Managing trade risk in uncertain times

The threat of a trade war is greater than any point in the last 50 years.  Multinational firms must deal with the strategic risks of moving forward in a climate characterized by uncertainty with respect to foreign trade and investment.  In times of uncertainty, supply chain flexibility is an excellent strategy for risk mitigation.

Supply chain flexibility starts with postponing non-necessary capital expenditures and reducing unnecessary expenses such as travel or technology upgrades in the short term, with the idea of investing that cash once the path forward is more clear.  In an extreme situation, the extra cash may even be needed to support critical suppliers who otherwise might find themselves in distress as a result of the trade war.  If critical suppliers’ operations are impacted, the risk to your business may be more significant than just increased materials costs, especially if supplier stock-outs shut down your operations.

Other approaches to increase supply chain flexibility involve supply chain network design and strategic sourcing.  If you currently manufacture in Asia, or subcontract with suppliers who do, the recent withdraw of the U.S. from the Trans-Pacific Partnership (TPP) means that at the very least, you are not likely to see the decreased materials costs you were hoping would result from the TPP.  In a worst-case scenario, firms may face a 35% import tariff on products entering the U.S. from Asia.

Developing, or expanding your pool of domestic backup suppliers is critical.  While the costs may be higher than what you had planned, moderate price increases associated with moving to a U.S. based backup supplier may be better for your business than being subject to a 35% tariff or the potential supply chain delays that could result from economic turbulence associated with a trade war.

Consider moving some of your foreign operations back early.  This could lead to a positive public relations opportunity while mitigating the risk of disruption.  Subcontracted domestic manufacturing is another option for risk mitigation.  While domestic prices may not be as attractive as imports, domestic subcontractors are less likely to be impacted by trade turbulence and you may be able to negotiate their ownership of some of your productive assets and inventory, further freeing up capital.  This strategy preserves precious cash reserves for alternate uses later.

Nearshoring is also worth considering.  With the future of NAFTA in question and the Peso at affordable prices, there may be opportunities in partnering with a subcontractor just across the southern border.  This strategy is higher risk than subcontracting with domestic suppliers, but it may offer higher rewards.  If NAFTA is modified to include the rumored 20% tariff on imports or a border adjustment tax, the cheaper Peso makes investments into Mexico very affordable in the short run relative to Asian imports.  However, there is a risk that foreign direct investment into Mexico may bear losses as the U.S. leaving NAFTA completely would reduce demand for productive Mexican assets.  Mexico is an interesting high-risk proposition that should only be considered by companies with large Asian exposures, significant cash holdings, low degrees of operating leverage or that are in industries where the markets are not dominated by U.S. demand so they can take advantage of export opportunities if necessary.

Exploring an increased role for automation in your domestic operations is also recommended.  Automation is a great strategy for reducing the impact of a potential labor shortage in the U.S., or subsequent wage inflation for manufacturing workers.  If upgrading your automation is of interest, you may need to move quickly.  Once announcements of changes to U.S. trade policy happen, your competitors may also undertake automation projects.  This may leave automation and robotics suppliers with significant backlogs and increase your project’s lead-time.

If your product has a long shelf life and is unlikely to become obsolete over the next year, consider advancing production.  Importing now, while tariffs remain low and building up domestic finished goods inventory protects the margins on those units in inventory.  This may require renting additional storage space or short-term borrowing to fund the increase in working capital.  Increasing finished goods inventory is not a long-term strategy, but the extra inventory can buffer any rough periods of transition as you recalibrate your supply chain to deal with any new trade policies that we may see in the short-term.

With so much uncertainty, now is the time to invest in your backup strategy.  The strategy may be a Mexican partnership, domestic subcontractor, or reintroducing some of your own operations back to the U.S., positioning you to react quickly to policy changes and take advantage of opportunities that are likely to follow in the near term while your competition is still reacting to the news.  These are the times where supply chain flexibility and responsiveness offer a strategic advantage for leaders with vision.

Professor Gregory Sabin is a senior lecturer at Boston College’s Questrom School of Business.  Prior to that, he was a lecturer at The Ohio State University and a Fellow of The Risk Institute.  Professor Sabin helped start Fisher’s student led Risk Management Association.