Supply chains can change but not for your reasons

Roger OakdenGlobal Logistics, Logistics Management, Procurement, Supply Chains & Supply Networks

Changing equilibrium in supply chains

A new trade agreement.

Your business is satisfied with its current arrangements with suppliers and service providers through each supply chain. But, due to external events, the equilibrium that has existed between your organisation and the parties in your supply network will change.

As the equilibrium changes, then change may need to be imposed on the structure and contracts within your supply chains. This scenario could happen with suppliers and customers affected by the renegotiation of the North America Free Trade Agreement (NAFTA) into the newly named United States Mexico Canada Agreement (USMCA).

A major emphasis of the negotiations appears to have been automotive component manufacturing and vehicle assembly. Under the USMCA, vehicles will be rated for zero tariffs if:

  • More than 75 percent of the components are manufactured in USMCA countries
  • More than 40-45 percent of the vehicle is built in factories where auto workers earn at least U$16 per hour

Supply Chains are likely to be affected by these clauses in the Agreement. The first requirement could affect where components are made and therefore from where they are delivered to the assembly facilities. The second requirement may affect the location of assembly facilities and therefore the patterns of distribution.

BMW is the largest exporter of vehicles manufactured in America; these are SUV vehicles powered by imported engines. Remaining with its current supply chains will mean higher import duties in China, levied on its US made vehicles and a likely increase in US import duties on BMW cars imported from Europe.

The current 25 percent tariff imposed by the US on imported trucks (including pick-up trucks and vans), has resulted in Mercedes importing vans as ‘completely knocked down’ (CKD) kits for final assembly in America. This supply chain may change under the new Agreement.

In addition to changes in the imports and tariff regime, supply chains could be affected by changes occurring in the US auto market. Consumers now prefer larger SUV, crossover vehicles and pick-up trucks, while small cars do not provide the same level of profits per vehicle for vehicle producers in America.

So, for example, an outcome of this change in demand patterns is that production has ceased in the US of the Ford Focus (a small passenger sedan), with demand to be satisfied through imports. However, it now appears that an upgraded Ford Focus, built in Europe and China, will not be imported into the US, due to the proposed tariff regulations. This will reduce choice for consumers of small city vehicles.

An unintended consequence of the USMCA is that assemblers in North America could focus on producing higher margin internal combustion engine (ICE) powered large SUV, crossover vehicles and pick-up trucks, only for domestic consumption in North America. Conversely, assembler facilities in Europe, Japan, China and Thailand could concentrate on making small electric powered vehicles, for sale outside North America. This would leave North America as a region with high transport pollution.

This scenario is only a guess. But similarly, the supply chains of other industries could be affected by USMCA, illustrating how a change to the equilibrium of International Trade can ripple through the global supply chains of organisations.

Actions and consequences

As background to International Trade, the blog Supply Networks change the view of International Trade provides an outline.

The US withdrew from the Trans Pacific Partnership (TPP) agreement to pursue multinational trade agreements with individual countries. The current strength of the US economy (and with only 13 percent of GDP exported), provides a signal that it has time on its side to negotiate ‘satisfactory’ trade agreements with other countries. However, this only works if the US economy continues to prosper. Increasing tariffs could prematurely terminate the conditions that generated the prosperity, as other countries have time for their economies to respond.

An example of a response could be a potentially closer relationship developing between Japan and China. Like China, Japan has a trade surplus with the US and 47 percent of its vehicle production exported to the US. So it is vulnerable to action on import tariffs.

In 2017, exports from Japan to China increased by 20 percent. In the first half of 2018, 35 percent of goods that Japan exported to Asia have gone to China – a 10 percent increase over 2017. China has indicated that it is willing to work with Japan on the Belt and Road Initiative (BRI); specifically the Eastern Economic Corridor (EEC) in Thailand, as Japan has more experience and networks in Thailand.

Responding in this way is based on multiplayer game theory, developed by the US mathematician John Nash. The theory states that an equilibrium in negotiations between parties develops around the current rules. If a party (player) changes the rules, no matter how rational the rule change may seem to be to the person who’s making the change; it makes all other parties/players change their response. The responses will go back and forth, until there is a new equilibrium.

A situation with some similarities occurred in America in the late 1920’s. This was a prosperous period of technological change; most prominent were the increasing use of electricity and the increasing popularity of vehicles (cars, trucks and tractors).

As fewer horses consumed less food, it created a farm surplus for grains, so prices fell and farmers complained of foreign competition. In the 1928 US presidential election campaign, the eventual winner promised higher import tariffs. The lower House passed the tariff bill in early 1929. The stock (share) market crashed in October 1929, but recovered most of its losses in the subsequent months. The upper house (Senate) passed the tariff bill in early 1930 and trade conditions declined to a depression in 1931.

This was a period of three years between a campaign promise and implementation. So, governments of other countries had the time to respond to protect their markets, recognising that the rules around equilibrium in trade agreements were changing.

This discussion illustrates that supply chain professionals must be across all external events that may challenge the equilibrium in their supply chains – even though it may be some years between an initial announcement and implementation.

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About the Author

Roger Oakden

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With my background as a practitioner, consultant and educator, I am uniquely qualified to provide practical learning in supply chains and logistics. I have co-authored a book on these subjects, published by McGraw-Hill. As the program Manager at RMIT University in Melbourne, Australia, I developed and presented the largest supply chain post-graduate program in the Asia Pacific region, with centres in Melbourne, Singapore and Hong Kong. Read More...