How to mitigate the impact of Brexit through sound procurement practice
While uncertainty about the UK’s decision to leave the European Union may be abating, the slew of changes it entails in everything from exchange rates and laws governing contracts to logistics and trade rules are forcing companies to reconsider their procurement strategies.
Category managers and procurement officers that are still grappling with questions surrounding its impact on sourcing, pricing and supplier relationships need to make sure they’re on top of things for the changes ahead.
Brexit’s impact: challenges procurement managers must contend with
Europe will remain the UK’s largest trading partner in short to mid-term, even if the UK leaves the EU. However, procurement trends may change in the long run, and UK-based companies may begin procuring certain commodities from other low-cost destinations.
It’s critical for procurement officers to account for the inevitable regulatory and foreign exchange changes, planning ahead with alternate strategies for purchasing in and out of the UK. Category managers are facing a lot of uncertainties related to Brexit, including:
Commodity Price Changes
With the Brexit, the pound value drastically dropped, falling from $1.48 in May 2016 to below $1.25 in Dec 2016 - putting automotive parts, electrical equipment manufacturers, pharmaceutical businesses, as well as importers in a dilemma about whether or not to continue with current contacts/vendors, or perhaps begin engaging new opportunities.
As currency fluctuations cause the cost of many imports to rise, companies may need to continuously monitor commodity prices in order to re-examine and renegotiate their contracts. Procurement managers are also expected to manage legal and regulatory exposure along with controlling expenses, while also providing valuable intelligence about future trends to key stakeholders.
Large automotive and pharmaceutical companies have a huge number of commercial contracts, particularly with companies in other EU-countries. After Brexit these companies are undecided on how to perform an audit of these contracts, and where to begin assessing the effect that Brexit may have on their rights and obligations under these agreements. Companies want to assess every point to negotiate new commercial contracts, including the Territorial scope of agreements.
Trade Agreement Changes
As a member of the EU, the UK gets access to preferential trading agreements with ~50 non-EU countries, and it can negotiate these agreements because of the large trade volume. After the Brexit however, these companies will likely opt out of these agreements. Re-negotiating trade terms with non-EU entities could take an average of two to three years for every country. Also, due to declining demand in UK as compared to the EU, the terms of new trade agreements are likely to be less favourable and expected to put pressure on UK businesses that have established trade relations with non-EU countries.
Although the Brexit will likely have a ripple effect throughout supply chains for several industries, it’ll probably affect some more than others.
Take the automotive components industry for instance.
Most British automotive manufacturers have assembly plants within the UK, but they procure a sizable portion of their components abroad. The UK imports about 36 percent of their components from the EU and about 21 percent from the rest of the world, while 43 percent of their parts are sourced locally. For both OEM and Tier-1 purchasing, a majority of goods sourced are from EU countries that aren’t regarded as ‘low cost’, such as Germany & France. Trade advantages between the UK and other European countries will wane after the Brexit, spiking the prices of raw components in the long-term. UK manufacturers will have to either procure locally, or opt for low-cost centers such as China and India.
British automotive parts suppliers will probably be hard-pressed if manufacturers opt for the local option however.
Local OEM suppliers are already running at peak production capacity, and scaling up will take some time to meet growing demand. It’s quite likely that, in the short term, British manufacturers will have to source most of their automotive parts from low cost countries such as India, China, Brazil, Argentina, and so on.
Indian auto components exports have increased at a CAGR of 11.3 percent, from $5.1 billion in 2009 to $10.8 billion in 2016. At 36 percent, Europe accounted for most of India’s automotive component exports in 2016, followed by Asia and North America at 25 percent, respectively. There are plenty of notable suppliers in India, including Sundaram Clayton Limited (SCL), Wheels India Ltd, JBM Group, Avtec Ltd, Minda Industries Limited (MIL), Sona Koyo Steering Systems Limited (SKSSL), The Amtek Group, and many more, all of who cater to local as well as global demand.
The sector is also being shored up through substantial investments.
$15.80 billion was invested in India’s automotive industry between April 2000 – September 2016 through Foreign Direct Investment (FDI) inflows, as per the Department of Industrial Policy and Promotion (DIPP) data. French auto parts maker Valeo is planning to invest $100 billion in India over next two to three years. Hyundai is investing $300 million for a new engine plant and metal pressing shop in India, and there are also plans afoot to open its second manufacturing plant in the state of Rajasthan. German auto component manufacturer ZF Friedrichshafen also plans to setup a Technical Centre in the state of Hyderabad.
Additionally, China’s auto parts manufacturing industry has witnessed a growth of 14.98 percent between 2012-2016, driven by a strong local passenger vehicle market. The auto parts manufacturing industry in China has also benefitted from globalization. The key vendors dominating this market space include Beijing Hyundai Mobis Automotive Parts Co. Ltd., Shanghai Huizhong Automotive Manufacturing Co. Ltd., Wanxiang Group Corp., and United Automotive Electronic System Co. Ltd.
With Indian and Chinese automotive components roughly costs 10-25 percent cheaper than their European and American counterparts, it could emerge as a key supplier to Britain’s automotive sector over the next few years.
Procurement best-practices to titigate or reduce the impact of Brexit
Despite the uncertainty and ambiguity of current affairs, there are certain measures that large organizations can take in order to mitigate or reduce the Brexit’s impact on their procurement processes, some of which include:
In order to improve sourcing success, large organizations in the UK will need to monitor spend for every business unit/category, allowing them to increase operational effectiveness. Large organizations can generate cost savings of 5 percent to 15 percent through centralizing or consolidating purchases for categories with high volume or low variants. Large organizations can use a 4-step approach that involves:
Gather and consolidate spend data from all sources into one spend sheet that includes category departments, plants, and operational business units.
Analyze the spend data to ensure that the client has negotiated the best contract/ deal with EU suppliers for every category, product or service.
Analyze the growth in supplier spend in each category across every EU country (post Brexit).
Identify the un-optimized categories where the prices/spend have been increased substantially after Brexit, impacting the overall spend.
Identify the Best Cost Country Sourcing (BCCS) for un-optimized categories
In order to minimize spend on un-optimized categories, large organizations should focus on identifying the list of other trading countries which could be more strategic than the current trading countries. Organizations need to identify a number of sourcing destinations (and the criteria that defines one, such as the availability of raw materials, local labor and utility costs, logistics costs, and so on) in order to decide best cost country for sourcing. Total potential cost reduction or savings may vary depending on category; however large companies can generate a savings of 10 percent to 30 percent. Large organizations are increasing their trade talks with Non-EU members such as Australia, Mexico, South Korea, Singapore and India to mitigate the impact of Brexit on sourcing commodities.
Cost Model Analysis
Identify and compare the production cost break-up covering the direct and indirect costs, such as raw material costs, energy costs, labor costs, overheads etc. for the identified low cost countries. Large organizations should negotiate with the large suppliers in these countries by understanding their cost base.
Supplier Identification and Shortlisting
Identify and engage with a new breed of professional suppliers in the best cost countries, seeking to deliver on quality and service aspects beyond just price. Large organizations can identify best-fit suppliers by developing deep-dive supplier profiling and capability analysis. Additionally, they can negotiate contracts with the new suppliers by identifying different SLA’s & KPI’s that help reduce supply risk.
Commodity/product price tracking and forecasting
Large organizations with multi-licensing needs, specific regional coverage, and other custom fields need continuous price monitoring of all products in order to:
- Track market trends after Brexit.
- Gain global market intelligence.
- Mitigate expected volatility by creating new engagement models/sourcing strategies.
- Assess the value of existing and potential deals.
It’ll be imperative for companies to monitor prices of raw materials regularly across EU and other countries after the Brexit to contend with the possibility of a decline in exchange rates.
By Vipul Kumar, Assistant manager, Procurement Research, Aranca, a global research and advisory firm
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