Brexit vote - the logistics nightmare has become a reality

Source: De Tijd (15/01/2019); Authors: Professor Robert Boute (Vlerick Business School), Professor Marc Lambrecht (KU Leuven) and Professor Maxi Udenio (KU Leuven)

On Tuesday 15 January the British parliament voted against the Brexit deal. The rejection of the deal has repercussions for industrial production. Even before the vote, multiple sources reported a drastic increase in stocks in the United Kingdom. This could disrupt logistics chains (for a lengthy period). Of course, the havoc will be even worse with a No Deal scenario.

Bloomberg stated last week that businesses in the UK have been reporting record increases in stocks; the production index in December 2018 was the highest it has been in six months. In the food sector, in particular, the increase is out of proportion. In that regard, the contribution in The Guardian (4 January, 2019) by our colleagues Alan McKinnon and Jan Fransoo was telling. Our experiences confirm this phenomenon. As an example, a yoghurt company in Wales has flown over three to six months’ extra stock from China and is holding it in inflatable warehouses. We see from our own Dutch frozen food producers that the available (deep-freeze) storage capacity is completely full. This increase is also apparent in other sectors, such as mechanical engineering. Rolls Royce, for one, reports an increase in the stockpiling of components for aircraft engines.

What is going on? The substantial stockpiling in the run-up to Brexit is a result of two factors. First, there is the fear of shortages, mainly of food and pharmaceutical products. Consumers and producers are responding in turn by ordering excessively (this is known as “shortage gaming”). A second factor in the Brexit story is the anticipation of potential price increases and disruptions to supply chains (so-called “forward buying”). People are not only concerned about higher import tariffs, but also about major problems with customs formalities and bottlenecks at supply ports. The stress test carried out last week in Dover with dozens of lorries speaks volumes.

Due to these problems, businesses respond by quickly ordering more to reduce risks to a minimum. This excessive reaction in the form of stockpiling will, however, be followed by a reverse (excessive) reaction in the form of decreasing stocks. This is a well-known phenomenon in logistics chains, which is also known as the bullwhip effect. This phenomenon points to strong fluctuations in stocks and industrial production and those fluctuations continue to amplify the further along the chain we go.

The bullwhip phenomenon in industrial production is nothing new. There have been drastic disruptions to supply chains before now, including at the end of 2008. At that time, the financial crisis and high demand for working capital created an unprecedented decrease in stock levels, whereby industrial production spectacularly (and rapidly) decreased much further than could be inferred from decreasing consumer demand. This gave rise to the global economic crisis.

Although the Brexit phenomenon and corresponding bullwhip effect have a different cause than the 2008 financial crisis, we can learn important lessons from it. In this case, too, the increased stocks will normalise in time and therefore be brought back to a normal level. Yet, it is typical of the bullwhip effect that the reduction in production is generally stronger and can spread out over a long period of time. Today’s stockpiling could therefore translate into a major dip in industrial production in the coming months to years. This will hit the entire supply chain, and thereby not only business in the UK, but also in the Netherlands and in the rest of Europe.

The extent of the backlash will depend significantly on the Brexit deal with which businesses are confronted: hard or soft. In the event of a hard Brexit, the backlash will be more serious and moreover, it will last longer. Even with a softer Brexit, businesses will still have to bite the bullet, albeit for less long. One thing is certain, the logistics nightmare has become a reality; stockpiling is a fact and we will have to bear the negative consequences for our industrial output in the future.

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