How will the Brexit impact UK retail, aerospace, electronics and automotive supply chains?
It happened. On Thursday, June 23rd 2016 the “Leave” camp won the referendum to decide whether the UK should leave or remain in the European Union. The British pound plummeted against the Euro and the USD. The UK got lost its AAA rating. Two of the three advocates for Leave, aka Brexit, resigned or withdrew from front line politics (Mr. Nigel Farage and Mr. Boris Johnson). Prime Minister Cameron will probably be remembered as the politician who wanted to sort out the Eurosceptics within his own party and gambled UK’s EU membership away. He was replaced by Mrs. Theresa May. (She was the Home Secretary strongly advocating UK’s efforts to counter modern slavery by introducing transparency provisions impacting Supply Chains in the Modern Slavery Act.) She brought back Mr. Boris Johnson as the new Secretary of State for Foreign and Commonwealth Affairs. The general sentiment is one of increased uncertainty. The summer forecast is mixed, potentially cold and damp as no-one knows what Brexit really means in detail.
Financial analysts at big financial service companies (Goldman Sachs, UBS, Deutsche Bank and HSBC), are warning clients that the UK is entering a period of slower growth and higher inflation. Supply Chain analysts haven’t made up their collective minds yet. They apparently only agree on the uncertainty it has created and how bad Brexit is for the UK. So I decided to take some time away from our management consultancy to reflect on how this will most likely impact UK supply chains and what the best tactics would be to cope with the new reality.
Time to take time? Short term impacts
The first consideration is time. How well the UK will perform over the next couple of quarters is different from its performance in the next decade. For simplicity’s sake, I assume the short term to be everything between now and 2-3 years after the UK has left the European project. (Roughly the next 5 years). The long term for me is more than a decade away.
On the short term, I’m worried about the side effects caused by the uncertainty (What’s the content of the first legislative changes? When will they take effect?) and the changes in business climate (attitude from Britons towards global trade, changing views on how trade should happen from now on with the other EU countries). For me, the former means a lack of clarity and stability. And this will hamper growth and investments by postponement. Companies and individuals will spend less. The latter is something we want to avoid because choosing products or services based on those producing or delivering them could in some cases be considered morally inacceptable and an un-economic performance criterion. But, as my colleague Charles Findlay rightfully pointed out, existing trade barriers to those importing into Europe would then be then be also morally wrong. (And buying the original French Brie instead of the Somerset version probably too.)
I’m also worried about a shortage of qualified workers. A big chunk of the EU commitment stood for free movement of goods, services and people all tied in a package. Curbing asylum and immigration played a big role in the Brexit debate. Not being able to fill jobs via immigration if need be would slow down the production lines.
While Britain (rightfully) might be proud on its research and competitively, it will have to an alternative scheme to keep the bar at the same level. According to the Royal Society , while Britain is a net contributor to the EU budget, but it is also one of the largest recipients of research funding in the EU and, it receives a far greater amount of EU research funding than it contributes. That flow will have to be replaced, as this recent headline suggests: UK scientists dropped from EU projects because of post-Brexit funding fears.
Costs, labour availability and trade restrictions are typical investment decision criteria. I would be surprised if companies didn’t factor in the current short term uncertainties in their equations. I suspect that acquisition activities shall be slowed down or paused. In 2015, Global Council polled to the investment intentions of UK firms with 29% more saying it will have a greater negative than a positive impact.
Over a slightly longer term, I suspect the details of the new trade agreements to promote certain trade corridors, while punishing others. I expect the UK-EU trade corridor to continue with only a minimal impact over the next decade. Nobody wins by a bad EU-UK agreement, except parochial thinking regional manufacturers who don’t like competition.
Factors influencing UK Supply Chains on the longer term
Over a long term, regulatory divergence (mainly with the EU) will increase. Unless appropriate measures are taken, I expect this to increase the cost of trade, impacting on volumes and the UK place in EU supply chains. The question remains how much this shall be compensated by having “UK style” trade agreements with other regions and countries, but I’m sceptical here. While I’m touching on this subject, according to the FT , evidence that EU regulations stifled British creativity, innovation, competition and growth is thin on the ground. The OECD assessed that the UK has the second lowest level of product market regulation among its members, just below the Netherlands.
Steve Banker, an US based consultant, wrote an interesting Forbes post where he suggested other developments impacting our supply chains. EU’s plan for eliminating tax havens is one of them. Large multinationals now often run their regional supply chains from local tax heavens, such as Ireland and, for certain industries, the UK. This strategy will become less accepted.
Another trend has symptoms visible in the US presidential election. According to Banker, a significant proportion of Americans who feel that global trade has not been in their interest. He suspects that, if Trump wins, he will seek to increase barriers to trade with low-cost offshore manufacturing countries. The goods made there not only flow into North America, but also into the UK (and Europe); and that will impact supply chains.
According to the 2015, Global Council study, UK companies are relatively upstream in global supply chains and particularly concentrated in a small number of sectors, compared to companies in other European countries. Let’s dig deeper on a couple of sectors, in no particular order.
Electronics: The devaluation of British pound will significantly increase the price for importing electronics and components. I thus expect an increase in the volatility of component pricing and thus costs. In downturns, typically, less is spent on the non-essential. The demand for consumer electronics such as tablets, phones and personal computers will slope downwards. Apart from ARM, now owned by the Japanese, there are few major UK electronics exporters.
Retail: British supermarkets will increase their prices for dairy and fresh produce, as a lot is imported from the EU with a higher Euro/£ exchange rate. Let’s not forget British farmers receive up to half of their income from the EU and it’s not clear how much of this subsidy the UK government will continue with. They may have to make up for their loss of income and cope with an increased demand because most supermarkets will try to localise their suppliers even more. That won’t help either to keep consumer prices low. Shoppers are now expected to cut spending and delay large purchases. Now might be a good time for US based retailers (Wal-mart, Amazon) to push hard. Same of the German discounters (Lidl, Aldi).
Logistics companies: Over the past decade, a whole bunch of 3PLs have been scooped-up by foreign investors. A weakend GBP will only make the remaining companies more vulnerable to takeovers. Cargo handlers might see disruptions because of the uncertainty in long-term contracts, taxation, and the continued employment of EU citizens. Let’s not forget the day-to-day: new customs control forms will add time and administration to logistics.
Aerospace: one of the immediate post-brexit surprises was that some of the gloomy pre-vote clouds disappeared by the 2016 Farnborough air show. Deals were closed there. It was wrong to assume that deals, sometimes years in preparation, would not go ahead on the very short term. (At a higher cost albeit.) But the vote to leave could threaten some of that dynamism and coordinated investment via the EU, argue many in the industry, in particular at a time when aircraft orders already show signs of slowing down after a six-year boom, according the FT. Small Suppliers to the two major Western manufactures might feel the effects of the uncertainty, but being in an industry with a niche product and supplying to governments and wealthy middle eastern or far eastern carriers should ease the pains.
Automotive: According the FT , if the UK struggles to retain good access to the EU single market after Brexit, then British car plants risk becoming uncompetitive, leading to lost work on refreshed models and, in time, possible closure. Some Asian manufacturers, such as Suzuki, have clearly said the currency market volatility after the Brexit would likely have a “major” impact on earnings, and that it would offset the impact by cutting costs and local procurement. On the side: I’m not convinced The Brexit is the only factor influencing the decision. They were struggling before because of a fuel testing scandal.
John Leech, head of automotive at KPMG UK, now forecasts the sales of 2.5 million cars in 2017, where they before thought 3 million would be sold. He still anticipates that UK car production will grow by double digits in 2016 to 1.7 million cars driven principally by EU exports buoyed by the weak pound. The uncertainty about the relationship with the EU and import/export tariffs will demand a far more flexible and agile procurement, production and distribution.
I don’t see niche automotive products (such as Formula 1) disappear, but I do think it will become less affordable.
There is a remaining question – is the local UK talent is sufficient for the UK automotive sector in case the free movement of people and services are challenged in the future.
Stressed spelled backwards
From the above, one can easily understand the effect of the Brexit will be layered. It shall be felt (in the Supply Chain) amongst others in: direct trade and sales relations (because of Trade agreement provisions, new tariffs or trade barriers), in logistics (marginally longer time to transport, higher administrative cost), when dealing with staff (who to employ, to outsource or not?), investment (to comply with trade rules), planning (increased uncertainty) and of course the supply chain footprint. But I would not expect “three day weeks” to appear.
What can one do to benefit most from the post-Brexit world?
- First of all, avoiding brutal changes or take hastily investment or divestment decisions until the tone of the negotiations between the UK and the EU are known. (Will the access to the market still be coupled with free movement of people and services?)
- Secondary: shaping up your knowledge of your own supply chain. Do you know where your tiers 3 or 4 are? Can you assess legislation and predict supply chain issues? Do you have an adequate Supply Chain Risk process? How is your monitoring and tracking of your supply chain?
- Third: Plan your moves in in advance in case risks materialise. It might be the ideal timing to careful redesign your footprint, taking in account contingencies.
Being prepared to eat the desserts first is always a good strategy in a stressed environment.