, is moving toward an everyday low pricing model on more of its items.

JCPenney CEO: Border tax would make short-term profits ‘virtually impossible’

Yet the rhetoric coming from these companies is a tale of two tapes. While on one hand, they're promising to lead on price, they're also warning that a border tax would cause consumers to pay more.

"We've spent our whole lives driving down prices, and recognizing also that [for] so many items... they don't exist [in the U.S.]," Costco CFO Richard Galanti told analysts on the company's earnings call. "Prices will ultimately have to rise."

Target CEO Brian Cornell has been particularly vocal on the topic, having met with President Donald Trump to express his concerns about consumers paying the ultimate price of a border tax.

"We had a really productive conversation," Cornell told reporters.

Analysts note that if a border tax were to go through, every retailer would be forced to deal with the repercussions, essentially putting them on even playing field. As a result, the price wars would likely continue — just off a higher base.

Yet some would be at a greater disadvantage than others. Wal-Mart, for instance, generates more than half its revenue from groceries, which would be less vulnerable under the tax.

Meanwhile, Costco is somewhat cushioned by its annual membership fee, which accounts for three-fourths of its operating income. Those two factors would make a border tax less burdensome than on a company like Target, analysts have said.

Many large retailers are already looking at their supply chains and sourcing strategies to figure out where they could save on the cost of goods. Possible options include turning to a country less impacted by the evolving trade rules or sourcing some products in the U.S.

However, there are limited opportunities for Made in the USA merchandise, as the country's infrastructure no longer supports large-scale manufacturing. That leaves retailers with little wiggle room.

"If they try to increase ticket prices what they're going to see is [fewer] people buying," Murali Gokki, a managing director in AlixPartners' retail practice, told CNBC. "Consumers have little appetite to pay a higher price."