When mitigating the impacts of increasing tariffs, organizations need to consider 4 important levers – procurement costs, supply chains, customers, and competitors.

Lever 1: Procurement Costs

For larger organizations such as Ford or GM with products integrating parts such as microchips, drives, and other critical components, tariffed materials may account for up to 10-15% of costs.

For small players, like metal stamping, material costs are unlikely to be significantly affected by increasing tariffs. In this case, suppliers will likely be domestic and they in turn are unlikely to face tariffs.

Organizations should:

• Ensure sources of expertise are accessed during the evaluation process, including engineering, manufacturing, legal, regulatory and commercial teams
• Evaluate the impact of an increase in the cost of raw materials throughout the production chain – for example, the impact of steel and aluminum tariffs from China could increase raw material costs by 2 to 5%
• Undertake risk analysis to identify the cost impact of different tariff scenarios
• Focus on total cost of ownership, not just prices to understand the actual impact of tariffs relative to costs

Lever 2: Supply Chains

With few alternatives, or with significantly limited capacity, we would expect costs to rise even more severely throughout the supply chain than would be indicated by the tariffs alone. Margins should be locked in by seeking long-term contracts with suppliers and buyers, so that uncertainty is reduced.

Supply chains that involve sourcing from providers whose goods and materials may be subject to increasing tariffs will need to evaluate which suppliers will pass on the tariff load and, if so, explore alternatives.

Organizations should:

• Deepen relationships with existing suppliers to identify joint solutions to mitigate the impact of tariffs
• Switch suppliers – identify the long-term supply chain risks, including the impact a supply shortage would have on manufacturing and operational costs
• Make engineering changes so that non-tariffed substitutes can be used
• Negotiate with suppliers to share in the tariff burdens
• Work with existing suppliers to source from factories they may operate in non-tariffed countries
• Insource – look for existing opportunities to produce items that were previously outsourced
• Seek product reclassification to place items outside the tariff bucket (e.g., specialty steel may also qualify for tariff exemptions so that in such cases, prices would not be impacted)

Lever 3: Customers

When evaluating if and how much of the cost increases can be passed along to customers, it is critical to consider how responses to price will vary. This depends on the relative value they ascribe to your products and their ability to source elsewhere.

Organizations should try to predict customer behaviour:

• If your product is key, or it cannot be easily substituted, or switching represents a significant risk, then customers will likely be less price sensitive (e.g., where switching products can be difficult or illegal)
• Conversely, if there are readily available substitutes, or customer margins are tight, or you sell large volumes that are not critical to their own activities, expect price sensitivity

Lever 4: Competitors

While competitors will also face the same tariff pressures, they may be impacted differently. Their responses may differ depending on their own cost structures, objectives, supply chain options, target markets and customers, geographic considerations, regulatory implications and strategies.

Organizations should:

• Look at previous competitor actions to determine which markets or customers are viewed as critical

Also, competitors may try to minimize price increases in critical markets while countering the impact on their bottom line by increasing prices more in other markets.

Organizations should:

• Understand key markets and develop pricing strategies based on which markets are critical and prepared to defend them given competitors’ objectives and strategies

Which lever(s) will work best for your business?

Overall, it’s important for businesses to make decisions that provide them with flexibility, given the continuing uncertainties with respect to tariff policies. Procurement organizations must ensure that mechanisms are in place to monitor changing developments, disseminate that information to key stakeholders, assess the potential impact of changing tariff policies, and use the four levers to mitigate the impact.

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What is a Monte Carlo simulation?

Monte Carlo techniques were developed during World War II. To create atomic weapons, complex mathematics related to probability distributions were used. Several decades later this technology was refined and is now used by the largest corporations and institutions in the world for different purposes.

The 21st century business environment is complex and rapidly changing. To succeed requires a ‘telescope and microscope’ approach: seeing the big picture but also being able to zoom-in on small details when needed. Monte Carlo simulations can provide business with sophisticated tools to master business planning, and maximize profitability.

Taking its name from the world-renowned casino town in Monaco, Monte Carlo is not a product. It is a collection of techniques that allows businesses to view all possible outcomes of a venture through statistical simulations.

Casinos, being filled with games of chance, were an excellent application of the mathematics for modelling and assessing uncertainty in the outcomes of these games. Monte Carlo simulations work by creating thousands – sometimes millions – of trials and seeing the outcomes that emerge from them. This is in contrast to an earlier and simpler method that required very restrictive and often unrealistic assumptions on its input parameters.

An everyday example

As an example, consider the time it takes for a car to travel between two cities. The model would have two inputs: the weather and time-of-day (peak and off-peak demand). In addition to these variables, two other parameters are distance and average speed. For the weather variable, a probability distribution of various weather states (rain, snow, fog, clear skies) and for traffic, its own probability distribution (low, medium, high traffic).

Generation of these probability distributions stem from historical data and/or objective expert measures – meteorologist and civil engineers. Combining all these inputs, Monte Carlo simulations generates a range of travel times and the corresponding likelihood of each time between the cities.

A Monte Carlo simulation would run through various scenarios covering all the different cases. For example, one case would be rainy weather and high traffic. Another case would be rainy weather and medium-level traffic. The travel time from these outcomes and the probability would then be computed.

All this information culminates in a full spectrum of possibilities for the decision-maker, and any one of these scenarios can be analyzed more closely. For example, observing the combination of holiday season and weather may produce unusual results and require closer investigation by the model design team.

Monte Carlo and the bottom line

There are many innovative uses of Monte Carlo simulations to generate additional revenue and differentiate products in the market. As an example, we developed an application that featured Monte Carlo analysis for a U.S. health insurance client to improve the effectiveness of their customer’s health coverage.

The client sells insurance products such as critical illness, long-term disability, medical, dental, and vision coverage through their agent network. One of the most important concerns for critical care coverage is the risk of personal bankruptcy in the event of a sustained medical condition. A customer will have a budget in mind but won’t know how much insurance they need to manage their risk.

The application we developed asks simple questions from the customer such as their age, weight, smoking history and other health factors. They also provide their current budget and expenditures with each insurance coverage area.

A Monte Carlo simulation can be run that simulates thousands of possible probabilities and paths to determine the potential health outcomes and the associated costs depending on different levels of coverage, to determine their risk of bankruptcy. The customer gets an easy-to-understand report that shows them the risks of their current product mix and suggests ways to optimize or increase their coverage to minimize potential financial hardship, resulting in increased revenues and lower risks for the insurer.

Although it requires millions of calculations, this simulation can be completed in just a few seconds. Just a few years ago, this type of system would be too costly to implement, but with the advent of Cloud Computing platforms, such as Amazon Web Services or Microsoft Azure, high-performance servers can be accessed nearly instantly and the calculations can be completed quickly with low cost.

Monte Carlo: the ‘Cook Book’ approach

Consider the following scenarios:

• A change in minimum wage
• A change in corporate tax rate
• A change in depreciation or accounting rules
• A disruption to your supplier network

Consider the familiar adage, ‘failure to plan is planning to fail.’ Any of the above scenarios could happen and understanding the full impact on your operations will be imperative to your success. Risk management for small and medium-sized (SMEs) business does not need to be guesswork. Monte Carlo simulations provide a scientific approach which has been proven useful to many organizations.

While modelling complex situations may require outside expertise, SMEs can use common office programs like Microsoft Excel and the widely available @Risk application to add structure to their risk-management.

The first step is to identify what key variables affect a risky situation. Next, consider the likely values that these variables could take. Formally, in statistics, this is called a probability distribution. Some examples of distributions are below:

The final step is to have a program calculate all the different combinations the variables can take and the interaction of these different combinations across variables.

As part of ongoing human capital growth, SME executives should explore the benefits of adding Monte Carlo simulations to their business planning.

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It’s no surprise that the current architecture of the global economic system – including the framework for global trade – is far from perfect. At the same time, it’s clear that there are significant links between trade, trade finance and value creation in the wider economy.

Of course, trade is crucial for developing nations and the companies looking to do business there. And, in turn, trade finance oils the wheels of global trade – helping finance orders as well as mitigate payment and supply risks for buyers and sellers. Yet there are numerous changes underway in the trade finance landscape. New players are entering the industry and technological advancements are automating processes, altering the very nature of the business.

More needs to be done to ensure broader inclusiveness, fairer distribution of wealth and benefits, and sharing of the benefits of trade and international engagement.

Fortunately, shared principles surrounding regulation and compliance will help level the trade landscape and prove useful for those operating in the trade finance industry.

The ever-shifting trade landscape

The global context in which trade takes place has changed dramatically – particularly the way policy is shaped, the way risk is analysed, and the way in which financing is extended. As the International Chamber of Commerce (ICC) Banking Commission’s 2017 Rethinking trade and finance survey highlights, several challenges have emerged in recent years.

Protectionism

Since the 2008 global financial crisis, mounting protectionism across the world has impacted the trade landscape and cross-border flows. While trade generates macro-level benefits as well as benefits for companies pursuing opportunities in global supply chains, voices advocating isolationism have still gained ground. In fact, new trade restrictions reached a post-crisis high in 2016, with G20 countries adopting more trade-restrictive measures than trade facilitating ones, such as distortive localisation requirements and export incentives, among others. In turn, trade growth has struggled to regain its traditional place in outpacing global GDP growth – meaning it is no longer driving economic prosperity.

Trade finance

What’s more, in recent years the trade finance industry has had to navigate dramatic shifts in the regulatory landscape. In the immediate aftermath of the financial crisis it was clear that increased regulation would be crucial to the health of the global financial system. Yet the industry has grappled with the need to find an optimal balance between encouraging global growth and implementing adequate and risk-aligned regulations on trade finance.

For instance, Basel III capital requirements reduce the amount of lending a bank can offer at each level of capital reserves. According to the Rethinking trade and finance survey, financial institutions have reported both anti-financial crimes regulations and Basel III regulatory requirements (80% and 71%, respectively) as major impediments to their ability to reduce trade finance gaps.

While banks have become better capitalised as a result of regulatory measures, misaligned implementation can also lead to a reduction in capital available for trade finance.

Still, efforts are underway in refining Basel III regulations to suit the trade finance industry, with the intention to make it fairer for trade finance practitioners. For example, we’ve seen recent changes aimed at reducing disparities in the way in which the internal ratings-based model is applied by banks, reducing regulatory complexity and arguably helping to level the playing field.

Compliance

In addition, compliance requirements such as those relating to anti-money laundering and Know Your Customer have inadvertently increased the costs and complexity of trade finance transactions. While essential, such requirements have weighed banks down with new oversight responsibilities and therefore contributed towards banks de-risking – reducing their portfolio of correspondent relationships and retrenching to their core line of services and markets. In particular, we have seen banks reduce counterparty networks in the developing world and regions deemed higher risk. This has reduced the amount of trade finance available in these regions, primarily at the SME end of the spectrum.

Meanwhile, the entry of non-bank players into the trade finance arena has raised questions over the role they will play in the future of trade finance. For instance, challenger banks, FinTechs, pension funds, hedge funds and insurers are all helping provide additional sources of liquidity and transforming trade finance. Still, with new players comes a need to recognise existing standards in the industry. Non-banks may have been attracted to the market due to the comparatively reduced regulation surrounding their activities, but regulation may be required in order to achieve a level playing field.

As long as trade finance remains critical to oiling the wheels of global trade, access to trade finance remains a prominent issue, especially for small to medium-sized enterprises (SMEs).

According to the 2017 Rethinking trade and finance report, 61% of respondent banks reported more demand than supply for trade finance, while the Asian Development Bank (ADB) also reported a US$ 1.6 trillion trade finance gap. In particular, it is SMEs – particularly those in emerging market regions – that suffer most from lack of trade finance provision, impacting their ability to do business overseas.

What’s more, the International Finance Corporation’s 2017 Survey on Emerging Market Correspondent Banking highlights how de-risking is affecting cross-border banking activities, particularly those underpinned by correspondent banking relationships. De-risking and the loss, or potential loss, of correspondent banking relationships may reduce banks’ provision of trade finance services. And de-risking can even potentially limit the contribution that banks and financial systems can make in maximising a country’s stability and macroeconomic growth.

Reinventing global trade finance

While there are numerous changes underway and challenges in the trade finance industry, those operating within it are far from powerless. There are plenty of efforts underway aimed at improving the global trade environment.

New ways to measure risk

For instance, ICC Banking Commission has been advocating a greater risk-aligned treatment of trade finance products. Its annual Trade Register is used as an evidence-based tool to highlight the favourable risk profile of trade finance instruments when judged against comparable asset classes, such as corporate and SME lending. The Trade Register ensures that trade finance is increasingly recognised as a reliable asset class by regulators in addition to other players – highlighting its scope for high yields and low volatility, and encouraging new sources of trade finance.

In addition, countering the protectionist rhetoric on trade by advocating the benefits of a multilateral trading system is imperative to reducing the uptake of trade-restrictive measures.

ICC’s annual Open Markets Index is one useful tool, representing 90% of trade and investment worldwide and highlighting the levels of trade openness from different economies. This is identified through barometers including: observed openness to trade, trade policy settings, foreign direct investment (FDI) openness, and trade-enabling infrastructure.

Digitalisation of trade finance

As this year’s Rethinking trade and finance report highlights, the digitalisation of the trade finance industry has the potential to bring significant benefits – increasing speed and efficiency, reducing risk, improved working capital management, transparency, and operational improvements, and much else besides. In fact, through increased transparency and reduced risk, digitalisation can potentially help trade banks to meet regulatory and compliance requirements. So, trade finance players need to focus on digitalising their processes in tandem with other industry players – certainly, interconnectedness and collaboration will drastically enhance progress.

Updating regulations

Moreover, ensuring that the rules of today – used by 90% of the banking industry – remain up to date is critical, since actors involved in trade finance should have risk policies and controls that are appropriate for their business. Efforts to improve and update legal rules surrounding trade finance go a long way in giving businesses and trade financiers the confidence they need to operate and trade successfully. The Banking Commission therefore regularly updates rules and standards surrounding various aspects of trade finance – such as documentary credits, forfaiting, demand guarantees, and bank payment obligation, among others.

Establishing universal trade finance principles

With concerns about the decline in correspondent banking relationships, multiple institutions are supporting the consideration of guidance on compliance, in addition to its application by regulators and the implications on participants. In particular, the joint ICC-Wolfsberg Group Trade Finance Principles Drafting Group was formed in April 2014 with a remit to redraft and update the Wolfsberg Trade Finance Principles paper.

The group’s members are drawn from Wolfsberg Group banks, ICC members globally, as well as BAFT, and benefits from broad expertise and global perspectives. Previously updated in 2011, the Trade Finance Principles provide guidance on a broad range of trade finance compliance areas – from control mechanisms (e.g. customer due diligence) to various transaction scenarios, and even on open account.

Clearly, this is useful for an industry spanning the entire globe, since the principles take into account differences in development, cultures and sizes of all banks involved in trade finance – and are not specific to any one country. The Trade Finance Principles outlines the role of financial institutions in the management of processes around addressing financial crime risks associated with trade finance activities, as well as compliance with national and regional sanctions and embargoes.

These principles have been updated this year – expanding to reflect changing regulatory expectations and where the basic principles or application need to be readdressed. The collaborative effort is designed to standardise the practice of financial crimes compliance for trade transactions – particularly the practice level of Financial Crime Compliance – within the trade finance industry.

The Trade Finance Principles try to set a base for compliance requirements globally in an attempt to level the playing field across the globe.

Certainly, Financial Crime Compliance regulations should not be used to competitively advantage or disadvantage a particular country or region. While there may be increased requirements regionally or locally each bank may have to implement these in addition to the Principles. Trade financiers should therefore keep up to date with changes to the Trade Finance Principles, so as to adopt regulation and compliance measures correctly and efficiently in a changing regulatory environment.

So, while we are clearly in a fast-evolving and challenging industry, ensuring that trade finance players follow principles that level the playing field will go a long way in shaping the global trade landscape for the better.

The post The ways in which trade policy is shaped, risk is analysed and finance is extended are changing fast – here’s how appeared first on Trade Ready.

Managing Risk in the Global Supply Chain, a report by the supply chain management faculty at The University of Tennessee, ranks natural disasters as the third biggest supply chain risk, following quality problems and the need for increased inventory due to longer supply chains.

The March 11, 2011 natural disaster in Japan brought to light the fragile nature of the global supply chain. Professor Willy Shih discussed how companies should be rethinking their supply chain strategy in response to this risk.

Very little has appeared to change in the five years following.

According to the study, 90% of firms do not formally quantify risk when sourcing production. Most firms, 54%, consider unit cost, transportation and inventory, while 36% of them consider only unit cost and transportation.

“Manufacturers have spent years building low-cost global supply chains. Natural disasters are showing them just how delicate those networks really are,” Bill Powell argued in a 2011 article for Fortune.

Natural disasters such as the Japan earthquake and tsunami in 2011 reveal just how quickly this carefully crafted ecosystem can be dramatically disrupted.

As Bob Ferrari, a leading supply-chain consultant, puts it:

You never want to hear about the guys who run the supply chains for multinational companies. When you do, usually it means something really bad has happened.

The need for better warning recognized at the top

The White House recently held an Earthquake Resiliency Summit, which brought Interior Secretary Sally Jewell together with the USA’s best seismologists.

Spurred on by new fears that the “Big One” will soon be rattling the West Coast, the administration proposed stronger efforts to prepare for earthquake-related devastation.

“We have the real opportunity to mitigate damage and save lives if we act now on an early warning system,” said summit participant Rep. Adam Schiff, D-Calif.

“Seismologists and other experts say that, in theory, early notification of an impending quake – even if it’s just a few seconds – would help. Transit systems could slow trains; pipelines could be closed off; first responders could be alerted; power could be rerouted; other public sector utilities could be warned as well.”

How common are quakes around the world? The USGS said there were 14,588 earthquakes of magnitude 4.0 or greater throughout the world in 2015; California has scores of quakes every week, but most are not strong enough to be felt by residents.

As you might expect, California tops the list of states most at risk, but states in the eastern United States have a greater chance of having a damaging quake than was previously thought.

A lot was learned from the magnitude-5.8 earthquake that hit Virginia in 2011, researchers say; the quake caused considerable damage and forced the Washington Monument to close for repairs, which were just completed in May 2014.

There are other parts of the U.S. where the “Big One” could strike. The New Madrid Fault Line zone in the central United States also has more potential for a larger quake than previous estimates suggested.

The zone could have a devastating earthquake that would be felt in nearly a dozen states, researchers say, threatening large cities such as St. Louis, Memphis, Nashville and Atlanta.

The recent catastrophes in Japan, Nepal and New Zealand show that the threat of devastating earthquakes remains a worldwide problem.

Until recently, the mitigation of the effects of earthquakes did not occupy a high priority in discussions of supply chain disruption. One of the reasons for that is the fact that earthquakes are so different from other natural hazards.

They cannot be predicted, and when they occur the warning time, even with an early warning system in place and operating, is measured in seconds – typically 15-20 seconds, depending on the distance from the epicenter.

That is a vastly different scenario than other disasters such as floods, hurricanes, tornados, wildfires and even tsunamis.

How does earthquake early warning work?

When an earthquake occurs, it begins in one location and the energy that is released radiates out in all directions, causing the ground to shake in the surrounding areas.

Sensors in place throughout the region detect the initial earthquake and radiating waves of energy to predict where the shaking will go, how strong it will be, and how long it will take to reach various locations.

This information is then used to rapidly send out a warning, giving the recipients anywhere from seconds to minutes to take protective actions. The farther from the initial earthquake a location is, the more warning time they can receive.

What actions can I take in those extra seconds?

While a few seconds to minutes doesn’t seem like much warning time, even a few seconds of warning can enable protective actions such as:

• The ability of individuals to drop, cover, and hold on, turn off stoves or safely stop vehicles.
• In the workplace, personnel can move to a safe location, automated systems can ensure elevators doors open, production lines may be shut down and sensitive equipment placed in a safe mode.
• Surgeons, dentists, and others can stop delicate procedures.
• Emergency responders can open firehouse doors, personnel can prepare and prioritize response decisions.
• Power infrastructure can protect power stations and grid facilities from strong shaking.

What automated controls should be put in place?

Automation is needed to take maximum advantage of what may be only a few seconds of warning time.

• Warning appliances should interface with factory, building and process automation systems. Legacy warning systems like the Emergency Broadcast System are too slow for automated earthquake warnings. Communications should and can take less than a second to avoid wasting precious time.
• Communications to automated controls should be encrypted to prevent unauthorized access or terrorist accesses to sensitive infrastructure.
• Communications security is essential when using earthquake warning to automatically protect property or controls on transportations systems.

Preventing dangerous false alarms

If people don’t trust the warning they won’t respond immediately. False alarms must be absent.

• A false alarm in a nuclear facility transportation system or refinery can have extremely undesirable consequences, including incurring large costs associated with complex restart procedures and losses of revenue due to being offline, not to mention resultant impacts from service interruption, affecting downstream customers.
• Unlike all other natural disaster warnings, there is no timely way to confirm an earthquake warning. There must be an immediate response.

Training and education is crucial

People must be trained to respond immediately to the warning. Seconds count, and there may be little time before the damaging shaking begins.

All earthquake warning fundamentally relies on quickly and accurately detecting an earthquake, and then successfully sending a warning out to people and/or automated devices to trigger appropriate actions before the shaking begins.

But if the proper knowledge and training isn’t in place, prompting the correct reactions to mitigate disasters, the warnings alone won’t provide much of a stop gap.

Setting an example in risk management

IBM provides a great example of how companies can use this sort of technology to prevent costly disruptions in their supply chains.

With IBM’s huge global outsourcing budget totaling tens of billions of dollars, including 20,000 suppliers, its supply chain is understandably complex, especially since some suppliers are, by necessity, sole source suppliers.

Executing a global sourcing strategy, where sourcing is conducted across developing countries, has a cumulative effect on the amount of risk introduced into the supply chain.

To manage risk, the company’s global sourcing looks far beyond unit cost to the total cost picture. All dependencies are fully mapped, and wherever possible back up sources are identified along with their impact on the company’s supply chain.

The company also develops contingency plans for events that will eventually happen in the future (e.g. an earthquake or pandemic).

In March 2011, the Japanese tsunami and earthquake placed IBM’s Total Risk Analysis tool front and center, and it responded flawlessly. Within a few hours, IBM determined all its potential supplier problems, immediately assembled details and developed backup plans.

IBM’s recent purchase of the Weather Channel has added a myriad of predictive analytical capabilities to its arsenal. It has also added the resources of its Watson supercomputer.

The utilization of earthquake early warning technology is one more resource in its comprehensive portfolio dedicated to managing all manageable components of its intricate supply chain.

What is your company doing to identify and prevent major disruptions in your supply chains?

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