Brexit has put the brakes on the UK’s automotive industry, which until recently had been achieving record performance levels. Maintaining competitive trading conditions with the EU and harnessing new opportunities for manufacturers and suppliers is vital to ensuring its progress is not reversed, writes Shannon Manders.
Up until the start of this year, the UK’s automotive sector had had its foot on the accelerator. 2016 was a successful year for the industry, with production achieving its best performance since the turn of the century, record exports and significant growth in local vehicle content.
But as Brexit negotiations rumble on, there is growing concern that the car industry – a stalwart of the UK economy, accounting for 12% of total exported goods – will run out of gas.
Already there are signs that it may be sputtering to a halt: in June, British car production was down significantly compared to the same month last year. Brexit uncertainty was blamed for the 13.7% drop.
The potential implications of Brexit on tariffs, customs charges and procedures, exchange rates, the free movement of people and supply chains has resulted in much uncertainty for an industry that is heavily reliant on cross-border trade in both components and final products.
It’s a double-whammy for UK car makers, who are simultaneously getting to grips with the demand for, and development of, hybrid, electric, connected and driverless cars, although progress in these new ventures may cushion any adverse effects of Brexit.
The good news is that cars manufactured in Britain are becoming more British, according to a new Automotive Council study, released in June. Today, a total of 44% of all components used by UK carmakers come from domestic suppliers – up from 36% in 2011. (Anecdotal reports suggest that countries such as France and German achieve up to 60% local content, says the Automotive Council.)
The growth in local content comes with a myriad of benefits for the UK supply chain, says the Automotive Council’s report, entitled Growing the automotive supply chain: Local vehicle content analysis. For one, because manufacturers are sourcing more from a local supply base, it means they’re able to operate on a “just in time” delivery basis, which results in savings in both time and cost, and reduces the risk of delays.
Secondly, a healthy domestic supply chain is a good draw for increasing the attractiveness of the UK as an inward investment destination.
Moreover, local supply chains are going to become increasingly important if the industry is going to take advantage of beneficial trading terms in any post-Brexit trade deal: originating content must meet minimum rules of origin thresholds, else reduced tariffs might not apply.
In other good news, up until last year, the number of cars being produced had increased: from 999,000 in 2009 to 1.7 million units in 2016. Exports last year also hit a record high, with 1.35 million vehicles shipped abroad – a 10.3% rise on the previous year, according to industry body the Society of Motor Manufacturers and Traders (SMMT).
In July this year, the export of commercial vehicles continued to look strong: the SMMT reported that 63.5% of all production of vans, trucks, buses and coaches in 2017 has been for overseas demand – the highest level in seven years – with the vast majority going to Europe.
The bad news, however, has seen a lot of this success being run off the road. Investment in the auto sector dropped significantly in 2016 (to £1.7bn, from £2.5bn the year before, according to figures compiled by the SMMT). 2017 is not faring much better: to date, investments have reached £647.4bn, which includes the London Taxi Company’s investment of £325mn into an electric car plant in Coventry, announced in March. It does not include any money allocated for BMW’s production of the first Mini electric vehicle, which it said in July would take place at its Oxford plant, as the financial terms of the deal have not yet been revealed.
Production is also beginning to dip. In the first six months of 2017, the number of cars made fell by 2.9% to 866,656 according to the SMMT. In June there was a 13.7% drop in output compared to June 2016. The number of cars made for export fell 0.9% to 683,826.
Domestic demand is also waning: new car registrations are down (nearly 5% in June compared to the same month last year), as is demand across business, fleet and private buyers – with falls of 23.8%, 10.1% and 6.8% respectively, says the SMMT.
The auto industry has blamed the lack of government clarity on Brexit for the plummeting numbers. It is widely believed that clear and transparent negotiations are needed to minimise surprises for an industry that will need time to transition.
“World-class engineering, productivity, strong government collaboration and massive investment in the past few years have helped the UK automotive sector become a global success story. At the heart of this has been the free and frictionless trade we’ve enjoyed with the EU – by far our biggest customer and supplier,” says SMMT chief executive Mike Hawes, addressing the manufacturing drops.
“But Brexit uncertainty is not helping investment and growth is stalling. The government has been in ‘listening’ mode but now it must put on the table the concrete plans that will assure the future competitiveness of the sector.”
According to statistics quoted by law firm Squire Patton Boggs in its report entitled Automotive sector contracts: The impact of Brexit, 79% of all vehicles produced in the UK in 2016 were exported, with some 56% destined for buyers in EU member states, and a good number of others going to buyers in 30-odd countries which have free trade agreements (FTAs) with the EU.
In addition, the firm says, the EU component content of vehicles that are produced in the UK averages out at 59% (and higher for engines), with many components moving between the UK and EU countries several times during the manufacturing process.
In short, the UK’s membership of the single market has enabled it to trade freely across the EU without incurring the cost of tariff and non-tariff barriers or customs checks; access talent from across the continent; and enjoy preferential trading terms with numerous global markets through the EU’s FTAs.
It’s understandable, then, that UK carmakers are getting revved up about Brexit, which threatens to remove all of these best nest practices and undermine the industry’s competiveness.
Speaking at the SMMT’s International Automotive Summit in June, Hawes described Britain’s decision to leave the EU as the “greatest threat” to the country’s auto sector.
“What has been bad for business is the sheer amount of political uncertainty, and the high chance that this government is not going to make it through all these very complicated and complex negotiations, and get them all through parliament,” explained Bronwen Maddox, director of the Institute of Government, at the summit, which took place just two weeks after the UK’s snap general election in June.
Chris Giles, economic editor of the Financial Times, speaking on a panel alongside Maddox, cautioned the auto industry against being complacent about Brexit negotiations. “It’s a zero-sum game,” he said. He and other speakers called on businesses to make their voices heard to drive the government to adopt a transition period.
“Having government realise that transitioning in pretty much the arrangement we’ve got today is something that industry should push for, because then you’ve got the time to work out what the long-term trade-offs and costs and benefits are,” Giles said. “Then companies can plan business as usual for a period, and you can have a much calmer discussion about what changes are going to happen in the longer run.”
It’s early days yet, but as this publication goes to press, it appears that the government has been taking heed of businesses’ pleas: a government paper published on August 15 sets out the UK’s wish to remain in a customs union with the EU for at least an estimated three years after its 2019 exit. Clearly, any arrangement of the sort remains at the behest of the EU – which would need to approve the deal.
For its part, the SMMT has outlined what it would like from Brexit negotiations. Among other measures, it wants the UK government to retain the benefits of the single market and secure tariff and customs-free auto trade with the EU; ensure that the UK auto sector has unrestricted and reciprocal access to talent across the EU; and manage the transition from EU membership to a new trading relationship by continuing existing trading arrangements with the EU and third-country markets.
Hawes tells GTR: “We need Brexit negotiators on both sides to recognise the importance of barrier-free trade for the European automotive industry. Any disruption to this risks undermining one of the EU’s most valuable economic assets. The industry needs certainty, so an interim deal, maintaining UK single market and customs union membership until we have in place the complex new agreement with the EU, must be a priority for the UK in its withdrawal negotiations.”
Supply chain durability
In addition to the political uncertainty, Brexit raises issues around the longevity of the auto supply chain, in terms of the movement of parts, and the accompanying tariff and non-tariff issues.
Although the UK’s domestic supply chain is the backbone of the industry, it is also a deeply complex pan-European network that sees components crossing borders multiple times throughout the assembly process.
In the worst-case scenario, should a trade deal not be reached, World Trade Organisation (WTO) tariffs would amount to as much as 10% on vehicles and 4.5% on auto parts, which will be devastating for margins in the industry.
But tariffs are only part of the problem: introducing customs checks would bring severe delays (by as much as 72 hours each time components leave or enter the UK), and significantly impact the ways that manufacturers run their factories.
“If companies have finely-tuned supply chains, as this sector does, any delays are going to impact just-in-time operations,” says Andrew Betts, head of global trade and receivables finance, Europe, at HSBC.
Delays will be unpredictable, and would result in costly line stops. While a solution may be to arrange for the delivery and storage of buffer stocks, this too will add costs to the delivery arrangements, not to mention the fees associated with building warehouses to store the stock.
“Our supply chain needs to be very short, very agile and able to deliver to very precise quality and timing logistics,” Ian Howells, senior vice-president of Honda Motor Europe, tells GTR.
Obstacles such as customs posts add friction to the process, says Howells. “Then our just-in-time process starts to break down or is just not as efficient. Which means, from our point of view, we have to invest that little bit more in inventory – and we’d expect the same from our suppliers – in terms of maintaining a certain level to ensure that production is not impacted.”
Howells explains that Honda has a policy of localisation (which stretches to Europe) for its supply chain, to ensure efficiency. “It shortens logistics time and reduces the risk of logistics itself – if it’s a long time on the sea, there’s a lot that can go wrong. Having a responsive and agile supplier on your doorstep is a lot more efficient than having a very long supply chain,” he says.
Although Honda’s approach may be to start producing a new model with quite a low volume of local intake or component content, Howells explains that its policy is to increase that over time. At its plant in Swindon, for example, the company produces two models: one new, and the other more mature. The newer model has a higher non-EU componentry whereas the vehicle that has been in production for longer has a very high local component element – one that has been built up over time.
The potential impact of Brexit on suppliers goes beyond skyrocketing costs: many of them – especially SMEs – will previously not have had to deal with the associated administrative complexities, such as customs procedures and VAT guarantees. They’re also unlikely to have much experience in trading with a third-party importer.
“From that perspective their working capital may start to get a little constrained, at least in the shorter term,” says Howells.
A silver lining?
Nevertheless, Brexit aside, opportunities for suppliers continue to reveal themselves.
Witness BMW’s afore-mentioned choice of Oxford over Germany to build its Mini. With the likes of Nissan and Toyota (notably, both after extracting government assurances), Jaguar Land Rover (for which the domestic market is enough to sustain some local production) and others continuing their investment, suppliers have a “significant sourcing opportunity to aim at”, says the SMMT. These opportunities, it says, are “arguably the largest the UK supply chain has ever seen”.
Financiers agree. “Financing of automotive supply chains, particularly multi-tiered suppliers, remains very topical and we are continuing to engage with our customers as the operating environment adds unpredictability,” says Betts at HSBC. The UK government’s recent decision to ban all new petrol and diesel cars from 2040, he believes, could be an opportunity for the industry.
The British government has been under pressure to keep up with other countries that have been forging ahead with plans to ditch petrol and diesel cars in favour of cleaner vehicles. India, France and Norway all want to switch entirely to electric cars (as soon as 2025 in India and 2030 in Norway), while the mayors of Paris, Madrid, Mexico City and Athens have said they plan to ban diesel vehicles from city centres by 2025.
At least 10 other countries have official electric car sales targets in place, according to the International Energy Agency: Austria, China, Denmark, Germany, Ireland, Japan, the Netherlands, Portugal, Korea and Spain. The US does have a central policy, but at least eight states have set out goals.
“Government is keen to back the production of electric cars, evidenced by the funding announced in the autumn statement to support companies to develop new technologies. So if the UK can secure this production, as BMW has pledged with the Mini, then this would provide a boost to British companies to invest, develop and reinforce their reputation as leaders in high-end engineering and advanced technology,” Betts explains.
“As the auto sector is seen as vital to the UK economy we are not surprised that there is momentum to be at the forefront of these developments: it may give our British-based innovation centres a great opportunity at securing those primary supplier relationships.”
Howells agrees that the impending “big changes” in the auto industry may bring about new opportunities outside of Brexit.
“There’s always a possibility that as we change the way we operate, and our customer requirements change, there are new opportunities for the supply chain. From that perspective, it may be that UK suppliers get that foot in the door and are able to supply to Honda in a way that they have traditionally not been able to,” he says.
A key area of growth is in the digitalisation of manufacturing, and the SMMT in its November 2016 report on the matter, states that by embracing digitalisation, the country’s auto sector as a whole stands to gain £6.9bn every year to 2035, with a “cumulative benefit to the wider economy of some £74bn”.
This prize is not without its challenges, says the report: “The UK’s digital infrastructure needs to be improved, the skills gap addressed and investment in digitalisation accelerated, while clear policies on cyber security and standards for data sharing must be developed to promote trust.”
The SMMT has called on the UK government to support the work that the sector is undertaking to ensure that the country remains a major global manufacturing destination, by putting digitalisation “at the heart of industrial policy”.
With the right kinds of policies in place, the application of digital technologies to the design and manufacture of vehicles may just be one of the means of securing the industry’s competitiveness in the decades to come.
Of similar importance will be the trade agreements that the UK is able to negotiate once it is outside of the EU. “Other large advanced economies and the emerging markets offer some important growth prospects for the UK, particularly if the UK can negotiate liberal trade agreements,” reads a report from HSBC entitled Brexit and vehicle trade, published in April.
Collectively, non-EU destinations account for nearly half of the UK’s exports (with China and the US taking the most of these), says the report, but there are also notable UK ties to firms based in Japan and suppliers in Turkey.
While UK exporters face high average trade-weighted tariffs with non-EU countries (for example, 32% with Brazil, 24% with China, and 66% with India), the report states “ambitious free trade agreements could greatly improve competitiveness of UK exports in such markets”. In its concluding remarks, the report calls on UK trade negotiators to consult with the industry in advance on these negotiating proposals, yet echoes the resounding views across the industry by saying that their focus should be
on negotiating transitional arrangements with the EU.