This article originally appeared on WSJ.com.
Every so often, politics drops a bomb on business, causing many firms to rethink how and where they operate. The bomb of Brexit has forced new risks and difficult decisions on companies as they stare at their supply chains designed for a borderless Europe.
The hard Brexit envisioned in the negotiating strategy of British Prime Minister Theresa May poses substantial risk to the profitability of companies operating in the U.K. (A hard Brexit would take Britain out of the EU’s single market in order to reclaim control of immigration and shake off the authority of the EU’s courts.) Disruptions to supply chains, for example, could reduce the net profits of five key manufacturing industries by as much as 30%, or £3 billion, with automotive and technology industries among the hardest hit, according to analysis by my company, Bain & Co.
Many boards and senior executive teams are actively discussing their next moves. But preparing for a hard Brexit scenario by reconfiguring the supply chain now could backfire. It will likely take two years or longer for the U.K. to agree on the terms of the country’s future relationship with the EU. If the U.K. eventually winds up with more favorable terms through a softer version of Brexit, companies that move manufacturing or sourcing out of the U.K. now risk incurring a higher cost base unnecessarily.
At the same time, leadership teams that are reluctant to act cannot afford to do nothing, as waiting for a clearer sense of the future is the riskiest option. When I hear executives talk about Brexit, I recall interviews I did years ago with Eastman Kodak executives, asking them why Kodak failed to respond in time to the threat of digital photography. One executive told me, “We never broke down the digital monster into bite-size problems. We kept the issue at too high a level and could never walk out of a meeting with specific actions.”
I fear this is happening with Brexit, a huge topic with many unknowns. It’s fruitless for leaders to ask their staff to create a supply chain that will respond to Brexit. Instead, they should break the problem down into subcomponents. Executives can pinpoint the few risks that matter most to their own business, look at how each potential Brexit scenario would impact their operations, and watch for the signposts that signal a scenario is becoming reality.
A handful of factors will determine how significantly Brexit will disrupt companies’ supply chains: tariffs, foreign exchange rates, and the U.K.’s labor market regulations, immigration laws and tax policy.
A hard Brexit could include a shift to standard World Trade Organization tariffs (2% to 13%) on all exports and imports, a 10% increase in the cost of U.K. labor and a 20% depreciation in the British pound. A moderate scenario could involve a rise of up to 5% in export and import tariffs, a 5% increase in the cost of labor and a 10% currency depreciation.
Industries facing the biggest risk are retail, automotive and technology. These sectors would see the greatest negative impact on profits from import and export tariffs, higher inventory requirements to compensate for procurement bottlenecks and delays, and a depreciation of the British pound.
On the other hand, net exporters in industries with low WTO tariffs, such as aerospace, or industries characterized by zero tariffs and a global production footprint and sales mix, such as pharmaceuticals, could potentially benefit from a hard Brexit due to pound depreciation and lower U.K. tax rates.
Brexit’s impact may vary even within a given industry because each company’s supply chain is different. A food company with heavy production in the U.K. and Spain could be hit hard if Brexit triggers a shift to WTO customs duties on sugar beets. By contrast, a manufacturer that currently pays high EU tariffs on sugar-cane imports from Brazil could benefit if the U.K. agrees after Brexit to the more favorable WTO tariff structure on non-EU sugar-cane imports.
Company leaders can anticipate multiple outcomes long before the post-Brexit world takes shape. To do that, they need to break down Brexit into specific scenarios that can each be managed. What is the potential currency impact of a hard Brexit, and what would it mean for our customer X? What is the effect on tariffs (raw materials and work-in-progress in, finished product out) on our operations in country Y?
There’s a side benefit as well: Greater agility may help companies brace for other supply-chain risks, from the possible instability or breakup of the eurozone to changing U.S. trade policy under the Trump administration. The best prepared companies have stopped asking “what do we do about Brexit?” Instead, they focus on “how should we change our supply chain in response to a set of realistic scenarios?”
James Allen is co-leader of the global strategy practice at Bain & Co. and co-author of The Founder’s Mentality.