Brexit resilience: increased risks require immediate actions

Brexit resilience: increased risks require immediate actions
Executive Summary
An uncompromising political backdrop foreshadows any and all Brexit outcomes. Short-term shockwaves are likely to hit manufacturing sectors in the UK and beyond, as non-aligned regulatory frameworks, talent restrictions, and currency volatility threaten operations.

The upheaval may last beyond the immediate horizon, requiring manufacturers to plan, now, to mitigate supply chain disruption implicit in non-tariff trade barriers.

Brexit, in catalysing the need for manufacturers to prepare for a period of global economic flux and stress, represents an opportunity to forge organisational resilience. By re-evaluating customer demand and consumer markets, reassessing business strategies, and revisiting supply chain foundations, manufacturing companies can still brace preparedly for Brexit.

 

Brexit’s political uncertainty drags on
In the future, the dateline 31 October 2019 – or a subsequently negotiated extended deadline – may come to represent a significant watershed in the history of global affairs. Will it mark as important a time as the ending of Britain’s empire in the second half of the 20th century? Will its waves crash the post-World War Two political and economic order, or will it resound more in ripples which alter balances just temporarily? Britain is currently the world’s fifth-largest economy, but France and India are projected to overtake it soon – and Brexit could hasten the change, foreshadowing permanent shrinkage of the UK’s economic power should Brexiteer politicians’ promises of a new golden age be, simply, unrealistic and undeliverable.

Brexit resilience: increased risks require immediate actionsBoris Johnson, Britain’s new prime minister, has rapidly reshaped the UK cabinet in hard-Brexit design, a move termed ‘Boris’s blue terror’. Claiming that his preference is still to forge a deal, he continues to bet that the EU, Germany and France in particular will be motivated to renegotiate if they see the reality of the threat of no-deal in its effects upon their own economies.

But Britain has more to lose than the EU. The European bloc is Britain’s single largest trading partner: 46% of all UK exports in 2018 were destined for the EU, totalling £289 billion, whilst £345 billion of goods were imported from the EU, comprising 54% of all UK imports.1

Brexit will come at a price
UK businesses, especially manufacturers with supply chains outside British borders, have been adversely affected by sterling’s decline and ongoing volatility since the 2016 referendum. Sterling fell 8% against the US dollar immediately the result was declared; by the end of July 2019 the currency was at two-year lows against both the US dollar and the euro.

The plummeting pound portends inflationary pressures in Britain. And output is sliding: 2018 GDP growth slowed to 1.4%, down from the 2017 figure of 1.8% – the lowest growth achieved in a decade.2

In August, as no-deal became an increasing possibility, the Bank of England cut its growth forecast for the remainder of 2019, and warned that no-deal carried a one-third probability of triggering recession in 2020.

In early September, Parliament legislated to block a no-deal scenario, but the government continues to punt this as an option – even in the face of a legal and constitutional crisis. Manufacturers must brace for drastic, imminent changes in the fundamentals of their operations.

Brexit will have resounding consequences
Businesses will have been preparing for different scenarios for some time. Now, however, it will be crucial to prepare for worst-case scenarios. Full implications need to be grasped and rapidly planned for.

A period of transition may no longer occur. Without a deal, the UK leaves the EU with immediate effect on 1 November. The term ‘crashing out’ relates to this eventuality. Businesses’ concerns of disruption were previously alleviated by the cushion of 21 months of transition. Now, the cliff-edge beckons.

Tariffs may kick in from 1 November, or from the day after any deadline extension given by the EU. How the tariff situation ultimately pans out depends on both political and negotiation complexities, some of which may take years and possibly decades to finalise.Brexit resilience

There are nuances for individual manufacturers depending on sector, proportion of domestic inputs, and destination of exports. But the default governance for trade between the EU and the UK will be World Trade Organisation (WTO) regulations which, however the UK government may opt to incentivise trade or mitigate producers’ Brexit cost escalations, will represent a major change compared to the seamless and zero-cost trade between the UK and Europe for the last 45 years. (See side-bar ‘The cost-creep of tariffs’.)

Border checks may occur. This will impact logistics in multiple ways, and impinge on the efficiency of supply networks. (See side-bar ‘What will happen at ports and borders?)

The cost-creep of tariffs

The Confederation of British Industry (CBI) has confirmed that a no-deal would result in 90% of UK exports to the EU being slapped with tariffs. Although the average would be 4.3%, these would be significantly higher in some sectors, notably agricultural products, processed foods and beverages, and textiles.

Tariffs would hit the automotive industry most significantly. The sector’s current, zero-tariff European supply chain movements contrast sharply with the best-case average scenario under WTO ‘Most Favoured Nation’ (MFN) terms of 6.2% on component parts and 9.7% on completed vehicles. Further, some of the sector’s likely key, newly targeted trading regions implement higher rates, such as China at 15%.3 So the WTO average is an understatement of probable cost escalations.

Free movement of people may cease. As the UK seeks to tighten immigration, manufacturers may feel the effects of a shrinking talent pool and a reduced labour supply. In Britain, labour costs may escalate as a result.

Regulatory frameworks could be dissolved. The UK is currently encompassed within the ambit of EU regulations governing massive industries including energy, life sciences, food and beverage, and chemicals. After October, British-manufactured goods may no longer be subject to – and approved within – the EU’s regulations. For sales and transactions to continue, the regulatory vacuum requires urgent filling.

Trade across the world will be impacted, not only between Britain and the EU. The UK’s global trade is governed by its membership of the European bloc. Imminently, Britain will need to restructure trading relations and secure terms with nations across the globe. These deals will take years, possibly decades, to forge.

Brexit resilience: increased risks require immediate actions

Manufacturers must barrel into the challenge
Britain’s largest manufacturing organisation, Make UK, which represents 20 000 manufacturers, has expressed deep concerns. Its chief executive lamented the manufacturing sector’s “clear weakening trend … and evidence of European companies abandoning UK supply chains.” Beyond the EU, customers of British manufacturers are balking at the uncertainties inherent in the UK’s exit from trade agreements forged under EU auspices.

Indeed, the UK manufacturing sector’s order books are already contracting. The Purchasing Managers’ Index (PMI) fell to 49.4 in May, down from 53.1 in the previous month – one of the severest drops in the last seven years. It declined further in June, to a six-year low of 48, with July’s number reflecting no improvement. It’s not a one-way street. Manufacturers in the eurozone are also suffering: the PMI for the joint bloc fell to 46.4 in July, also a six-year low.

Going it alone may work for political sloganeering, but manufacturers need new frontiers – fast.

What will happen at ports and borders?

The Irish land border is fiendishly complicated. As late as August 2019, the UK government had confirmed it will not construct a physical border, which would threaten the Good Friday peace agreement. In the same breath, it continues its refusal to accept Irish backstop clauses to any potential Brexit deal. This contradiction necessitates that manufacturers with significant volumes transiting to or from Ireland will need to keep a watchful eye on the political situation leading up to 31 October, or any extended deadline.

The issue at sea ports is straightforward: There is a clear risk of costly hold-ups on both sides of the English Channel. Two-and-a-half million lorries pass through Dover on an annual basis, carrying 17% of EU-UK trade, including medicines and fresh produce. The Imperial College of London calculates that checks and paperwork of just two minutes per vehicle could triple Dover’s current queues, as well as those at the Eurotunnel in Folkestone. French authorities concur with these dramatic conclusions, and envisage trails of lorries stretching for between 17-27 kilometres at Calais, Boulogne and Dunkirk.

It now seems inevitable that Britain will leave the EU customs union. The time required to implement highly efficient border controls is extremely short.Although the UK government has just tendered for £300 million of new rail, air and ferry services for freight throughput at Dover, this added capacity will still take time to construct and to operate smoothly.

Border delays seem inevitable.

 

Fail to plan, or plan to fail
At the end of August 2019, a no-deal scenario seemed very likely. Despite being prorogued by Boris Johnson in early September, Parliament moved to block a no-deal, effectively maneouvring an extension to Britain’s withdrawal. Fresh elections loom, and, in theory, all outcomes are still feasible, including a soft deal involving the UK’s continued customs union membership – or even the revocation of Article 50 by a new government.

But a no-deal is still in the balance, and ongoing uncertainty itself represents a substantial hurdle. Manufacturers must now brace for the future with strategies and action plans focused around four key areas:

1. Business strategy. Brexit should catalyse comprehensive assessment of core business, operations alignment, and issues of future-proofing – including R&D and capex investments, talent sourcing, and the entity’s Industry 4.0 status.

2. Market protection. Consider geographic priorities in light of likely higher interest rates and inflation in the UK, and the possibility of sterling’s medium- to longer-term devaluation. British-based manufacturers should assess whether to carry buffer stocks of crucial materials imported from the EU. The dispersal of production plants – or their entire offshoring – may now become vital. If feasible, fast-track plans to enter new markets in other parts of the world.

3. Cost management. Take steps to mitigate possible tariff and trade barriers within the end-to-end supply chain – including non-tariff barriers implicit in the inevitable new regimen of border checks and human capital restrictions – and to understand their operating cost and cost-of-goods (COGS) impacts.

4. Revisit supply chain basics. Basic questions now take on crucial importance, such as ‘Do any customer contracts permit force majeure cancellation on the grounds of Brexit?’, or ‘Have regulatory applications been lodged with the newly-applicable authority?’

The sands are shifting for Britain’s major manufacturing industries
Shockwaves are likely to hit all manufacturing sectors. The automotive industry has been warning, almost since the result of the 2016 referendum, of the importance of a deal to protect its just-in-time (JIT) supply chains and to limit cost escalations. (See side-bar ‘The cost-creep of tariffs’.) Britain’s car industry accounts for 9% of the country’s manufacturing, and represents nearly 1% of GDP. But, with the UK industry’s exported vehicles comprising just 56% local content, it epitomises the dissipated but tightly integrated supply networks across the EU.

The dilemma is summed up in The Financial Times headline of 29 July 2019: “Vauxhall owner ready to quit UK if Brexit fallout hits profitability.”

Food manufacturers, meanwhile, thrive on healthy retail spending. Generally, British food manufacturers rely heavily on imported ingredients; overall, about half of the UK’s foodstuffs are imported – mostly from EU ports. And 30% of all packaged food consumed in Britain is produced in the EU. The pound’s plunge bodes negatively for inflation, with supermarket shelves likely to see the quickest effects.

Brexit resilience: increased risks require immediate actionsIn life sciences, pharmaceuticals and medical technology, no-deal threatens crucial R&D investments. Britain has been a leader in these industries for the last 20-30 years. But it has benefitted hugely from EU research co-operation; the European Commission’s Horizon 2020 programme, for example, has liberated billions of euros of funding, from which Britain was a main beneficiary 4.

The Royal Society is concerned that “the loss of support from European research grants and collaborations would have an immediate impact on innovation in the UK and stop valuable research in its tracks.” The UK’s life sciences and pharmaceuticals manufacturers will face major challenges in seeking to remain leading global players post-October.

Chemicals cross borders multiple times in supply chain processes. This means that tariff equations will hit the EU and UK chemicals industry hard. Sixty percent of Britain’s chemical exports head to the EU, valued at £50 billion. Using the WTO tariff rules, these shipments will suffer a minimum 6% cost escalation across their supply chains.

Comparatively smaller manufacturing sectors are no less effected. In aerospace, Airbus Chief Executive Tom Enders has confirmed that hard Brexit scenarios would lead the company to assess its entire UK operation, where it employs 14 000 people across 25 sites, including its Broughton facility in Wales where it makes wings for all northern hemisphere orders. “Of course it’s not possible to pick up and move our large UK factories to other parts of the world immediately. However, aerospace is a long-term business and we could be forced to redirect future investments in the event of a no-deal Brexit,” he said.

Today’s networked dispersal of supply chains means that disruptive ripples spread widely. Motor vehicle tariff impositions, if they result in weaker European demand for British-made cars, will hit the UK’s steel industry, which currently employs 32 000 workers and accounts for nearly 1% of Britain’s manufacturing output.

Britain’s manufacturing sector is the 9th largest in the world
Accounting for 45% of the country’s overall exports, at £275 billion, manufacturing industries are dotted across the island. Notable strongholds are in the North West and West Midlands, where manufacturing comprises £26.9 billion and £19.8 billion in output and represents 15.6% and 16.1% respectively of the economies of those areas.5 Just how deeply Brexit may cut, and whether it will be a short-term pain casting longer-term benefits, may be difficult to ascertain. But the people of cities like Liverpool, Manchester, Birmingham and Coventry may see significantly receding factory skylines from 1 November.

For better – or, more likely, for worse – Brexit is about to break
Brexit’s impact upon manufacturers will be significant. Irrevocably, politics has infiltrated the boardroom, and plans need to be put in place, immediately, to mitigate disruption.

A hard Brexit – in particular a no-deal Brexit – would be a huge deal for manufacturers.

1 https://researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-7851
2 https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpfirstquarterlyestimateuk/octobertodecember2018
3 China’s tariff has actually come down, from 24% in May 2018
4 https://ec.europa.eu/research/evaluations/pdf/archive/h2020_monitoring_reports/h2020_monitoring_flash_092018.pdf
5 Manufacturing Fact-card 2018/2019, Make UK, page 2

Sources:
‘Asian companies warn of ‘serious implications’ of no-deal Brexit’, Asia Nikkei, 16 January 2019
‘The Brexit Storm: how procurement and supply chain professionals are tackling the issues’, Chartered Institute of Procurement & Supply, July 2018
‘Impact of Brexit on the manufacturing industry: Managing through uncertainty’, Deloitte, August 2017
‘A year to go: how Brexit will affect UK industry’, The Economist Intelligence Unit, 2018
‘No-deal Brexit: what would ‘WTO terms’ mean for UK-EU?’ www.euronews.com/2018/12/19/how-would-uk-eu-trade-be-affected-by-a-no-deal-brexit
‘Harnessing Brexit, Technology and Insight: British manufacturers – maintaining a competitive edge in an age of uncertainty and opportunity’, Jon Moody, Dr Hongwei Zhang, Prof Sameh Saad, Insight with Sheffield Hallam University, August 2018
Association of the British Pharmaceutical Industry [www.abpi.org.uk]
‘UK Steel: Preparing for Brexit, Update 1’, UK Steel and Make UK, June 2019
www.makeuk.org/Services/Brexit
Food & Drink Business Europe [www.fdbusiness.com]
www.bbc.com/news/politics/uk_leaves_the_eu
www.bloomberg.com/europe
www.euronews.com
www.forbes.com
www.ft.com
www.theguardian.com/politics/2019/jun/13/parliament-is-out-of-options-to-stop-no-deal-brexit-tory-mp-oliver-letwin
www.theguardian.com/international
The Institute for Public Policy Research (UK): www.ippr.org/
www.makeuk.org
www.supplychain247.com
www.gov.uk/government/publications/existing-trade-agreements-if-the-uk-leaves-the-eu-without-a-deal/existing-trade-agreements-if-the-uk-leaves-the-eu-without-a-deal

researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-7851

UK Office for National Statistics, manufacturing

Disclaimer
This resource has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained herein without obtaining specific professional advice. Competitive Capabilities International (CCi) does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this resource or for any decision based on it.

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