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Brexit: the impact on your supply chain - what you should be doing now

Introduction

No end to the red tape

The decision of the prime minister to trigger Article 50 of the EU treaty still leaves a huge level of uncertainty for businesses. When Article 50 of the EU Treaty is triggered before the end of March 2017 ambiguity will continue throughout the two years of discussion with some economists saying negotiations may take up to 10 years. Whatever the outcome of trading arrangement negotiations with the EU, the UK is likely to be bound by some or all EU obligations. And yes, there will still be red tape.

Life after Brexit

British retailer Next plc has said the weakness of the pound since Brexit is likely to increase sourcing costs and as a result, consumers may see price rises of up to 5%. In order to mitigate costs further, they are continuing to increase efficiency, improve capabilities and develop sources of supply in places such as Bangladesh, Cambodia, and Burma.

In July, Tata Steel announced it was putting the plan to sell its entire UK business on hold in light of Brexit concerns.

Arla Foods UK is focusing on minimising any potential impacts on the business as it continues to grow. It is important for Arla that their products can continue to move freely to and from the UK across the markets in which they operate.

Risks and implications

This briefing examines some of the implications for your supply chain and outlines actions that businesses should be taking now. We explore some of the most likely Brexit scenarios, describing the impacts, and identifying the key focus areas that businesses should consider in order to build an informed response to Brexit. We also provide a structure to define and understand the risks and implications.

Given the situation, it is increasingly important for companies not to lose sight of their strategies and remain focussed on their customer proposition. They also need to clearly understand  their sourcing and supplier base, capital investments, production and distribution networks, talent and skills, and the impact on profitability.

As the external impacts of Brexit become increasingly clear, the key to success will be flexibility, agility and most importantly, immediate action across their international supply chains.

Possible post-Brexit scenarios

A number of possible post-Brexit scenarios have been suggested since the referendum was first announced in February, and then scrutinised in more detail following the result to leave the EU in June.

Amongst the many scenarios, we have identified four key areas of debate that will influence the eventual outcome: migration policy, trade agreements, fiscal policy and regulatory requirements.

  

Brexit scenarios supply chain


We see a number of emerging scenarios that depend largely on the result of UK-EU negotiations. One of the biggest unknowns to overlay on these scenarios is what will happen to our biggest trading partner (the EU) in the aftermath of Brexit; does it continue to integrate or start a process of disintegration itself?

The extent to which firms are affected by, and can react to these scenarios, depends on a number of factors, including:

Geographic scale

  • Firms who only have operations in the UK market have little opportunity to move their operations into the EU and avoid potential tariffs, without the requirement for fairly significant capital investment

  • These firms are also likely to have fewer opportunities to exploit the weaker Sterling through driving their international business

Levels of existing investment in the UK

  • Firms that have significant levels of investment in the UK will be looking to achieve a payback on these investments before considering other options

Industry sector

  • The WTO tariff structure will impact more heavily on firms in the automotive, financial and agricultural sectors

Understanding the impact on supply chains

LCP has developed a framework to help businesses understand the impact of various Brexit scenarios on their supply chain. It helps describe the potential impacts of Brexit on each part of the supply chain, with a focus on what firms can do now to better position themselves.

Customer proposition

Business will be looking to understand the impact of Brexit on their customer proposition; what opportunities and challenges exist? The risk of lower economic growth presents an opportunity for those serving the value end of the market e.g. Aldi, and a weaker Sterling makes businesses who operate internationally more attractive. However, imported food and utility bills will become more expensive leaving many consumers with less disposable income, negatively impacting on discretionary items.

What should firms consider and what can firms do now?

  • Understand the impact on your sales since Brexit. Have you seen a shift in the mix of sales, in terms of channels, categories or geographies?

  • How do you expect your customers to respond in the short, medium and long term? Segmenting your customers will help you understand the impact at a more granular level.

  • What opportunities do you have to exploit a weaker Sterling? Similarly, how can you use the risk of lower economic growth to your advantage?

Sourcing and supplier base

Increased cost prices has been one of the major discussion points since the vote. As the UK is a net importer of components, parts and services in most industrial sectors, a weaker Sterling has caused most firms cost of goods to increase. Many larger firms ‘hedge’ against currency fluctuations, often a year in advance. However, they will eventually feel the upward cost pressures and if no other action is taken, this will likely result in price rises for the consumer, and inflation. Firms who buy more internationally will be exposed to this on a greater scale, but the global nature of most supply chains will mean this pressure is likely to be felt across the board.

What should firms consider and what can firms do now?

  • Protect your business against a weaker pound by moving sourcing back to the UK. Where are the real near-shoring opportunities? In reality, most supply chains are now global, meaning sourcing from a tier 1 supplier locally may not offer enough protection from a weaker pound as their input components are also globally sourced

  • Explore opportunities to introduce or increase levels of dual supply to mitigate future risks. Several factors need to be considered in any dual supply decision, including cost price impacts and the implications on stock and working capital resulting from minimum order sizes.

  • Mitigate your currency risks and protect trading profits by planning future currency income (‘hedging’) and expenses? Hedging alone will not solve all sourcing issues, however, and as currencies stabilise this window of opportunity will close.

Capital investments

Brexit has caused many firms to review their planned capital investments. A number of UK based companies are still planning to invest in the UK, including pharmaceutical giant GlaxoSmithKline which is planning to invest £275m expanding its three UK manufacturing sites despite Brexit, saying the country remains "an attractive location" due to its skilled workforce and competitive tax system. However, the attractiveness of the UK as a foreign investment proposition has reduced substantially. The tendency in uncertain times is to rebalance the mix of low and high risk investments. Firms looking at major infrastructural investments may choose to defer their decisions until they have a better view of the future, leading to a potential reduction in Foreign Direct Investment.

What should firms consider and what can firms do now?

  • Review your planned investments and ask if they are still the still the right things to do. The speed at which investments are made is a lever that firms may be able to use to mitigate any perceived risks.

Production and distribution networks

Using the UK as a gateway to Europe has long been an attractive proposition for many global firms. Increasing complexity will make the UK less attractive, but decisions by companies like Toyota and Honda on whether to leave the UK are expected to take between 5 and 10 years due to existing global product placements. Similarly, other companies that have more flexibility in their European production and distribution operations may consider alternatives to manufacturing in the UK that provide better access to EU markets and more competitive labour rates. This choice represents risk and opportunity to make a step change in manufacturing cost of goods sold.

What should firms consider and what can firms do now?

  • Does your business rely on having a production or distribution footprint within the EU? If so, what are the economic and operational impacts of Brexit on this footprint?

  • Location of sites. If you have sites outside of the UK but within the EU, how easily and quickly are you able to shift production and distribution to these sites, and what are the implications of this?

  • Are you able to leverage any relationships or alliances and partner with firms to gain access to their production or distribution capabilities within the EU? What are the implications of doing so?

  • Should you consider ‘lift and shift’ of manufacturing to lower cost EU countries?

Talent and skills

A points based immigration policy could reduce the flow of low cost labour into the UK economy and drive manufacturing and retail wages up in the longer term. Although favoured by a points based system, highly skilled engineering and technical individuals may decide the uncertainty around their future prospects is such that the UK is no longer country of choice. The UK is unlikely to be able to fill this skills gap quickly, meaning firms could face complex and expensive visa sponsorship processes in order to import the right skills.

What should firms consider and what can firms do now?

  • Understand your exposure to an increase in the cost of low skilled labour. What steps can you take to make your operations more efficient and/or less labour intensive? How can you increase the rate at which existing efficiency improvement projects deliver? How does the business case for automating parts or all of your operations change when taking into account possible labour cost increases?

  • What capabilities will your firm need in 1 year, 3 years and 10 years? How is that different from today? What ‘pipeline’ is in place to develop this talent and address any gaps, and what employment package will be needed to attract the best talent?

Impact on profitability

Firms are already reconsidering their capabilities and developing different options in the wake of Brexit. A reduction in consumer confidence will mean revenues are under pressure whilst costs are only likely to increase given the weak pound and increasing complexity. Many industries such as grocery are already experiencing very tight operating margins  and will need to develop effective strategies just to sustain current levels.

What should firms consider and what can firms do now?

  • Develop economic models that accurately reflect the operating model of your business in order to understand cost levers better and allow them to explore different scenarios and the impact on company profit. The model variables must be at both the macro (e.g. labour rates) and micro (e.g. productivity rates) level to generate the best assessment of possible outcomes.

  • The scenarios that are modelled should reflect those that are possible; in the context of Brexit this could be the adoption of the WTO tariff model, or an increase in labour rates over the longer term. Models should allow outcomes to be reviewed over the short (1-2 years), medium (3-5 years) and longer terms (10 years+) to understand how the impact of available levers might change over time.

  • Through modelling, firms can filter out the noise surrounding Brexit and identify the levers that really matter to them, allowing for more informed decision making.

 

Diagnose and clarify your supply chain position

The key to future success is to understand and model a set of agreed Brexit scenarios and to translate these into alternative operational scenarios that enable business growth and strategy

Brexit Operations Supply Chain

Businesses that adopt this approach will identify the key levers that impact their operations and international supply chains allowing them to focus on to what really matters.

Taking action

Where customer propositions are threatened as a result of Brexit, companies need to understand the implications for their operations and supply chain.

Firms should review the impacts from the ‘bottom up’ to understand whether customer propositions can still be delivered given the possible changes such as:

  • Can next day delivery be maintained if the DC has been relocated from UK to France?

  • Can we still deliver our value proposition and make an appropriate level of margin in a given category if supply is near-shored?

  • What are the cost-to-serve implications of these changes?

For LCP, the key is to assess the impact on costs and profitability of potential changes to the operating model and end-to-end supply chain, in order to fully understand the options available and their implications.

There are still many uncertainties as to the shape that Brexit will take. But, there are practical steps that you can be taking now to mitigate the risk on your supply chain and therefore your business.

 

To find out more about our approach to developing an intelligent response to Brexit, or discuss how we can help your business, contact:

Tom Horigan
info@lcpconsulting.com
T: +44 (0) 1442 872298

 

 

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