The only thing that seems to be certain about Brexit is, on-going uncertainty
The start of the formal two years negotiation period initiated on June 19th has provided little further clarity on the expected outcome. The EU has stated its negotiating priorities but with the UK preferring to hold its cards close to its chest, the forecast for businesses with suppliers across the channel seems set to, changeable and uncertain.
Most people consider that a wait and see approach is too passive and could be fatal to many companies.
There are two key areas of legislation which affect the relationship a business will have with its continental suppliers:
- The Single Market – enables suppliers to send their goods from any EU country to another freely, i.e. no tariff or import duties – this is the area of EU law that covers the four key freedoms: goods, services, capital and people.
- The Customer Union – sets the standard paperwork and agreements for the transportation of goods across the EU (and beyond), it also mandates that all countries set standard tariffs for goods coming in from non-EU countries – i.e. the rest of the world. The Customer Union excludes food and agriculture.
Looking at the Single Market and Customs Union alone and putting aside challenges such as standards and other regulation, there are three basic scenarios that should be considered in mapping the impact to continental suppliers of Brexit:
1. We remain in the EU and there is no change – this seems unlikely at the moment, but politicians such as Vince Cable have been talking it about in recent weeks.
2. We get no deal and revert to World Trade Organisation rules – this again seems an unlikely outcome, and although it would mean paying tariffs and charges on some goods which currently arrive free of import duty from within the EU, it also gives the UK access to non-EU markets, i.e. the rest of the world, for those same goods and services – currently priced out of consideration by the EU’s import duties.
3. Removal of access to low cost labour from Europe – We need also to consider the free movement of labour in our analysis. The potential major reduction in the availability of low cost labour from Europe may cause price increases for some goods, either directly or in the supply chain. This is likely to be noticed most where suppliers have a significant reliance on the use of such labour, either long term or when the need is temporary e.g. fruit picking, harvesting and other peak demands times such as Black Friday and Christmas.
Here are four practical steps companies should do now in order to be ready for any of the foreseeable changes to come:
1. Supplier Segmentation:
From your supplier list, starting with direct, but also including the critical indirect, identify and segment your suppliers:
Suppliers should be identified by:
- Being an EU company supplying goods or services from an EU country.
- Being a company, which is reliant on significant raw materials or components from the EU. This ideally should be segmented by % of price of the goods supplied.
- Being a company, which is reliant on the availability of low cost labour from EU. This ideally should be segmented by % of price of the goods supplied.
- Identification of items sourced from outside of the EU but which transit via land through the EU, which should also include goods transiting through Rotterdam.
In order to identify key suppliers, look for products and sectors where the UK is a significant importer of those goods. The lists of major imports includes, but is not limited to, Computers, Cars and car components, Medicines and beauty products, Crude Oil, Apparel, Food & Wine, Medical instruments & reagents, Metals (aluminium, titanium etc) and other, non-native, base and raw materials.
Given the complexity in modern supply chains, the list of suppliers each company produces is likely to be quite long. Each organisation’s knowledge of its suppliers will be fully tested and more likely involve liaising with suppliers to establish the latest cost assumptions and supply chain challenges.
2. Sequencing the list:
The list needs to be sequenced by each company in order of importance. This is likely to identify the supplier with the biggest impact on costs escalation for the goods and services you sell onto your customers, either as finished goods or larger sub-assemblies and components.
3. Analysis of the list:
Each supplier on the list needs to be looked at in turn, although segmentation by country and product may be useful. Dependent upon the challenges faced there are a number of strategies and remedies, which can be applied to reduce the impact of Brexit cost increases and, ideally, identify some of the cost saving opportunities.
In this article, I will look at three example companies and suggest some high level, simple strategies to attempt to offset and eliminate any cost increases, whilst taking advantage of access to global markets, which in future will no longer have EU import duties applied.
Example 1 – A company in an EU Country with an EU centric supply chain and no requirement for low cost labour.
Risk
· No agreement reached, application of import duty or tax at WTO levels.
| Possible mitigation | Rational | Comment |
| Does the supplier have a UK subsidiary or factory that could be traded with? | Could intercompany trading within the supplier reduce or shield the impact of tariffs? Could manufacturing capacity be moved to a UK facility? | Financial engineering is unlikely to fully offset import duty and the associated admin costs. Moving manufacturing capacity to UK might be attractive to some suppliers if viable. |
| Be sure to co-operate with the supplier on new import and export documentation for smooth transportation of goods through local customs – possibly different documents for each country the goods transitions through. Consider increasing stock holding, if practical, during transition period. | The exit from the EU may include the Customs Union and new unfamiliar paperwork will be required to ensure cross boarder transfer of goods. Increasing stocks may off-set the risks of supply disruption during transition. | Companies may wish to invest in new systems to support the administration of customs documentation and legal requirements against both EU and WTO rules, plus further bi-lateral trade agreements as they are signed. Short-term capital requirements may increase in order to hold additional stock. |
| Does the supplier have a subsidiary or alternative manufacturing plant outside of UK & EU that could be traded with? | Lower prices might be available from outside of the EU. With WTO rules in place it might be cheaper to source global rather than buy from the EU factory. | Opportunity to access global pricing without the EU import duty might reduce business costs. Note: Using non-EU sourced items as sub-assemblies or components and forming these into finished goods may prevent the final product from being sold in the EU market. |
| Investigate if there is one or more UK suppliers who could provide the same goods or service. | No import duty for goods sourced within the UK. | Opportunity to resource items in UK if competitive; compared to the EU price plus WTO import duty. However, there is still likely to be a price increase compared to current free market arrangements. |
| Investigate if there is one or more non-UK, non-EU supplier, you could buy from, who can provide the same goods or services. | Lower prices might be available from outside of the EU. With WTO rules in place, imports to the UK from non-EU countries might be lower than EU free market prices. | Opportunity to switch supplier to achieve price reduction or hold. |
From Example 1, we can see there are many options available to companies but it is dependent upon the goods being traded as to whether these options are possible and advantageous. The exit from the Customs Union is likely to increase costs for administration and paperwork for the import and export of goods.
Example 2 – UK supplier with significant exposure to EU raw material supply and a medium but stable requirement for low cost labour:
Risk
· No agreement reached, application of import duty or tax at WTO levels.
· Brexit curtails access to low cost EU labour.
| Possible mitigation | Rational | Comment |
| Ask the supplier to investigate UK suppliers of raw materials as a contingency. | Ask the supplier to apply supplier segmentation approach or a similar process. An alternative UK source, if available, may reduce impact of tariffs. | Local sourcing, if available, may deliver additional supply chain benefits through reduced stock holding and shorter logistics. |
| Ask the supplier to investigate other global sources or raw materials as contingency. | Lower prices might be available from outside of the EU. With WTO rules in place, imports to UK from non-EU might be cheaper than EU free market. | Opportunity to access global pricing without the EU import duty may reduce costs. Note: Using non-EU items as sub-assemblies or components and forming these into finished goods in the UK may prevent the final product form being sold in the EU market. |
| Investigate setting up new UK supply chain for raw materials. | Local sourcing in UK removes the impact of tariffs. | May not be possible, if raw material is a natural resource, which is not found in the UK, or requires particular climate for growth. For manufactured items, alternative UK centric sourcing arrangement may take more than two years to set up. |
| Ask supplier to improve internal processes and automate repetitive tasks to remove exposure to low cost EU Labour. | Low cost EU labour is likely to be undertaking low value add activities which could be automated. | UK economic efficiency is low. This is an opportunity to automate and use robotics. Investment in systems and training will be required. |
Example 2 highlights that impact of suppliers’ exposure to the EU market. This issue needs to be managed holistically, potentially by product or sector, with companies and suppliers supporting each other in resolving challenges and issues. Steady low-cost labour requirements may best be solved through automation.
Example 3 – UK supplier, UK centric raw materials, except for some items sourced in Morocco and currently shipped by sea and land to UK. The company has a significant transient requirement for low cost EU labour:
Risk
- Exit from Customs Union curtails free flow of goods across the EU
- Brexit curtails access to low cost EU labour
| Possible mitigation | Rational | Comment |
| Examine sea shipment to UK directly for goods from Morocco. Work with supplier to ensure paperwork is compliant to avoid disruption of supply. Investigate alternative sources or markets for item, eg source from or ship via USA or other country to UK may be a contingency. Hold increase stock of Moroccan item(s) if negotiations seem to be stalling. | Direct transportation removes complexity of transit through EU. New Customs paperwork will be required, possibly country-by-country if no deal is reached. Alternative global sources may be available. Increasing stock at the transition, if practical, could avoid the risk of supply disruption. | Prominence of Rotterdam as the port Hub of Europe may limit scope for direct shipping. UK market for goods may not be large enough to justify direct shipment. Companies need to be ready for new paperwork should negotiations flounder. Alternative sources should be sought as possible replacement or as a contingency. Switch of EU to WTO tariffs may be advantageous. Capital requirements may increase if increase stock holding is an option. |
| Smooth out labour demand | If possible smooth out the demand for labour to reduce transient requirement. Improve resource efficiency and scheduling. | May not be possible for some areas of work such as fruit picking & harvesting. Businesses may need to incentivise consumers to buy early for Black Friday and Christmas. |
| Automation and Robotics | Some low value add tasks can be automated or use the new generation of robotics. | Business may require significant investment in capital and training in order to exploit the benefits of automation and robotics. Certain tasks still require a human. |
| Alternative Source of Labour | Investigate bringing people from outside of the EU to undertake low wage, low value added work | Post War migration to the UK has been on going since the 1948 arrival at Tilbury of the Emperor Windrush from the Caribbean 22nd June with nearly 500 men on board. Alternative sources of low cost labour are available from outside of the EU. |
Example 3 highlights the issue of low cost EU labour and identifies some options to move away from that business model. However, some sectors will have an inherent requirement for transient low-cost labour during peak demand.
Looking at the three simple examples above, it is easy to see why an individual approach, supplier by supplier is required. The size, scale and level of internationalisation of each supplier, product and commodity will change the likely remedy selected. Other factors will include level of competition in the market and the geographic spread of the industry.
4. Pricing the changes:
For each supplier, each of the mitigation options, which are deemed possible, should be priced, as an increase or decrease to the unit cost. The benchmark to measure each contingency against is to: stay with the same supplier, transacting in the same way but applying WTO tariffs rather than Single Market trading.
Completing the first pass of this work will enable companies to identify the biggest cost increase, risk and opportunities available to them and focus scarce resources on managing them appropriately.
Once completed this analysis will give managers:
- An understanding of the impact of Brexit on your suppliers and inbound supply chain with expected costs, both increases and decreases
- An understanding of the options available to buyers and suppliers to offset some, or all, of the costs and impact of Brexit under the worst-case scenario
- Ability for buyers and suppliers to start contingency planning and mitigation actions for Brexit
- Identification of new suppliers from outside of the EU, which were previously not competitive due to EU tariffs
- Ability to work with new suppliers to take advantage of improved pricing once Brexit is completed
- A document that can focus and support involvement with trade bodies to resolve and minimise the negative impact of Brexit on your business and sector
- A working document that you can evolve and be updated as the negotiations proceed.
By taking action now, it is more likely you can mitigate the effects of Brexit, and perhaps even find ways to benefit from the changes ahead of us.
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