Since the automotive industry is one of the industries we work with, we have to understand how a macroeconomic factor such as Brexit could affect our partners. Therefore, we did some research into “how Brexit will affect the automotive industry” and we are happy to share with you our findings.
The answer is pretty simple: right now, the automotive industry occupies one-tenth of the total manufacturing output in the UK. There are more than thirty manufacturers, who produce approximately seventy different models. How do they decide where to produce each model? There are plenty of factors regarding the economics of volume production, which include local legislation, taxation, infrastructure, ease of exporting/importing, availability of skilled workers and many more. So what happens if the business climate changes? The manufacturers stop investing.
According to the Financial Times, investment in the UK’s automotive sector has halved due to the Brexit uncertainty. And it is absolutely understandable: if manufacturers cannot foresee what to expect from a certain political decision, the best case scenario would be if they postpone local production of new models. Some big market players are even able to switch their production between different countries. But how could this huge and stable (at first glance) sector be affected by Brexit so much, that manufacturers will prefer to leave the UK?
The automotive industry is one of the most exposed industries to potentially damaging setbacks resulting from Brexit, considering that four in five vehicles made in the UK are made for export, and half of these are being exported to the EU. Despite the fact that postponing the date of Brexit is being discussed, we still have at least three options on the table regarding how Brexit could end: soft Brexit, hard Brexit and no-deal.
Shortly put, soft Brexit is an agreement with limited tariffs and regulations. Hard Brexit and no-deal, in regards to our subject matter, have essentially identical consequences. So with this in mind, in case of a hard Brexit or no-deal, the UK can face two types of barriers: tariff and non-tariff. You can read more about different options here. At this point, you may wonder which option actually works for the automotive industry and the answer is “none of the above”.
One of the largest trade associations in the UK – The Society of Motor Manufacturers and Traders (SMMT)– in an open statement regarding Brexit, states that automotive industry needs to maintain access to the single market, keep the same regulation policy and access to the EU’s workforce, as well as still be a part of the regulation process. Basically, the automotive industry wants to keep everything as it is right now. And there are plenty of reasons why, let’s review them one by one.
In case of a hard Brexit, no-deal – or another such sup-par deal on part of the UK – WTO tariffs are liable to be applied. The WTO tariffs for cars are 10%, for vehicle components – 4.5% on average. These numbers are huge considering the average profit margin of 3.5-4%. A report prepared by The House of Commons’ Committee says that:
Since automotive manufacturing is a complex process, which requires multiple border crossings, the prospect of tariffs being applied every time a part moves from one country to another, is a daunting one indeed. A situation like that would call for the implementation of a fickle system of repayments of multiple charged payments if the product is imported for re-export.
According to SMMT analysis, EU tariffs on cars could add an annual £2.7 billion to imports and £1.8 billion to exports. At the same time, Jaguar Land Rover claims that frontier crossing under the new rules could cost them up to £1.2 billion annually. However, it is unclear whether this number includes additional costs that could arise from non-tariff barriers.
There are three major types of non-tariff barriers that could potentially come to affect the British automotive industry:
Border delays. Currently, the logistics of the UK’s manufacturers is built around the fact that transportation across the Strait of Dover is a reliable and robust process. There was no need to keep more than one day’s worth of stock of imported parts from the EU, and no more than two-three weeks’ worth of stock of imported parts outside the EU. This means that to avoid delays attributed to altered border procedures, manufacturers will have to build logistics processes from the ground up. Honda went over the calculations and, according to them, a 15 min delay could cost as much as £850,000 annually. Expected bureaucracy will raise the cost further: Ford is getting ready to provide 115,000 declarations for its import alone.
Access to a qualified workforce. SMMT states that at least 10% of all people employed in the UK’s automotive manufacturing sector are from elsewhere in the EU. Moreover, the UK automotive industry currently has over 5,000 vacancies in the sector, that cannot be filled locally.
Rules of origin. Even if Britain will be able to get a free trade deal, manufacturers still have to comply with the “rules of origin”, to avoid paying duties or tariffs. Rules of origin are designed to determine a product’s country of origin. When a product as complex as a car is being exported, it is quite a task to determine the originating country, due to the fact that the imported parts can easily reach 80%. For example, if 80% of all the parts were made in China and then a car is assembled in the UK, it cannot legally be considered a UK-made car. To be labelled as a vehicle made in Britain, the overall percentage of locally produced parts has to be at least 55%. But why?
Let’s say that China and the UK have a preferential trade agreement with each other. Accordingly, China doesn’t have to pay duties on parts exported to the UK or has to pay less than if the same parts were exported to Europe. Hence, China is obviously benefiting while a final assembly is being exported to the EU under EU-UK free trade agreement. If simplified, the rules of origin should prevent benefiting any other country that doesn’t have a free trade agreement with the EU in place.
At this point, vehicles made in Britain contain approximately 44% local content. But the number can very well vary for different market players. For example, Honda sources only 25% of locally-made parts. Therefore, to enjoy preferential treatment under the free trade agreement that the UK could potentially enter into, manufacturers would have to rebuild their supply chain and source more parts from the UK.
If the deal won’t be ideally tailored, there are not many options. The first two which are coming to mind are:
It has to be mentioned that there are multiple factors – and combinations of said factors – that correlate with the amount of damage that Brexit could bring to each manufacturer. For example, part of the players came to the UK to have access to the single market, as Toyota or Honda did. Part of the players can’t just move their production to a different country, because their core of brand was built on the idea of “Great Britain origin”, it is the case for Bentley, for example. Middle and luxury segments will have a different set of issues that has to be solved. The list of details goes on and on. The major thing that everyone will have in common, is a rapidly rising need to establish strong local supply chains.
Rules of origin, tariffs, drag on the border – at least these issues could be eliminated if using locally made parts. Of course, a decision to move production will increase costs in the short term, but in the long term it will bring obvious advantages: the UK components will become more competitive compared to imported ones.
That is why, at Polymermedics, we have decided to move the expertise in optical production and automotive market from our Germany-based sister-company to the UK. Neil Skyba, Polymermedics Operational Director says: “We were always focused on the medical and pharmaceutical markets, which means that Polymermedics is an unordinary combination of medical cleanness, precision and highest quality standards. And this combination gives us the freedom to implement production for any demanding market, such as automotive. We believe that it is possible to build a strong domestic supply chain for car manufacturers and we can clearly see here an opportunity”.
This vision is supported by the government’s policy the government’s policy, the goal of which is to increase the value of the UK content in produced vehicles to 50% by 2022. The policy is backed with match-funding to supply companies in the automotive sector.
There are dozens of trends that are shaping the market right now. Among them are: moving of manufacturing centres to Asia, electrification, rising demand for autonomous-driving vehicles, safety and emissions reduction focus and many more. In terms of economy, this means that the costs for manufacturers are constantly rising. At the same time, according to the McKinsey report on the automotive industry, EU prices on vehicles were almost constant for a decade: growth of the price was wiped out by the same level of inflation.
Due to the low-profit margins in this sector, a potential introduction of tariffs and non-tariff barriers could have a devastating effect on profitability. The safest long-term solution would be to build a strong and robust local supply chain, and we at Polymermedics are ready to take up the challenge.