Originally Published by PwC.
By Rajiv Jetli and Kevin Smith
The United States-Mexico-Canada Agreement (USMCA) has potentially far-reaching implications for industrial companies. Assuming the pact, a replacement for the North American Free Trade Agreement (NAFTA), is ratified by all three countries’ legislatures next year, its provisions won’t be fully enforceable until 2023. Four years may seem like a long time to get ready, but given the significance of the changes in store (and that key deadlines arrive sooner), now is the time for manufacturers to start taking a hard look at implications for strategy and operations.
Even though USMCA has been getting ample media coverage, the almost 2,000-page agreement still can be challenging to untangle. Some of the most important provisions govern regional value content (RVC) of manufactured goods – essentially requiring that a certain percentage the components in a product be made in one of the countries that are a party to the pact. This will have implications for a range of industries, but automakers may be particularly affected – the USMCA requires that 75% of the value of passenger and heavy-duty vehicles originate in the U.S., Canada or Mexico, compared with 62.5% under NAFTA. Likewise, USMCA sets new labor value content (LVC) rules that are likely to push manufacturers to either raise wages for low-paid workers or bring some manufacturing back to regions with higher labor cost.
If companies don’t act now, they face the risk that pre-NAFTA duty rates could be applied to the value of goods imported into the U.S., Canada and Mexico as of Jan. 1, 2020 (versus a 0% duty rate under NAFTA). Furthermore, if companies incorrectly certify their goods as duty free under the USMCA, they may be exposed to penalties up to the value of the merchandise plus interest in the U.S., C$150 to C$400,000 per occurrence in Canada, and 150% of the duty in Mexico. This type of additional cost can be enough to erode profit margins on goods and significantly impact the financial success of a company. That’s why it’s imperative that companies start evaluating whether their goods qualify under the new tariff free USMCA now — and, if not, take immediate actions to adjust their supply chain operations.
Companies should perform in-depth analyses of their bills of materials to determine USMCA compliance. By modeling the effect of changes in value or origin of various materials, components and systems on a product’s overall compliance with RVC and LVC rules, it’s possible to get a clearer picture of the most cost-effective way to meet USMCA requirements. PwC is working with major U.S. manufacturers, including automotive OEMs, to deploy such a model.
Thoroughly analyzing bills of materials is a smart first step in what could be a lengthy process of bringing manufacturing operations in line with USMCA requirements. While politicians may hope that the USMCA will help bring well-paid manufacturing jobs back from overseas, the reality may be that increasing levels of automation in manufacturing could limit how much workforces grow. Manufacturers will need to carefully assess the costs and benefits of reconfiguring their supply chains to comply with the new trade deal. That will not be achieved overnight. Every manufacturer that depends on suppliers in Asian, European, or other markets should begin by making sure they have a clear, product-by-product picture of their current exposure.
It may well prove advantageous to shift supply chains or manufacturing plants to North America to avoid taking a hit under USMCA, but putting all options on the table sooner rather than later may reduce the cost of doing so before the entire sector wakes up to this new reality. That includes keeping assessments of political risk up to date. It may be too early to commit to wholesale strategic, operational or financial changes, but it’s certainly the right time to begin evaluating potential impacts and putting all appropriate options on the table.
We suggest the following three steps for executive leadership:
- Understand your gaps in meeting USMCA regional value content requirements now
- Take this opportunity to reassess your sourcing and make-versus-buy strategy
- Make sure your operational strategy is being optimized for tax efficiency
Manufactures need take a holistic view of their exposure to changing trade agreements and tariffs. That’s why it’s more important than ever to take an all-encompassing approach to optimizing the enterprise for the future. The first step is knowing where your products stand today.