Thursday 21st Nov 2019 - Logistics Manager Magazine

Logistics Manager Analysis: supply chain and procurement – deal or no deal?

For more than three years, sourcing and procurement teams have had to grapple with the potential implications of the UK withdrawing from the European Union. Procurement responses have varied widely, Sam Tulip investigates.

Some firms are in denial (that it will ever happen, or alternatively that there will be any major consequences); some have planned and war-gamed a host of alternative scenarios; some, rather fewer, have actually committed quite significantly both to short term emergency provisions, and to longer term supply chain remodelling.

Brexit, on whatever terms, will be a serious shock and cause disruption to many supply chains. But Brexit is only the starkest and most immediate of a series of shocks that are set to hit international trade.

For a generation or more, the belief has been that ever-greater globalisation of trade between increasingly interdependent nations is desirable, inevitable and irreversible. Bilateral and multilateral agreements for trade free of tariffs and quotas will mushroom. National economies and political systems will ‘converge’ around a liberal free market model and procurement can romp in an ever-expanding, risk free, playpen of global supply.

Things don’t look quite so rosy now. Voters and politicians have pushed back against globalisation. NAFTA has been under pressure. Both the TransPacific Partnership between 12 countries around the Pacific Ocean, and the EU/US TransAtlantic Trade and Investment Partnership, have failed to get off the ground.

Trade is becoming re-enmeshed in power politics. The US asserts exerts extraterritorial rights to dictate whether and on what terms other nations can do business. China regards any refusal to allow the likes of Huawei to bid on contracts as an unfriendly act. A buyer’s concern about environmental, human rights, or animal welfare is an unwarranted interference in a nation’s internal affairs. Japan is restricting supply of materials for the electronics industry to South Korea over claims relating to the pre-1945 occupation of Korea. A minor issue, if you are not Japanese or Korean, but one that could impact many supply chains.

And then there is climate change. Professors Leon Terry and Richard Wilding of Cranfield University said:

“We’ve created a just-in-time system that’s delivered all kinds of benefits in terms of choice, cost savings and reducing inventory needs – but which contains an essential vulnerability. We know that unpredictability is going to become more the norm.”

They were writing about food, but the point is more widely applicable.

So Brexit hasn’t come out of a clear blue sky – it is rather the bellwether for a flock of issues and challenges to regional and global supply chains.

Pile it high

Given this context, what have been the responses to Brexit from the UK’s procurement and sourcing professionals? We can get a good idea from the most recent Brexit Survey from the Chartered Institute of Procurement & Supply (CIPS), which was conducted before the original leave date in March.

Inevitably, defensive strategies take centre stage. There is a quite reasonable belief that any Brexit, deal or no deal, will involve some level of friction and disruption for goods entering the country, especially, but not solely, via the Channel Tunnel and ports.

Some 60% of manufacturers, and 48% of retailers, reported that they were increasing stocks of goods and materials in advance of Brexit. Another 8% and 5% respectively would, except that they can’t locate suitable warehousing space. That was in the Spring – for the October deadline, when many firms would normally be stocking up anyway in advance of Black Friday and Christmas, the warehousing market must be even tighter. Even without Brexit, the UK is said by property agents Savills to be ‘underwarehoused’.

What exactly are these stocks guarding against? In manufacturing, 12% of the CIPS survey sample operate essentially stockless just in time supply chains; 4% carry 1-3 days’ stock and 7% less than a week’s worth. These companies are at risk from all but the most minor border friction. For other firms the rationale behind stock-building is less clear, though thoughtful buyers will consider the risk of supply failure should vendors, such as food processors, experience post-Brexit labour shortages.

The impact of stockpiling is hard to judge. Macroeconomic figures in the Spring appeared to show a stockpiling bounce for UK manufacturing. When the Autumn figures are published, Brexit effects may be masked by the normal pre-Christmas stock building, and of course many firms may not have run down their Spring stockpiles. Nonetheless over the Summer the CIPS/Markit Purchasing Managers’ Indices had businesses reporting that stockpiling was directly leading to higher prices and extended lead times.

Stockpiling activity may show up in the Office of National Statistics figures for August: not in manufacturing particularly (up just 0.3 per cent) but in rental and leasing activity (up 3.3 per cent over July) and in warehousing and support services (up 1.2%).

Of course, amid the over-excitement of pundits and politicians, it is not easy to distinguish emergency or panic ‘stockpiling’, from a well-considered decision to increase the buffering in the supply chain, or to move stocking locations, or from an entirely normal seasonal stock increase.

For example, Irish cheesemakers and French champagne houses have prepositioned extra stocks in the UK, while UK exporters have increased inventory holdings in Europe. That doesn’t necessarily increase the amount of stock in the system. (The champagne houses claim to hold enough to satisfy a year’s UK demand, which does seem to be a bit of an over-reaction).

In March, Tesco reported it was holding an additional £200 million of long life goods – which in the context of a £50 billion revenue company isn’t even a rounding error. Different firms clearly see risks in different areas: Waitrose is said to be increasing stocks of wines, olive oil and canned goods; the Co-op’s pain points are bottled water and toilet rolls. Domino’s Pizza has put £7 million into stockpiling imports of tomato sauce and cheese. In some cases these increases may not be in the expectation that supply will fail, but that panic stockpiling by other firms (and consumers) will drive prices up.

Meanwhile Scottish Power was reported as ‘stockpiling’ wooden line poles from Scandinavia. Actually, they said ‘We are buying in enough materials to ensure are stocks are at the right level for winter and storm season’. Likewise, Anglian Water has ‘maintained winter levels of critical spares throughout the summer’. Not quite the ‘race to beat Brexit stockpiling’ of the headlines.

Who pays the ferryman?

Extended journey times and stock building inevitably increase logistics costs. Of greater immediate concern to buyers is the current impact of exchange rate fluctuations and the unknown future impact of tariffs.

During the Brexit process the pound has fallen significantly –and whether Brexit is fully priced in is anyone’s guess. That raises the price paid not just for imports but also for UK sourced goods that are traded in, or whose major constituents are traded in, other currencies. Even domestically produced milk is traded in Euro.

Some buyers may even be tempted to hedge their positions against exchange rate movements, or currency-influenced changes in underlying material prices, through the currency and commodity markets.

As to future tariffs, the headline WTO rates – an eye-watering 40 per cent plus for some agricultural products for example – are of course misleading: those are the maximum that the UK is allowed to impose. We could choose lower, or even zero, rates, providing they apply universally. Many retailers and consumers, but for manufacturers, tariff-free inputs are only a partial consolation if finished goods exports to EU markets still attract the full rate while their EU competitors for the UK domestic market can bring goods in free.

Also to be considered are goods currently imported tariff-free from non-EU countries under EU-negotiated trade agreements, which do not automatically carry over. Deals with nations including Japan, Turkey and Algeria are not expected to be renegotiated by 31 October.

The CIPS Survey suggests that the preferred method of dealing with tariffs and other new costs is by reaching for the contract. Just under a third (31%) of companies have added new clauses to contracts to allow renegotiation over currency fluctuations, and three-in-ten (29%) have tried to renegotiate existing contracts to DDP (Delivered Duty Paid) or similar Incoterms to cover tariffs.

Some buyers will have the clout to impose new contract terms; many will not. Either way, these conversations are unlikely to improve supplier relations, especially as between a quarter and a third of buyers say they would delay payment if receipt of goods is delayed even through no fault of the supplier. This strategy may be very short-sighted.

Onshore, offshore

Other strategies are in play. In manufacturing 17 per cent of firms say they have reshored part of their supply chain to the UK and 14 per cent have switched suppliers (not necessarily to UK companies). Two thirds of companies said that at least some EU inputs could not be replaced by UK suppliers, even if those suppliers had the capacity. Within Europe there may be sources better placed to use ports and transport routes that are under less pressure – and greener: a study by Hull University for port operator ABP found that shipping through the Humber ports, rather than through Dover, added 3 hours to a 34 hour journey, but reduced carbon emissions by a quarter.

The CIPS survey found that 18 per cent said that they could switch to UK suppliers but at higher prices. If main suppliers either from the UK or EU hit problems then 37 per cent don’t have a back-up in mind, while 27 per cent have back-up outside the EU, 11 per cent have a back-up elsewhere in the EU, and 21 per cent have back-up in the UK.

A sudden rush of manufacturing back to the UK seems unlikely: there isn’t the spare capacity or labour. New capacity takes time to build and the old industrial sites are now being converted into office space and blocks of flats.

Understanding your supply chain

So how are sourcing and procurement teams analysing and planning their longer-term responses, not just to Brexit but to the other threats to existing supply chains?

It is about fully understanding risk, at the level of individual items, suppliers and shipping lanes, and looking not just at direct vendors, but at the risks in their supply chains. Even a British vendor may depend on key imports and dual sourcing is not a strategy if both vendors use the same at-risk component.

After the immediate turmoil of Brexit, or any other seriously disruptive event, there will be a ‘new normal’, but this could take several forms, demanding different responses.

Physical trade could settle back into a predictable pattern much like the present, only with increased transit times.  Exploration with suppliers and carriers of ‘the road less travelled’ could be profitable, as could choice of mode – unaccompanied trailers or containers rather than ‘driver with load’. Transport costs will inevitably rise (because time is labour cost, and because longer transits effectively take up capacity), and there will be more inventory in the system, which needs financing, but JIT business models are not necessarily invalidated.

Physical trade could alternatively become permanently unpredictable, as authorities increase random inspections, or run targeted ‘campaigns’, or border crossings become weaponised – diplomatic spats, labour protests, fishing rights. Unpredictable transits could lead to significant demurrage costs. The response may be permanently to increase buffer stocks at appropriate locations, to seek alternative domestic sources, to purchase fewer, larger consignments, or to sit down and reconsider the business model. Is JIT operation still viable or desirable? If ‘stockless’ manufacturing can only be supported by large inventories further back in the supply chain, it may not be. The rationale may also be undermined by friction in export logistics, if fulfilment can only be satisfied by holding large finished goods inventories abroad.

Unpredictable transit times imply undependable lead-times. There will be an increasing need to track and manage goods and contracts in real time, and to share this with end users and customers. It is particularly important that end users have confidence in this, otherwise demand forecasts and purchase quantities will be inflated by ‘just in case’ provisions.

New tariff regimes and potentially more volatile exchange rates are obvious commercial risks. There may also be changes to VAT, and other duties and excises, not least in the mechanisms for netting these off or claiming them back. Changes in licensing requirements for trucks and trailers, and in the rules on cabotage, could also affect costs.

Procurement will also need to consider possible non-tariff barriers. An increase in the use of quotas is not impossible, despite what GATT/WTO rules say. Changing rules on holding goods ‘in bond’ may also have an impact. Divergence on standards and regulations would lead to considerable increases in physical inspections at borders. Labelling and packaging specifications need to make verification easy for officials, while standing up to extra, not necessarily respectful, handling. Companies switching to alterative non-EU suppliers will have to become more familiar with ‘country of origin’ rules.

Trade disruption inevitably increases variable costs. Contracts may not share this pain equitably and will need to be renegotiated. If the burden of increased inventory is pushed back onto suppliers, these may need financing support.

A good procurement team will have most or all of the skills necessary to weather Brexit and other storms. But to use these skills proactively they need to develop in three ways:

  • A deeper understanding of where their supply chain risks lie
  • A full visibility of their supply chains, end to end across all the components
  • Systems that will automate the mundane, and support risk analysis and mitigation in real time.

These are not traditional areas for Procurement, but they will become increasingly central to sourcing strategies. And the bad news is that there is no one-time fix – even with a no-deal, or some sort of withdrawal agreement, there will at some stage be a ‘proper’ UK-EU trade agreement with new rules. Meanwhile, the general increase in trade friction ensures more uncertainty. Cross-border sourcing and procurement can no longer be reactive: they need to be alert for emerging problems, solutions, alternatives, and opportunities, across the supply chain.

Peaking for Christmas?

As the supply chain prepares for the Christmas Peak a CIPS survey, published before the now-missed exit deadline of 31 October, found that one-fifth (21%) of UK and EU supply chain managers were importing their Christmas stock earlier to avoid border disruption. However, there was evidence that the risk of a no-deal is making this difficult with 9% of businesses struggling to find affordable warehouse space to store Christmas stock and the same proportion concluding that they may not be ready for Christmas at all this year as a result of Brexit.

While almost half (48%) of UK businesses have not had their Christmas preparations affected at all by Brexit, more than a fifth (21%) say that moving the deadline from March to October has made their Christmas preparations more difficult.

Dr John Glen, CIPS economist and visiting fellow at the Cranfield School of Management, said: “Festive cheer appears to be in low supply for UK businesses, with many concerned about the impact Brexit will have on their ability to survive the busy Christmas period.”

This feature originally appeared in the October 2019 edition of Logistics Manager: click here to subscribe to the print edition