When the UK leaves the EU one option is to revert to World Trade Organisation (WTO) rules. This is our fall back option – the letter triggering Article 50 references it explicitly.
UK SMEs will pay tariffs for any goods imported or exported at rates historically agreed between the EU-28 and the WTO. Any free or preferential trade agreement between the EU-28 and other countries, like South Korea, will also be lost and tariffs will again come into force.
The below analysis comes from our recent report “What does defaulting to World Trade Organisation (WTO) rules mean for UK businesses?” conducted by the Price Bailey Research & Insight team.
This is likely to negatively impact the productivity, profitability and/or cash flow of UK businesses:
- Higher trade barriers mean less competition internally as protection from EU-27 competitors is provided. Reduced competition means less incentive to be productive.
- Businesses that export into the EU will be encouraged to split their distribution or manufacturing bases – to access the EU single market. The remaining UK branch can afford to be less competitive as it now has more protection from EU-27 competitors, who will need to drop prices to continue to access the UK market. Again, a reduction in competition provides British businesses, who are laggards when it comes to productivity versus other G7 nations, with the breathing space to be more inefficient.
- Splitting bases will also split cash flow, profits and future investment. Future investments would reflect reduced ROI (return on investment) expectations – expectations that are lower because we have poorer access to foreign markets. Businesses should consider performing a cost-benefit analysis of the tax implications of such splitting, as well as the harm it may cause company morale and productivity during the shift. If the cost and risk outweigh the reward, consider strategies for accessing markets from the UK more competitively or increasing domestic market share.
- The trade barriers of the WTO Option also make it more difficult for early stage businesses to scale, or encourage them to outsource more elements of the supply chain to achieve access to the EU.
- The path of least resistance for accessing EU markets is not innovation at the UK base, but to relocate and rearrange the supply chain.
- The WTO Option does not cover labour access. Trouble recruiting talent will compound the above challenges, further encouraging businesses to take the path of least resistance in which future investments, profits and cash flow are split with EU-based entities.
Smart businesses can use this context to their advantage:
- Rather than splitting output between the UK and EU, and enduring the set up costs of the EU entity without any revenue growth, businesses should look to increase UK market share to justify their existing UK capacity to as great an extent as possible. Letting talent go and downsizing in the UK will be an unnecessary additional cost if UK market share can be expanded. Achieving such an objective will likely affect profitability in the short term, but will ensure that the business becomes more competitive, in relative terms, simply because rivals have started to split operations, lose scale and find productivity gains more difficult to come by.
- Forecast what prices EU-27 suppliers must use to access the UK market – is there an opportunity to use existing capabilities/capacity to diversify product lines and take customers previously supplied by EU-27 base businesses? If so, then existing UK capacity can be justified and scale maintained.
- With the future of UK productivity under threat, strategies to maintain scale could reap noteworthy market share gains in the medium-term.
- With less access to talent and lower investment rates, those that do innovate to ensure long-term access to EU markets can feedback productivity improvements into UK pricing. In other words, make use of the fact that a tariff must be paid to access EU markets to encourage productivity gains. Doing so will translate into greater profit, and/or market share, when servicing the UK market.