Hard Brexit could reduce UK company profit pool by £3 billion

13 February 2017 Consultancy.uk

The effect of Brexit on the UK economy remains a key uncertainty. A new report finds that a hard Brexit has the potential to wipe around 30% from the profit pool of companies across key sectors – with the grocery and automotive industries the hardest hit. A considerable share of the profit reduction is likely to be passed on to consumers.

The decision to leave the EU hit many businesses across the UK with, unexpected, uncertainty. Trade between the UK and European Union members has for the past forty years been simple; the barriers that had for centuries existed, from antipathy to tariffs, replaced by a trade regime of minimal paperwork and zero tariffs.

All this is about to change however; although exactly how it will change remains a key area of negotiation between the UK and Europe, but also with wider global trading partners. Much has been made about the possible consequences of Brexit on the UK, some point to relatively dire consequences, while others suggest that it might not be all that bad. In a new report from Bain & Company, titled ‘Is Your Supply Chain Ready for Brexit?’ a range of scenarios, and their wider effects on the supply chains of companies operating in the UK, are considered based on the broad quality of the deal made between the UK and the EU following the triggering of Article 50.

Brexit creates supply chain uncertainty

Three Brexit scenarios

To better understand the effects of Brexit on companies in a range of key economic sectors the firm developed three models for negotiation outcomes. For supply chains, the effect of Brexit remains fraught with uncertainties, raising a range of key questions. The impact of these effects is likely to range from very negative to potentially positive.

In the case of a ‘hard Brexit’ standard WTO tariffs (2% to 13%) may be imposed on all exports and imports, while the cost of labour increases 10% and the pound depreciates a further 20%. A more moderate scenario, in which some mutually beneficial deal can be closed between the UK and the rest of Europe, may see a 5% in export and import tariffs, a 10% currency depreciation and a 5% increase in the cost of labour. The final scenario would see the UK hammer out a deal that minimises tariffs on trade with the EU.

Hard Brexit Scenario could reduce net profit by 30 percent

Profitability hits

The consultancy firm also considered the implications to the wider supply chains on which companies across the UK depend. The effects are relatively broad, including changes to export tariffs, foreign exchange rates and the UK’s labour market regulations, immigration laws and tax policy.

The total loss of profitability at businesses across the UK could be significant in a ‘hard Brexit’ scenario, with decreases in the order of 30%, or £3 billion, on the current £11-£12 billion in profits generated by key UK industries. The grocery sector would be the hardest hit, losing close to £20 billion – much of which would be passed on to consumers, pushing up inflation. The automotive industry would see around £2 billion in losses (around 300% of their total profit), while technology would see losses in the range of £660 million (35% of their total profit). Other sectors, including pharma and aerospace would see small profit increases, at £130 million and £80 million respectively.

Impact of a hard Brexit depends on potential future tariffs

In the automotive industry, both export and import tariffs would hit profitability in the case a hard Brexit will become reality. With export tariffs of 10%, the current 3% margin of the industry would be hit with a -5 percentage point drop; import tariffs would see a further -2.6 percentage point decline. Further exacerbating factors, including exchange rate changes, labour market changes and tax changes, would see a total -7.7 percentage point drop for margins to -4.7%.

The findings by Bain back the results of a recent study by PA Consulting Group, which found that car factories and automotive suppliers in the UK face an uncertain future following Britain’s vote to leave the European Union.

In technology, where margins are currently considerably higher, with lower import or export conditions, the exchange rate would be the most impactful change in a hard Brexit scenario, with total margins falling 2.6 percentage points, from 7.6% to 5%. One industry that may see some benefit from the effects of Brexit is aerospace, deriving benefit of about +0.2% to profitability, all things being equal.

Brexit has the potential to create winners and losers, as what negatively affects the supply chain of one company, may benefit another. The continued uncertainty however, makes betting risky.

“Uncertainty around Brexit has left many executives feeling anxious and reluctant to act, but inaction is actually the worst path to take,” says Thomas Kwasniok, a supply chain expert in Bain’s London office and lead author of the research. “Based on our extensive work with clients in the UK and across Europe, we’ve seen that the most successful companies plan for change by incorporating it into their strategy process. This will enable them to pivot faster than the competition once Brexit details become clear, minimising the risk to their supply chains.”

Related: UK firms concerned about Brexit, but uncertainty is hindering action.

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