Be prepared: This is the message to businesses facing changes to their supply chain as the UK’s exit from the EU draws nearer.
It is possible that in the short term the UK will remain within the EU’s Customs Union, lowering immediate risks to existing supply chains. But longer-term changes may emerge from the Brexit process, and a cliff-edge “no deal” rupture in March with serious consequences for businesses is a possibility.
Major accountancy firms have been warning for months that Brexit’s potential multi-faceted impact on trade costs may put pressure on companies’ working capital. Writing in March 2018, PwC’s Johnathon Marshall also emphasised the importance of companies’ reevaluating their supply chains. Marshall identified seven areas businesses should take into account: customs and tariffs, legal changes, value-added tax (VAT), systems for managing import and export declarations, supply chain hubs, lead times, and grants and incentives.
The UK Parliament’s rejection on 15 January of the withdrawal agreement negotiated between the EU and the UK raises the possibility of a no-deal Brexit on 29 March in which the UK would leave the Customs Union and be forced to trade with the EU in accordance with rules set by the World Trade Organisation (WTO).
This would imply tariffs for UK goods entering the EU averaging 2.6% for nonagricultural products and of up to 35% for dairy products, according to the BBC. The UK could unilaterally introduce lower tariffs for EU imports but only if it did so for all WTO members. The UK would also drop out of existing EU trade agreements with countries such as Canada and South Korea.
Tariffs would not be the only downside risk to supply chains: Nontariff barriers including product standards and safety regulations are also likely to be a challenge. Customs clearance is likely to take longer for many products, increasing lead times and cost burdens on businesses. Legal differences with the EU could also prompt changes to supply chain contracts.
With risks mounting, smart companies are already examining their currency arrangements and how they manage their supply chains.
“Brexit has forced people to have a fresh look at their sourcing plans. It’s forcing them to make some decisions,” said Duncan Brock, group director and chief Brexit spokesman of the UK’s Chartered Institute of Procurement & Supply (CIPS). “Because of the currency impact that Brexit has already had, companies are looking at supply chains to the third or fourth tier, where they may not have worried about it before. Companies that already hedge against currency fluctuations and have mechanisms in place are better-prepared, and finance teams may be increasing hedging.”
According to CIPS research from March 2018, one-third of UK businesses had already increased their prices as a result of Brexit; one in seven EU businesses with UK suppliers had already moved parts of their business outside of the UK; and three in five UK businesses with EU suppliers said that currency fluctuations had made supply chains more expensive.
Brock said that the depreciation of sterling has led to inflationary pressure on imports. While this could be expected to benefit UK-based exporters, the UK has a relatively high import value of exports: that is, many of its finished-product exports are dependent on imported inputs, meaning that currency depreciation is not universally beneficial to exporters. Currency risk is set to increase if there is a no-deal Brexit, which would put pressure on the pound.
Brock added that companies are already making decisions to change suppliers in case barriers to trade rise in the short or medium term. This has led both to EU companies that source products from the UK seeking new suppliers within the remaining 27 member states and to UK suppliers reconsidering whether to relocate supply chains within the country.
Feedback from EU-based companies suggests that in many cases, UK products are not competitive or differentiated enough from European equivalents. But companies with strong intellectual property and technology stand a better chance of maintaining relationships with EU customers.
“Companies are managing risk and making longer-term decisions, rather than waiting for a cliff edge,” said Brock, though he added that most businesses still believe that a no-deal Brexit will be avoided and are not prepared for a worst-case scenario. Inventory build-ups have been one result: for example, UK companies holding more foreign-source raw materials on-site, and pre-positioning more finished goods in their target markets, as KPMG target value leader Mike Mills has suggested.
In the case that tariffs increase, Brock said that a short-term inflationary spike would have an impact on company finances. New processes, staff, and systems may be needed to manage revised customs, taxation, and legal regimes. Sectors that may be particularly affected include the heavily regulated pharmaceuticals industry, where companies selling into the EU require European marketing authorisations. This could lead some companies to relocate their authorisation processes to EU-based bodies and revise deals with third-party logistics suppliers.
Rising costs from currency shocks and tariffs may encourage companies to include clauses in supply contracts that allow for repricing if costs rise or fall by a certain amount. These are already fairly common in contracts with partners outside the EU.
Unless the UK and the EU retain current arrangements, it will take up to four months for companies to recover the 20% VAT that they will be obliged to pay on imported EU goods at the port of entry. And if the UK leaves the jurisdiction of the European Court of Justice, EU companies may start to demand letters of credit backed by banks in order to sell to UK firms.
Despite the substantial risks on the downside, KPMG and organisations such as the Institute of Chartered Accountants in England and Wales (ICAEW) are urging businesses to consider upsides as well as they reexamine their supply chains. UK-based companies without external suppliers may find themselves more competitive in the medium term, particularly if the UK uses Brexit to ease the regulatory burden on companies.
Meanwhile, producers in EU countries that are often overlooked can offer themselves as “Brexit-proof” alternatives. Cost-competitive countries in central and eastern Europe are attracting new attention from companies that have been using the UK as a base for the EU market, while Ireland is attracting more service businesses.
Moreover, while detailed reassessment of supply chains is necessary, the ICAEW warns against a “bias to action”: Cost/benefit analyses may lead to a rational decision not to alter business plans.
“Our advice is: do your planning, look at your risks, look at your exposure,” said Brock. “If you don’t need to change, don’t. It depends on your appetite for risk.”
— Andrew MacDowall is a freelance writer based in France. To comment on this article or to suggest an idea for another article, contact Drew Adamek, an FM magazine senior editor, at Andrew.Adamek@aicpa-cima.com.