The result of the 2016 referendum on whether the United Kingdom (UK) should remain in or leave the European Union (EU) shocked Europe ‒ and indeed the world. The UK's decision to withdraw from the EU created uncertainty, leading, among others, to a reduction in UK foreign investment.
The British pound also witnessed a sudden plunge, resulting in higher prices for imported goods and lower wages in some parts of the country. The Brexit referendum’s overall impact on trade was surprisingly low in the years that followed. This was at least until the Trade and Cooperation Agreement (TCA) came into effect in 2021, concluded between the UK and the EU. The TCA marked the end of the transition period and prevented the burden of tariffs, but it was no substitute for free trade and gave rise to red tape that led to UK businesses rethinking the configuration of their supply chains.
Mind the import gap
In 2021, trade with the EU and beyond was likely significantly affected by Brexit, with the TCA reducing goods trade with the EU by around 15% relative to non-EU trade.1 Interestingly, while goods exports have returned pre-pandemic levels relatively quickly (figure below on the left), UK goods imports from the EU have struggled to reach pre-pandemic levels until March 2022 (see figure below on the right).
This import gap does not seem to be exclusively attributable to the pandemic, considering that within-EU trade—for example, trade between Germany, Italy and France—returned to pre-pandemic levels much sooner.2
Moreover, since March 2022, the gap between the growth in UK imports from the EU and those from non-EU countries has persisted (see figure below on the right), with the level of imports from the EU being only marginally above their pre-pandemic level, 4% on average, against 41% higher growth on average in non-EU imports.
Reconfiguring supply chains
One reason why imports from the EU lag those from non-EU economies might be related to how UK businesses have been adjusting their supply chains since Brexit. According to ONS survey data on 39,000 firms, around 7.5% of UK businesses had transformed their supply chains within 12 months of the end of the Brexit transition period3. The two most common strategies were supplier diversification and nearshoring (i.e. transferring business operations closer to home or to the domestic market).
Businesses that diversified their portfolio of suppliers, are likely to be better prepared to absorb shocks of different nature. At the same time, since the TCA increased red tape and made trade with the EU more difficult; some UK businesses might have looked for alternatives in the domestic market as a result.
By the end of 2020, 28% of surveyed businesses planning to transform their supply chains stated that they wanted to further diversify their suppliers. After the TCA came into force in 2021, many more businesses decided to diversify their supplier portfolio4. Fifty per cent of businesses that had planned to adjust their supply chains sought to increase their domestic suppliers (see figure above and figure below). Data from 2021 corroborate that the number UK businesses' domestic suppliers did indeed increase in line with their initial plans5.
This supply chain reconfiguration was evenly distributed across businesses of all sizes, possibly indicating a change in mood among UK businesses. Faced with a trade-disrupting shock such as Brexit, they may have preferred suppliers that are located closer to home. Yet nearshoring is not necessarily a risk-minimizing strategy. In fact, overreliance on domestic suppliers may end up being self-defeating. Although businesses that rely primarily on domestic suppliers may be less exposed to foreign shocks, they could be left with no alternatives to source supplies from if subjected to a domestic shock.
Partnering with the right businesses to reduce risk
Value chain reconfiguration usually entails fine slicing and the modularization of activities. It furthermore entails choosing the right suppliers and ensuring a smooth onboarding process, which increasingly requires availability of high-quality data. The risks suppliers might pose to the value chain need to be regularly evaluated as well, even if such assessments affect the speed with which businesses are able to transform their supply chains. To test a potential partner, for example, a business might order only small quantities of goods from a supplier until it feels confident about scaling up, which might prolong the overall transition timeline.
Lengthy supplier onboarding times signify that businesses set up supply chains with the aim of proactively protecting themselves from future shocks before they even arise rather than being left to adopt a reactive response to an external or internal shock.
Business size plays an important role in risk assessment and when evaluating potential partners. Large businesses tend to have bigger budgets, i.e. they are more likely to have the necessary resources to mitigate damage caused by changes in the marketplace. This makes teaming up with larger suppliers more desirable than with smaller ones. On the other hand, however, large suppliers might use their bargaining power to squeeze out small buyers when market conditions tighten. Tighter market conditions usually lead to longer payment delays and higher insolvency risk among smaller businesses. This was not the case in 2021, however, when business liquidations remained well below pre-pandemic levels for the whole year (figure below).
While government support kept insolvency risk artificially low during the height of the COVID-19 pandemic, data for the from first trimester of 2022 shows a surge in UK business liquidations as government support, like the Job Retention Scheme, came to an end. Now, smaller businesses are likely to face more difficulties than their larger counterparts in terms of optimizing their supply chains, growth and staying competitive in our rapidly changing global environment.
Strategies to identify and monitor risks along the entire supply chain are becoming increasingly commonplace. Businesses will essentially have to expand their risk control activities, especially as they diversify and start incorporating more suppliers into their value chains. In short, to stay competitive, businesses, regardless of size, have to set up agile supply networks based on a systematic and risk-based approach. In turn, investments in technologies that can process data and monitor suppliers in the value chain in real-time will also play a crucial role, providing businesses with a competitive edge.
The way forward for UK businesses
In the current turmoil, Brexit is likely acting as a shock amplifier – first at the micro level for British businesses, which are at risk of facing severe supply disruptions in case of delays in delivery, and at the macro level for the UK as a whole.
Going forward, businesses should continue to pursue supply-chain strategies that minimizes risk across multiple dimensions. Which strategy businesses apply to achieve these objectives depends on the business’ individual characteristics (e.g. size, revenue, industry) and the contingencies they face (e.g. macroeconomic condition in the customers and suppliers markets, at home or abroad).
Rapidly changing markets make it difficult to forecast how global developments—even those closer to home—will continue to impact supply chains. On the one hand, businesses need to be open to pursuing new avenues while not making any snap decisions; on the other, that might impact them in the medium- to long term.
This is where investments in accurate data, technology and partners can support businesses in gaining greater transparency about their supplier networks and the insights they need to make informed decisions about how to diversify them.
There is no ‘one size fits all’ solution when it comes to hedging against supply chain risks. While thorough risk assessment might endorse a higher reliance on domestic markets and suppliers, this should not be the starting point. Rather, businesses in the UK and beyond should adopt an agnostic approach to risk assessment and supply chain design, one that enhances business agility and minimizes risk in a dynamic fashion.
Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).
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