Navigating Sourcing in a Volatile Trade Agreement Climate

Navigating Sourcing in a Volatile Trade Agreement Climate

A new US President is set to take office in January, which means there may be major changes ahead for manufacturers and suppliers with international supply chain operations.

In our previous blog post, Domestic vs. International Sourcing, we note that typically organizations source domestically for better quality control and shorter commercialization timelines, and source internationally to reduce costs. However, in what could be a volatile North American Free Trade Agreement (NAFTA) climate, this may no longer be the standard notion for globalized companies.

Overview

A major message throughout the President-Elect’s 2016 campaign was to bring more jobs back to the United States. This was proposed to be accomplished in part by withdrawing the United States from the Trans-Pacific Partnership (TPP) and renegotiating its terms in NAFTA, if not completely disengaging from it.

The new White House administration believes that such actions would trigger American companies to begin onshoring  – defined as any direct investment into the domestic marketplace by a domestic company – to reduce the number of workers US corporations use overseas, maintain the production of goods and services in the US, and help alleviate considerable pressure on the US economy.

Example Scenario: Tariffs on Vehicles Imported from Mexico

Current trade agreements in place make manufacturing vehicles in Mexico, then importing them into the US, a smart financial strategy for automotive OEMs due to the following:

  • Lower labor costs with qualified workers in Mexico
  • Shipping vehicles from Mexico into the US is less complex and less expensive than from other low-cost labor nations overseas
  • Free-trade regulations have Mexico exempt from tariffs
  • OEMs have a substantial network of manufacturers, suppliers, and logistics organizations in place in Mexico

If the US decides to impose tariffs on vehicles imported from Mexico, OEM automakers would see significantly smaller profit margins and need to move operations back to the States. Thus, tens of thousands of American jobs may become available, but at the expense of US automakers’ financial interests.

Impact on Automakers

Onshoring by US automakers and manufacturing OEMs has the potential to create new American jobs, improve quality control, and expedite project timelines. So why might these large corporations hesitate to move production?

One significant factor is that existing auto-manufacturing facilities in the United States are near maximum capacity and building a new factory, for example, costs upwards of one billion dollars or more. In addition, if automakers begin onshoring and the nation experiences another recession where Americans are not buying as many new vehicles, staying above the break-even point will be difficult.

In the auto industry, factories bear favorable margins when operating at over 80% capacity, which means a downturn in the US economy would cause production to fall below this threshold and increase losses; whereas, if a recession hits while operations are in Mexico, a reduction in capacity would not have as extreme of an impact since fixed costs are lower.

Another factor giving OEM suppliers pause to onshore is the lack of qualified personnel in the domestic labor pool. Though there may be plenty of job opportunities, the education for manufacturing skills in the US will not meet the demand required to maximize production.

Big Company Benefits

Big companies and industries in the United States would benefit from the new free-trade policies because of the President-Elect’s promise to make the US energy independent, launch an extensive national infrastructure program, and increase the nation’s defense budget.

This increase in spending both federally and privately means procurement plays a critical role. Projects formerly placed on hold by oil, gas, coal, construction, and defense contractors could resume, and new projects would be launched. As a result, manufacturers and suppliers will need to make additional investments in highly-qualified and experienced procurement professionals in order to make sure funds are used as efficiently as possible.

Executing Strategic Sourcing

Companies that continue to align procurement processes and strategies to support organizational strategy in these evolving circumstances will maintain a competitive advantage. As American manufacturers and suppliers move forward into a volatile trade climate and are faced with the possibility of needing to onshore operations, procurement teams need to be adaptable and responsive to impending policy changes and how they impact sourcing the supply chain.

Driving down costs and mitigating supply risk will always be primary procurement goals. These are accomplished by defining value drivers, effectively managing supplier relationships, and tracking performance of preferred suppliers. Now, with new NAFTA terms potentially in development, specialized tactics will further optimize strategic procurement.

Stay up to date on environmental policies to monitor their impact on domestic manufacturing and be aware of partnerships where supply partners are making investments based on environmental policy changes. Likewise, determine how potential TPP and NAFTA changes will impact total cost on global sourcing in the short term and analyze how possible tariffs could impact global supply chain decisions in the long term.

Consistent success experienced by procurement professionals is the result of diligent monitoring and evaluation of sourcing risk. A changing trade agreement climate could mean more advantageous trade policies and more relaxed environmental regulations, ultimately sparking US companies to invest domestically and onshore several, if not all, parts of their operations. These elements make executing strategic procurement at the highest level critical to sustaining an organization’s long-term viability and driving sourcing performance.

-Ben