Tariffs to Markdowns: The Margin Squeeze

Tariffs don’t usually show up in your P&L as a neat little line item labeled “Tariffs.” They show up sideways.

They show up as cost creep, then promo pressure, then markdown funding, then returns, then deductions. By the time the dust settles, everyone’s arguing about why the margin missed… and no one can point to a single smoking gun.

That’s the problem. Most teams model the first hit (landed cost). Very few model the second hit (what retail does next).

And retail always does something next.

Why this matters right now

Trade policy has been volatile since the Supreme Court struck down a large swath of tariffs imposed under IEEPA, and the administration has been pivoting to other authorities with temporary global tariffs and talk of rates rising to 15%+ for some countries. Translation: uncertainty is not going away.

When retailers can’t cleanly predict costs, they get more aggressive about protecting traffic, cleaning up inventory risk, and tightening the back end.

That’s where suppliers get squeezed.

The three-stage squeeze most suppliers miss

1) Tariffs raise the floor

You feel it first in landed cost. Maybe it’s packaging. Maybe it’s a key ingredient. Maybe it’s a whole finished good.

Your instinct is rational: adjust pricing, renegotiate, hold margin.

Retail’s instinct is also rational: protect the shelf price, protect the shopper, protect the category’s price image.

So the negotiation begins.

2) Markdowns become the pressure valve

When price can’t move fast enough, markdowns (and promos that behave like markdowns) become the release valve.

McKinsey points out that markdown optimization can swing margin by 400–800 basis points—which tells you how powerful markdowns are as a profit lever.

Now flip that around:

If markdown execution is that material for retailers, it’s also material for suppliers—because markdown funding often gets pushed back upstream through allowances, bill-backs, and post-event “corrections.”

3) Inventory distortion makes everything worse

Inventory distortion (out-of-stocks + overstocks) is still a monster problem. IHL estimates the global cost at $1.7 trillion (with out-of-stocks and overstocks both contributing heavily).

When overstocks build—especially after demand shifts or cost spikes—markdowns accelerate. That’s not “retail being mean.” It’s retail being retail.

The supplier’s exposure comes after the markdown, when the paperwork arrives.

A fictional example (not a real company)

Imagine a mid-sized supplier in the shelf-stable grocery sector. (Fictional.)

A tariff change hits packaging costs mid-quarter. The supplier asks for a list price increase. Retail says, “Not right now—category can’t take it.”

So the supplier agrees to a deeper promo cadence for 8 weeks to hold volume while they “work it out.”

Sales look fine. Everyone breathes.

Then the back end starts:

• Deductions labeled “allowance discrepancy.”

• A wave of “pricing corrections.”

• Returns increase because the promo moved more units into homes that didn’t really want the product

• And suddenly, a year-end “clean-up” claim hits for defectives/returns above allowance

Nobody did anything illegal. Nobody even did anything unusual.

But the supplier just got squeezed twice.

What to do instead: model the second hit

If you want to behave like a modern supplier finance leader, don’t just model “tariff impact on COGS.”

Model:

1. Promo/markdown elasticity: If retail won’t accept price increases, what’s the likely promo ask?

2. Funding mechanics: Off-invoice vs bill-back vs lump sum—how does each one show up in deductions later?

3. Returns and defectives sensitivity: Returns are a giant cost center across retail—NRF projected $890B in returns in 2024 (16.9% of sales), and $849.9B in 2025 (15.8%), with online returns estimated at 19.3%. That volume inevitably drives back-end claims and reconciliation activity.

In other words, even if your category isn’t apparel, the system-wide returns machine affects how hard retailers push to recover costs.

The “Tariff-to-Deduction” checklist

Here’s a simple gut-check your team can use when tariffs spike or swing:

• Did promo frequency increase within 60–90 days of a cost event?

• Did the retailer change item setup, deal sheets, or pricing windows (ship date vs receipt date)? That’s where “discrepancy” deductions are born.

• Did your trade terms get messy (stacking, overlapping events, regional exceptions)?

• Did your deductions queue swell after the promo ended?

• Did returns/defective claims rise in the following quarter?

If you answered yes to two or more, you’re not just dealing with tariffs. You’re dealing with tariff-driven revenue leakage.

Where HRG fits (without the sales pitch)

This is exactly the zone HRG lives in: the messy intersection between trade terms, retailer behavior, and what actually hit your cash.

The opportunity isn’t theoretical. It’s practical:

• Catch invalid or inflated deductions

• Prove what the deal really was

• Recover what you shouldn’t have lost in the first place
  

Not glamorous. Very measurable.

Punchline

Tariffs start the story.

Markdowns write the middle.

Deductions finish it—quietly, in the back room, long after the headline has moved on.

If you only model the first chapter, you’re going to hate the ending.