Friday 19th Jul 2019 - Logistics Manager Magazine

Brexit highlights procurement challenges

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From the crash of Carillion to the brawls over Brexit, procurement is making headlines. For sourcing and purchasing professionals, these are certainly interesting times, says Sam Tulip.

The UK’s withdrawal from the European Union is the gorilla in the room. Any of the likely outcomes demands at the least a deep and urgent review of sourcing and procurement policies in most supply chains. Brexit is already well factored in to the exchange rates, and, with the important exception of foods and agricultural products, any likely tariffs under World Trade Organisation rules are not too onerous. (Typically under WTO, components attract tariffs around the 4 per cent mark). For industry, though, the challenges are as much around disruption, delay and uncertainty. Over half of the UK’s imports from the EU are of intermediate goods – indeed, over 10 per cent of UK industry’s inputs are sourced in Europe. Interestingly, over 70 per cent of our exports to the EU are also intermediates. Duncan Brook, group director at the Chartered Institute of Procurement & Supply, warns that many companies underestimate their exposure to EU suppliers – they know their first tiers, but don’t fully understand what goes on further down the supply chain. Two industries that do have this understanding are aerospace and automotive. Airbus UK has 4,000 suppliers in the UK producing 10,000 original aircraft parts within a highly integrated supply chain in which parts may cross the Channel multiple times. In a “no deal” Brexit the firm expects severe disruption, partly from “friction” in the movement of parts, and more specifically to aerospace, the need to gain new regulatory approvals for design, production and maintenance. Airbus UK suggests that buffer stocks worth Euro 1 billion would need to be set up. Over in Belfast, Bombardier, which makes wings for the Airbus A220 and receives over 1,700 shipments a year, believes it will have to put £25-30 million into buffer stocks: “cash I don’t have” according to Michael Ryan, president, Aerostructures & Engineering Services. Even a more orderly Brexit “… would entail new procedures, regulatory regimes, duplication of tasks, divergence of standards… potentially leading to higher complexity, more effort, more cost, more risks, more friction/delay in our cross-Channel, deeply integrated supply chain operating on a just-in-time basis”, says Airbus. It puts additional costs from more complex trade procedures at up to Euro 1 billion a year. Unsurprisingly Airbus UK says it will “…carefully monitor any new investments in the UK and refrain from extending its UK suppliers/partner base”. In aerospace, re-sourcing is not really a short term option – project lives are measured in decades, and certifying new partners and parts could be as onerous as re-certifying existing arrangements. The automotive sector may have more options to re-source. In fact, this is already happening, and not directly because of Brexit. The UK content by value (measured at T1 supplier level) of volume manufactured vehicles assembled in Britain a decade ago was not much higher than 30 per cent. By 2017 this had risen to 44 per cent, reflecting investment decisions taken prior to the Brexit referendum. Other investments are still coming on stream. However, most observers believe that 50 per cent local content is around the upper limit of what is achievable – even in France and Germany, 60 per cent is as good as it gets. These figures provide a significant incentive for buyers to increase local sourcing. Under most Free Trade Agreements, cars (and many other goods) have to have a minimum home content to qualify for FTA treatment – in automotive, 50-55 per cent is typical, and as it appears, just on the borderline of what may be practicable. It is probably wishful thinking to imagine that we can retain existing EU FTAs with third countries and count parts from our former partners as domestic; and any new trade deals would have similar stipulations. Dr Ralf Speth, CEO of Jaguar Land Rover, warns that over 40 per cent of his production parts are imported from Europe and that at the Solihull plant, 1,500 cars a day use 15 million components. “Any delay to parts delivery would force the suspension of production at a cost of £1.25 million per hour”. At Swindon, Honda’s worst case scenario involves holding an extra 9 days” supply of components, as against the current 36 hours. That would require a 300,000 sq m warehouse – “one of the largest buildings on earth”. In fact it may be that the big challenge for manufacturing procurement generally post-Brexit may be not so much around goods as around procuring logistics services. Can for example transport be contracted for that can economically exploit ports that are under less pressure. And can they source additional warehousing, without committing long term when the situation is likely to remain fluid for some years? Rather incoherent government utterances on whether or not foods, medicines and anything else were going to be stockpiled have created a bit of a panic about warehouse availability, but Charlie Pool, CEO of Stowga, says that “On average, each warehouse in the UK is only 75 per cent full” because firms have taken long-term leases to accommodate growth that didn’t fully materialise, and he advocates bringing warehousing in to the “sharing economy”. Similarly, Steve Purvis, operations director at Bis Henderson Space, says: “The opportunity for collaboration is far and wide. Many warehouse users have excellent facilities, cutting edge IT, and a highly motivated workforce”. This may not solve Honda’s problem, but for other businesses a spot of pro-active tactical property procurement seems in order. Feeling peckish after that quick industry review? Consider the post-Brexit sandwich. The UK hasn’t been self-sufficient in food for centuries and sandwich fillings are no exception. And unlike for most manufactured goods, if there is a fall-back to WTO terms, the potential tariffs are eye-watering. According to the British Sandwich Association, the BLT and other favourites are under threat. 60 per cent of the UK’s Cheddar cheese comes from Ireland and could attract a tariff of Euro 1,671 per tonne (on a current price of Euro 3,000 per tonne). 60 per cent of our ham comes from Denmark, Germany, Holland and Belgium and tariffs on pork range from Euro 172 to as much as Euro 1,494 per tonne while every consignment would need strict veterinary and phytosanitary checks. Although British farmers produced 90,000 tonnes of tomatoes last year, 82 per cent of our consumption is satisfied from abroad, mostly Spain and the Netherlands. There is a similar imbalance in lettuce and the list goes on. Even if British farms could ramp up, say, salad production, that would be at the expense of some other produce which would have to be imported. And, in engineering or in farming, will companies make the large investments (not just in facilities but in training) in increasing UK supply to meet what might be, after all, a relatively short term problem? Even if we do hit a “hard Brexit” that is surely not the end of the story. At some point, perhaps when a few egos have retired, trade negotiations will resume. Meanwhile the bureaucratic nightmares expected at ports will be short-lived. How do we know? Because the EU has told us so! Barely mentioned in Press or Parliament is the Union Customs Code. This simplifies and streamlines Customs and other procedures for trade into, out of and through the EU. It encourages the use of pre-arrival and pre-departure declarations, centralised clearance, and electronic transport manifests. Shippers and carriers will get even simpler procedures through being AEOs (Authorised Economic Operators) using guarantees and self-assessment. And this is a fully electronic system, looking very much like the “maxfac” (maximum facilitation) proposal that EU spokespersons have dismissed as unachievable. Which is odd, because the UCC legal package was approved in 2016, and the whole system is supposed under EU law to be operational by the end of 2020 (although, there is the inevitable IT slippage). HMRC in fact started the roll-out of its UCC-compliant Customs Declaration Service this August. So, buyers face a dilemma. Even if there are alternative sources available, (and as we have seen there may not be) is fundamentally changing the supply base worth the inevitable disruption when new arrangements may take some years to bed down and the problem itself may be significantly ameliorated shortly afterwards. On the other hand, can companies risk doing nothing and hope to survive a significant period of increased costs and disruption, while their Continental counterparts take maximum advantage? How purchasing managers are addressing this conundrum has been the subject of a series of six-monthly surveys by CIPS. (We are using the March figures – new results are due out very shortly after this article is published. See www.cips.org). The major Brexit impact up to March appears to be on pricing – almost a third of UK businesses with EU suppliers had already increased prices, primarily because of currency movements. But two fifths were expecting to increase prices in the future to offset the potential costs of Brexit. Meanwhile, 14 per cent of EU businesses with UK suppliers had already moved parts of their businesses out of the UK. 36 per cent of UK supply chain managers with EU suppliers were already looking for alternative suppliers inside the UK, although “looking” isn’t necessarily “moving”, and John Glen, economist at CIPS, warned “They are likely to have difficulty finding suitable alternatives in the UK. It is therefore crucial they don’t burn their bridges with their EU contacts”. An April survey by procurement advisors Odesma put the proportion of firms looking to re-source to the UK higher, at 45 per cent, but 72 per cent had no current plans to seek new suppliers in non-EU markets. Interestingly, almost half of respondents believed that restrictions on the free movement of workers post Brexit (rather than on movement of goods themselves) would have the most impact on procurement – a point stressed by Airbus – “Our people make 80,000 business trips between the UK and the EU a year”. Brexit may also have implications for public sector procurement rules (which also affect private sectors such as rail and utilities). There is pressure, some of it misguided, for significant change. The UK was one of the prime movers behind rules which seek to stop governments secretly (and sometimes corruptly) favouring particular companies at the expense of the taxpayer. In fact, and despite the furore over the contract to print the new UK passports, relatively few government contracts are won by (or even bid for by) EU companies that aren’t also UK operators. Many of the perceived problems lie not in the Brussels directives, but in Whitehall gold-plating, and in misapplication of the rules. It is not, for example, the case that tenders have to be awarded on the basis of lowest cost – a wide range of other values can be legitimately written in to the award criteria. What is true is that, if the tender has been bid for on a lowest cost basis, the awarder can’t then add in other considerations for political convenience. Too few public servants fully realise that. Leader of the Opposition Jeremy Corbyn wants the UK to opt out of rules on State aid and open competition, to give British businesses preferential or exclusive access to key government contracts. Less radically, the procurement rules are widely blamed for many ills: on the one hand and despite changes in 2014 they are said to make it difficult to encourage smaller suppliers to enter the public sector market; at the same time the Public Accounts Committee report looking into the collapse of Carillion suggested that government procurement processes “incentivised businesses who thought they were too big to fail” to focus on winning bids at unfeasibly low prices. PAC chair Meg Hillier MP called for government to create the right incentives in its procurements by “turning its proposed “playbook” of guidelines, rules and principles for contracting into a set of mandatory requirements”. She also called for greater use of the recently expanded Social Value Act to evaluate the social value of major procurements. Supposedly this will attract new entrants into the market. There is however a problem: ever-increasing compliance requirements, from financial stability to social value, anti-bribery and modern slavery legislation, sustainability objectives and so on inevitably favour large and incumbent companies who can expect to amortise often significant costs over many public tenders. Indeed, a recent Dun & Bradstreet survey of purchasing professionals in the UK and US found 53 per cent claiming that regulations and regulators stop them doing their jobs effectively, while 65 per cent claimed that existing regulations have increased the risk to their businesses. “Due diligence” is the top concern for two thirds of the sample. What space does this leave purchasing managers for the daily grind of identifying and negotiating with suppliers on price, service and specification. Can technology help? There are a lot of tools, some of which have been around for years, to help reduce costs and improve efficiency in procurement, from e-auctions and requirements matching sites to entirely electronic purchase to pay solutions. Artificial Intelligence is beginning to make a contribution. But in most organisations take-up of procurement technology is patchy to say the least. Paul Smith, executive director of YPO (formerly Yorkshire Purchasing Organisation) says that procurement has “only scratched the surface on technology: we are really quite poor generally. Things like blockchain and AI will be massive, but we don’t know in what way. Generally, we are pretty good at getting data, but we aren’t very good at doing anything with it. We have no insight”. Duncan Brooks at CIPS agrees: “People are presenting little pilots of what could be done in the future, but actually there is a lot of current technology that could be used right now”. Part of the problem lies in getting the budget to make change but also, he says, “There are not enough people who really understand how to use technology effectively”. Technology will change the role of the buyer. “By using technology, the buying experience we want to give stakeholders should be like Amazon. Our role may be to get the strategic specifications right, and let Amazon and their automation do the commodity stuff,” says Brooks. And funnily enough, that is a route that YPO is taking. Paul Smith is talking to Amazon about setting up an interface through which his customers can buy from the Amazon Business marketplace for their “tail spend” requirements beyond YPO’s 30,000 lines. As he says “Every school needs a hamster cage. We don’t stock them, but there are six on Amazon”. Of course, buyers already use Amazon independently, but this isn’t necessarily efficient or compliant. By going through a YPO/Amazon portal, the necessary surveillance, compliance and accountability can be applied automatically. At the same time, it is a simple route for SMEs to access the public sector market.

This feature first appeared in the September issue of Logistics Manager.