What should procurement and supply chain professionals be thinking about when it comes to Brexit? This is the question we grappled with most of the weekend (that and, of course, the politics and economics of it all, but we’ll leave our take on what the vote signals longer term for another day).
We’ve grouped our Brexit analysis into two categories: obvious and less obvious considerations. And a big hat-tip to Peter Smith at Spend Matters UK/Europe, who has been covering Brexit and some of these ideas already (see some his posts on the topic here, here and here).
Unfortunately, it is hard to know which way Brexit will drive commodity prices. It could end up being a “big nothing,” or the market could treat it as a black swan event and anything could happen.
Here’s what to look for in gauging impact and direction: If the dollar rallies and the euro and pound fall, commodity prices will likely fall as well, at least in the short term. The converse is also true, if by chance there is a rally in European currencies. In short, procurement organizations should pay particular attention to exchange rates to hazard an educated guess on where commodity prices are likely to head as a result of Brexit.
We are coming off a period of lower volatility in markets. Brexit has set in motion, at least for the short term, a more volatile environment. One way to monitor volatility is the VIX, also known as the fear index, which measures the implied volatility over the next 30 days of the S&P 500 index (i.e., blue chip companies). On Friday, the VIX index jumped over 50% — its largest one-day shift since 2007.
On Spend Matters and MetalMiner, we have cautioned that we are entering a more volatile period for commodities overall. With the rise of the VIX, we can expect greater volatility in general and hence more price uncertainty, as well. Given this, risk averse organizations may consider paying a premium to lock in prices with suppliers over the short-to-medium term. Financial or inventory hedging strategies may also be more realistic in this environment, even if short-term volatility trends negative overall.
Supply Base Management & Sourcing
Organizations with U.K.-based suppliers providing materials or goods directly to Europe, the U.S. or other regions of the world will need to monitor trade agreements closely. These suppliers have been operating under E.U. rules to date and, therefore, exporting materials and goods based on those E.U. trade agreements. This could change in the future, potentially raising costs and increasing supply risk if the total cost of British goods rises in specific regions given less clout at the negotiating table. (Note: Demand may also create additional risk.)
From a procurement angle, any company in the U.K. that is sourcing globally has two risks. The first risk is the import tariff risk and how that might change. Here, procurement groups should evaluate the trade agreements for the products they are sourcing. However, it is likely this will not change quickly, even for products purchased from the E.U., but sourcing organizations will want to quickly identify affected suppliers and parts. Trade lanes such as China to the U.K. pose less risk.
Less Obvious Considerations
Total Cost Management
From a stability perspective, suppliers in the U.K., which are heavily dependent on exports, will likely weather Brexit on stable footing if their component of value-added activities is materially greater than 50% or if their suppliers are sourcing from truly local sub-tier vendors, as well. However, the value-added and local source components are essential to look at. If the supplier is importing materials in Britain, costs could rise, particularly in the medium term.
Welcome to the UK: A New Lost Cost Country for Clever Buyers
Well, not exactly. But the weakness of the pound could make the U.K. more attractive for sourcing efforts for global companies. However, given the death of basic industry in the U.K., it will be essential for smart buyers to separate out base material costs from value-added components, even offering to buy raw materials and commodities on behalf of U.K. suppliers given rising import costs for U.K. companies — or off of negotiated pricing schedules and potential demand aggregation programs and rebate structures tied to an OEM agreement.
Such a strategy could allow global buyers to take advantage of a weak pound while also shoring up their U.K. supply base from a risk management perspective. In short, look at the U.K. as a potential lower-cost source of goods if you can get clever with the raw material and commodity component of total cost.
Brexit: Who is Next?
Procurement and supply chain professionals should look at Brexit not only as a U.K. supply chain issue but also as a broader European political issue. What would happen to suppliers and the supply chain if the Netherlands, Denmark or Sweden left the E.U.? This is a more serious risk that is still out there. Companies may wish to consider Brexit as the “first volley” in a longer-term struggle rather than an isolated shot.
Welcoming Back Basic Industry to the UK
The E.U. dealt the last blow to basic industry (e.g., steel) in the U.K., owing to stringent environmental legislation that made it significantly less expensive to import base materials from heavily polluting suppliers in China (and elsewhere) compared with producing raw and semi-finished materials locally based on E.U. requirements. Exiting the E.U. could help bring back basic industry to the U.K., potentially creating greater diversification and capacity among lower-tier suppliers on a localized basis. Will steel be the first basic industry to see a revival in the U.K.? Time will tell.
What are your thoughts on Brexit, the supply chain and procurement implications? We welcome your comments and input.