Is the trade war breaking global supply chains for good?

Iconic US manufacturer Harley-Davidson was one of the first companies to cry surrender in the tariff wars earlier in 2018 when it announced its intention to move production for its European customers out of the US. 

“Frankly, it had no choice with a 25% extra cost in its export market. That is not insignificant,” says Johan Gott, principal at management consulting firm AT Kearney. Indeed, Harley-Davidson recently reported that it expects to pay an additional $43m to $48m in 2018 to cover the costs of new tariffs across the world.

Other companies are also shouldering similar burdens, but unlike Harley-Davidson they have spent the past six months in wait-and-see mode. That period is now ending as more companies take steps to realign supply chains and change procurement patterns.

As they do so, some companies are realising the world could be at an inflection point, one in which global supply chains are permanently altered due to growing trade tensions.

Two spheres of trade

This theory was put forth in a television interview of Yngve Slyngstad, CEO of the $1000bn Norwegian sovereign wealth fund, in which he posited that one day global supply chains could be reconfigured along regional lines, with one focused on the US and the other centred on China.

Stanley Chao, author of Selling to China: A guide for small and medium-sized businesses and managing director of All In Consulting, shares Mr Sylngstad’s views. He envisions a trading world where the US’s sphere will incorporate North America, most of South America, the EU, and some Asian countries such as Japan and South Korea. China’s sphere will include the Middle East, central and eastern Europe, most of Asia, and the African continent – with much of it tied together by the country’s Belt and Road Initiative. 

“China is building deep-water ports, highways, rail lines and airports interconnecting all these countries into a single seamless transportation and logistical network,” says Mr Chao. The long-term picture is clear, he adds: companies will need to have multiple manufacturing centres to cover these separate spheres.

Short-sighted view

In the shorter term, though, the picture is far murkier for companies, especially those focusing on the daily tit-for-tat exchanges of world leaders. Through this prism it is impossible to known whether tensions will relax or exacerbate further, Mr Gott says, leaving companies stuck between with two uncomfortable choices: do nothing and watch as an approaching train gets closer or make a large investment as part of a change and then, if there is a resolution, the company has needlessly spent a great deal of money.

Many companies have begun to abandon this stance and are now starting to make at least low-cost investments in shoring up alternative supply lines. “In areas such as procurement, companies are starting to find alternative suppliers, looking to the Philippines or Malaysia for example instead of China,” says Mr Gott.

William Vogt, managing principal at Weilian Poder Global Consulting, a business advisory firm, describes a similar trend. “South-east Asia is notably attractive to many American companies, especially those with long-standing relationships in China,” he says. Mexico should also prove a popular area for multinational supply chain growth; the US-Canada-Mexico Trade Agreement will provide greater policy stability, he adds.

A more expensive change some companies are making is to rebalance their production within an existing footprint, which essentially is what Harley-Davidson is doing.

“There are a lot more in-depth conversations with people in the field that need to make decisions in terms of where to allocate their next manufacturing facility,” says Joy Dantong Ma, research associate at Marco Polo, the in-house think tank of the Paulson Institute. “We are seeing a trend in which some people are more willing to move away from established supply chains.” 

That said, she adds, it is going to be a difficult process.

A deeper decision

But it is not just because of recent trade wars that companies are considering moving or diversifying their production and supply chains to cheaper areas in south-east Asia. They clearly have been for some time, according to Milena Rodban, a consultant on VerSprite’s geopolitical risk practice team. “The trade war helped push those decisions, but the motivations were already there before it began,” she says. The difference now is that instead of simply wanting to cut costs, firms need to also consider how to avoid sanctions, tariffs and other fees, she adds.

“The geopolitical implications are striking. If there are alternative sites for production and other routes for transit, existing areas and routes decline in importance – making it less likely that countries will be willing to negotiate terms of use that are high cost or high risk,” says Ms Rodban.

There are other risks facing companies reforging their supply and manufacturing patterns. Leaving areas that depended on these firms for jobs or trying to enter new areas without the necessary skilled labour will introduce new political and economic factors to consider, possibly leading to wasted efforts, community pushback or reputational damage, according to Ms Rodban.

But such scenarios may be preferable to the alternative for companies that cannot move their supply chains. Some will be able to shift their production and supply chains in a way that allows them to benefit from risk arbitrage, says Ms Rodban, while others that have extremely complex supply chains will find themselves struggling to deal with a new reality. Just look to Harley-Davidson, which faces a hefty price tag, to say nothing of reputational damage, in its home market.