Bracing for Brexit: how manufacturers can prepare for disruption and safeguard supply chains

Bracing for Brexit: How manufacturers can turn disruption into opportunity
Executive Summary
29 March 2019 has come and gone, and political uncertainty continues around the terms and timing of Brexit – or, if it will indeed happen. Business needs to peer through the smokescreen and plan for scenarios such that short- or medium-term problems are minimised, and longer-term advantages are enabled.

Manufacturers, particularly, are caught in a web of complex strands – threatened by sticky regulatory changes, logistical red tape or logjams, customer confusion, and supply chain dilemmas. Manufacturing is vital to the UK’s economy, comprising 10% of GDP and 44% of export activity – half destined for the EU. This article, the first in a series focusing on likely or potential issues and impacts upon manufacturing sectors, addresses some of the crucial issues facing manufacturers, with a view to facilitating clarity and a framework for actions.

 

Separation anxiety

The narrow Brexit referendum result, reflecting very close to a 50-50 split in public will, started Britain down an uncertain path. The snap June 2017 general election, and then the Prime Minister’s July 2018 Chequers proposals, unleashed a political tempest in Britain. Divisions are rife within the ruling Conservative Party, and the government has been unable to agree and set strategy around withdrawal terms. As the UK’s political fractures have widened, so businesses’ concerns have deepened. Today, uncertainty prevails, tarnishing not only current trading conditions, but also impinging upon investment and planning decisions.

In August 2018 Chancellor of the Exchequer Philip Hammond suggested that failure to reach agreement with the EU would have devastating economic consequences, including a sharp decline in GDP growth rates. He also warned of the possibility of needing to increase national borrowings by £80 billion per annum in 15 years’ time, a direct fiscal consequence of a smaller British economy.

Moderate UK leaders are seeking to avoid these repercussions. Others – substantial numbers of ‘Remainer’ politicians across party divides – either continue to lobby for the revocation of Article 50, or are pushing for voters to be allowed a ‘final say’ referendum on the ultimate exit terms. Attitudes are hardening at the other end of the spectrum, as Conservative hardliners brush aside concerns about the implications of Britain crashing out with no deal in place.

Another snap general election seems increasingly possible. But this may not ease the political logjam, as the Labour Party’s stance on Brexit is also divided, its MPs split across constituencies heavily in favour of remaining or significantly weighted towards exiting the EU.

Different scenarios make planning complicated

The EU will not compromise on any of its four-freedom pillars – free movement of people, goods, services and capital – for fear of setting an easy-exit precedent. And the Irish border – which almost all parties agree cannot return to a hard, physical border in violation of the Good Friday agreement, risking renewed conflict – complicates the logistics of what otherwise may have been practical compromises, such as light-touch border checks.

The conundrums mean that, on the brink of deadlines and frantic, further extensions, multiple scenarios could still materialise. These range from a long extension (a de facto ‘remain’ situation for perhaps a further year), to middle ground options such as the UK remaining in a customs union with the EU or participating in the European Economic Area (EEA) single market, to a no-deal default to World Trade Organisation (WTO) rules.

Thus, companies operating in the UK and Europe – or those whose supply chains have an EU footprint – face the extraordinary challenge of having to navigate ambiguity and strategise around divergent Brexit outcomes which will cause significantly different economic, trading and business contexts.

The shifting sands of economic foundations

Within hours of the UK referendum result, the pound fell 8% against the US dollar, the largest ever one-day drop by a G10 currency. Sterling stabilised, but has weakened again by 3% in the first quarter of 2019. Some economists project a 15% differential in the pound’s value between softer free-trade agreement (FTA)-type and hard no-deal scenarios.

brexitThe UK’s currency decline or volatility is one spoke in a large wheel of economic flux. Brexit uncertainty is a factor in the UK’s slowing economy: 2018 GDP growth dipped to a modest 1.4%, down from 1.8% growth in 2017. Current forecasts for 2019 vary considerably depending on the Brexit outcome, with an average forecast at around 1% growth. But, as Ray Barrel, professor at Brunel University puts it, “Growth will continue to stagnate until the situation over Brexit becomes clear. Output will rise, or fall, or stay the same as projected, depending on which of the exit or stay options arrives.”

Interest rates in the UK can be expected to increase, too, as government tightens its monetary policy in the wake of the weaker currency. Increased borrowing costs may in turn discourage corporate investments and capital expenditures.

Massive change lies ahead for consumers and companies throughout Europe, especially in Britain.

The primary shock waves to UK manufacturers’ supply chains

brexitWhatever form Brexit may yet take, it will reverberate in manufacturing industries large and small. In Flintshire, Wales, Airbus makes almost all passenger aircraft wings for its northern hemisphere orders; 1 200 units are transported to assembly lines in America, France and Germany. “You can’t run this operation by breathing through a straw,” says Klaus Richter, Airbus Chief Procurement Officer. What he means is that supply chain connections run very deep and very wide.

The reality is that frictionless trade between the UK and the EU will cease. Customs controls at ports, airports and the Irish border threaten to derail logistics. Cargo flights may even cease for a time, as airlines will need to reapply for flyover and landing rights in both directions. The harder the shape of Brexit, the greater the likelihood of material customs duties on all goods moving between the EU and the UK. But even in a best-case preferential trading scenario, non-tariff logistics barriers will arise. Industries with any time-sensitivity within their supply chains will be impacted, and where just-in-time (JIT) operations underpins a company’s efficiencies, the value network will be compromised.

The weaker pound has already made nearly all raw material imports more expensive for production plants located in Britain. Together with likely tariffs, the currency’s fall will continue to pressure the cost of imports and UK manufacturers’ costs-of-goods (COGS). The latest available survey of 2 000 supply chain managers by Britain’s Chartered Institute of Procurement & Supply (CIPS) revealed that a third of British suppliers have already increased prices due to the falling sterling. And EU-UK commercial links are already being disrupted: one in seven EU businesses with British suppliers has already shifted parts of their supply chains out of the UK.

The only certainty is that almost every link along the value network will be significantly affected, from manufacturer operations, imports, exports and production logistics, to the sales pull of consumer demand. Consider, too, that Brexit scenarios will reverberate in its global effects: the UK’s trading relationships across the world may need to be restructured, from bilateral deals with individual countries to new agreements with blocs such as the Trans-Pacific Partnership.

The cessation of free movement of people into the UK seems non-negotiable for Britain’s government. Manufacturers reliant on skilled EU-national talent will see a brain drain as people’s free movement ends, materially impacting industries which employ a significant number of EU nationals, notably life sciences and food and beverage. EU nationals comprise over 30% of the latter’s workforce.

Standardised regulatory frameworks will no longer apply. Giant British industry operations in food, chemical products, and pharmaceuticals would forfeit current automatic regulatory sanction for distribution throughout the EU. And goods manufactured for sale in the EU may require separate configurations for UK sale, depending on British rules – when Britain ratifies its own standards or regulations into law.

Four key manufacturing industries face trying times

Manufacturing’s importance spreads throughout the isle. Major production nodes are the lifeblood of regional economies such as metropolitan Liverpool, northern Wales – two-thirds of whose exports head to Europe – and the Midlands. In the north-east, over 60% of the region’s manufactured goods are exported to the EU; the area hosts giant multinationals including Coca-Cola, Siemens, General Electric, and Nissan – the region’s largest employer, and the country’s single biggest car manufacturer, whose Sunderland plant produces over 500 000 vehicles per year.

Sectors such as automotive, pharmaceuticals and biotech, food and beverage, and chemicals are major drivers of the national economy. A no-deal Brexit could cut £17 billion in annual export revenues from these industries.

Automotive manufacturing: on the brink of momentous change

British motor manufacturing has long, strong traditions, and is the essence of global brands like Jaguar, Rolls Royce, Mini and the domestic stalwart, Vauxhall.

brexitBut, today, all UK car-making plants are part of globally-dispersed value networks. This adds logistical complexity to component supplies. Isolating the EU’s component portion, and assuming an average 4.5% import tariff under soft-Brexit scenarios, UK car manufacturers will incur at least £350 million in extra annual costs, with some projections as high as £875 million. A no-deal scenario, with an average WTO automotive sector tariff of 9.7%, would dramatically increase costs for UK automakers.

The crux for the industry is that three-quarters of Britain’s annual car production is exported, predominantly to the EU. Overall, if there is no deal, The Economist predicts 13% fewer new car sales between 2019 and 2022 – a loss of some 840 000 units.

Automotive sales are already suffering in other parts of the globe. Jaguar Land Rover, Britain’s largest vehicle manufacturer producing some 30% of local production, suffered a 5.8% unit decline in its fiscal ended March 2019. European sales were down 4.5%, but China’s 34% drop contextualises the potential ongoing impact of China’s economic transition. Brexit, for UK and European carmakers, is an unnecessary hurdle, and the supply chain uncertainty has already caused Honda to announce the closure of its Swindon plant in 2021, with the resultant loss of 3 500 local jobs.

This points to a hazardous transition for UK vehicle manufacturers even under a soft-Brexit, and a gloomy outlook under a no-deal scenario. Indeed, Britain’s automotive industry association, the Society of Motor Manufacturers and Traders, recently warned the UK government that a “no-deal scenario would have a devastating impact on investment and our hard-won reputation – risking the UK’s position as a leading global market and a centre of excellence for innovation”.

Brexit will cap potential of the pharmaceutical, biotech and life sciences industries

The UK’s BioIndustry Association (BIA) and the Association of the British Pharmaceutical Industry (ABPI) have flagged four crucial implications of Brexit:

  • The seamless trade flow of medicines and pharmaceuticals
  • Streamlined continent-wide regulation
  • The necessity of industry professionals’ and researchers’ mobility
  • The continuation of research funding and collaboration initiatives

brexitIndividual companies have expressed concern at the implications of inevitable trade barriers. GlaxoSmithKline plc, Britain’s biggest pharmaceutical manufacturer with worldwide headquarters in London, estimates a cost nearing £70 million to implement supply chain adjustments across 1 700 affected product lines. Anglo-Swedish giant AstraZeneca plc, based in Cambridge, calculates that in the absence of an FTA the company would pay £30.5 million in duties resulting from outdated WTO product and ingredient schedules covered within the Pharmaceutical Tariff Elimination Agreement, and has ring-fenced a £40 million provision to manage anticipated supply chain disruption.

Through the EU, Britain is a member of Horizon 2020, the largest pooled funding collaboration across European countries and corporations, in multiple areas of life science and medical research. Further R&D benefits accrue via the European Investment Fund, which provides a grant to match companies’ UK biotech innovations spending. In total, EU organisations provide approximately 15% of publicly-funded research in the UK. In part, this has resulted in Britain’s excellence as a hub for life sciences, and its employment of 10% of Europe’s 730 000 industry workforce.

The continuation of this industry’s vitality in Britain depends on whether the EU-UK regulatory environment remains aligned post-Brexit. Without this, foreign investment into the UK’s healthcare and life sciences industry may drop, as many multinational pharmaceutical companies are based in the UK because of the ease of access to the European Medicines Association (EMA). Talent-wise, too, 17% of UK life science employees are EU nationals.

Unless there is a deal which guarantees mutual recognition between the EMA and Britain’s Medicines and Healthcare products Regulatory Agency (MHRA), the industry in the UK will undergo the flight of R&D capital and skills, and delays in sourcing new drugs.

In any Brexit alternative, Britain’s pharmaceuticals and life sciences manufacturers will face challenges to maintain status as leading global players – especially under the no-deal scenario.

Food and beverage: margin pressure as consumer spending squeezes
brexit

Food production is Britain’s single largest manufacturing sector. It has already seen Brexit’s hard realities bite: immediately after the referendum result, the weaker pound led manufacturers such as Nestlé and PepsiCo to raise prices, by 14% for Nescafé and 10% for Walkers chips, respectively. Generally, British food manufacturers rely heavily on imported ingredients, with approximately half of the UK’s foodstuffs being imported – much of which enters via EU ports. Ongoing FMCG food price escalations are unavoidable should raw ingredient costs continue at higher levels, and despite retailer reactions such as Tesco threat to pull certain Unilever brands from its shelves.

Ultimately, the sustained health of food, beverage and consumer goods manufacturers’ businesses in the post-Brexit UK depends largely upon consumer confidence and spending. A no-deal exit could see UK retail sales tail off by as much as 13.4% in nominal terms by 2022, compared to a free-trade agreement (FTA) scenario. Premium FMCG categories like frozen desserts, and impulse purchase confectionery, have steepest downside risk in a no-deal scenario due to wider income and price sensitivities. But all manufacturers will need to assess scenarios with reference to their specific product portfolios and category elasticities.

Chemicals: the epitome of Brexit’s complexity

Perhaps no industry illustrates the far-reaching consequences of Brexit more than chemicals. The worldwide dispersal of value chains means that chemical value-adds routinely cross multiple borders before they are in useable form or captured within finished goods, and the EU is core to the chemicals value chain in the UK: three-quarters of its raw material or semi-processed chemical inputs are EU-sourced, while 60% of Britain’s chemical exports – some £50 billion – head to the EU. A no-deal Brexit would cause significant pressures for UK chemical firms: besides non-tariff barriers and the costs of JIT supply chain complications, WTO tariffs would add 6% to baseline costs of shipments in either direction. Little wonder that UK chemicals firms have been among the most outspoken regarding the possible negative consequences of Brexit.

Yet, if the UK’s chemical clusters can weather the Brexit storm, they may thrive. British chemical-producing installations are located close to user-customer industries, and benefit from proximity to feedstock sources such as North Sea hydrocarbons. And global energy giants are re-invigorating their North Sea exploration initiatives, evidenced by Shell’s Penguins field, north-east of the Shetland Islands. Fifteen other oil and gas developments could receive approval in the next 12 months, unlocking investment of about £5 billion, according to Oil & Gas UK. This signals the first positivity since 2013, when the collapse in oil prices triggered near cessation of exploration in this area.

Necessity is the mother of innovation

Brexit is no dreaded ‘black swan’ event. Especially given the likelihood of some extension to the political process, there’s still time to ensure immediate readiness, to leverage medium-term opportunities, and to future-proof for unknown horizons. To gear for change, and new possibilities, companies should act around four aspects:

  1. Re-evaluate core business strategy elements
    Strategic, longer-term planning should be prioritised, and include assessments of geopolitical and macro-economic risks, regulatory environments, comparative tax regimes, talent availability, and access to investment capital. This will uncover the degree of exposure to Brexit scenarios, as well as the opportunities it may present in new markets, or company restructuring, or acquisitions.
  2. Revisit exchange rate hedging policies
    It will be important to consider major upcoming milestones in the timeline to the UK’s departure, whether these transpire as a short withdrawal date extension to 30 June 2019, a snap UK election date, or a date for a confirmatory UK parliament vote – or other alternatives. Each watershed could see a significant exchange rate swing, and the ensuing EU-UK political relationship may influence currency volatility. Manufacturers should track the process watchfully through to the conclusion of any probable transition phase.
  3. Industry 4.0 opportunities
    Data management systems will need to be updated for new suppliers, COGs, sales prices, duties and VAT, among many other details. Over-and-beyond specific ERP reconfigurations, it may be opportune for manufacturers to embrace Industry 4.0 – effectively, to envision the factory of the future. In its information technology-operational technology (IT-OT) convergence, use of virtual application software, networked capability with suppliers and customers, advanced analytics, robotics and next-generation artificial intelligence (AI) automation, new technologies are driving next-level productivity in manufacturing.
  4. Supply chain visibility has never been more important
    This will enlighten decisions around many strategic and operational aspects of Brexit-driven change. It should become apparent, for instance, if a UK food manufacturer can maintain profitability only by sourcing 100% locally, in turn establishing a separate EU-based factory to access that market efficiently. Supply chain segmentation, if not already implemented, may be the key to enhanced agility – whether this takes the shape of urgent action or a deliberately deferred decision until a clearer business context emerges.
Turbulence is the new normal

It is vital that manufacturers understand how the various Brexit permutations are currently affecting their operations, and how they may shape risks, business models, and opportunities in the future. Brexit has not yet begun, and it is one further disruption in a turbulent global business environment. Holistic, visionary planning has never been more vital.

 

Sources:
‘The realities of trade after Brexit’, Baker McKenzie, 2017
‘Pain or Promise: Where Brexit Matters Most’, Bloomberg, 15 June 2017
‘The Brexit Storm: how procurement and supply chain professionals are tackling the issues’, Chartered Institute of Procurement & Supply, July 2018
‘Making Brexit Work for the Chemical Industry’, Chemicals Industry Association (UK) in association with Squires Patton Boggs, February 2018
‘How Brexit could smash the British pound a second time’, Alanna Petrov, CNN Money, 21 August 2018
‘A year to go: how Brexit will affect UK industry’, The Economist Intelligence Unit, 2018
‘Brexit and its Impact on the Largest FMCG Companies’, Euromonitor, March 2017
Quarterly Brexit Report: Q2 2018, Euromonitor Passport, June 2018
‘Port of Rotterdam reveals scale of Brexit challenge’, Financial Times, 27 December 2017
‘Brexit: The impact on sectors’, KPMG Economics Insights, February 2017
‘A Brexit Risk Barometer for SME Manufacturers: How tough could things get?’, Menzies LLP, November 2018
‘The impact of Brexit on the pharmaceutical sector’, UK Parliamentary business, section 2, ‘Tariffs’ [www.parliament.uk]
‘Industrial Strategy: Building a Britain fit for the future’, UK government white paper, 2017
www.forbes.com
www.ft.com
www.manufacturingindustryadvisor.com/brexit-dead-ahead/
The Manufacturers’ Organisation UK
pharmaceutical-technology.com
www.supplychainquarterly.com
www.supplychain247.com

 

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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