Many trade disputes are going on. Some are between Saskatchewan and other provinces; others are between Canada and other countries. Some have escalated into trade wars.
Saskatchewan is affected when other countries enter a trade war largely because global supply chains and markets are tightly integrated. Changes to the international trading environment affect all aspects of business, including consumer demand, pricing, and the competitive environment.
Trade happens when companies in one country (or province) sell something to companies in another jurisdiction. Canada tries to protect Canadian companies from foreign competition by creating barriers that make it harder for foreign companies to sell into Canada. Fees called tariffs make foreign goods more expensive, and policies such as quotas (limits on the amount of a commodity that can be imported) restrict what can be brought into the country. All countries do this. It’s called protectionism.
Free trade is the absence (or near absence) of trade barriers. The idea is that two countries adopt a free trade agreement so that companies can easily do business across borders. Companies have access to many more customers, but they also now face foreign competition. Companies that survive increased competition tend to produce better products, provide better service, and sell at lower prices.
In a period of uncertainty, the most effective step is to map out the information you have that can serve as a basis for strategic decisions.
What’s happening now
The global system of trade is in disarray. Largely driven by dissatisfaction with globalization, some of the world’s largest and most influential western countries – historical advocates of open market economies – have voted in governments with a protectionist mandate. After its citizens voted to leave the European Union, Britain faces economic uncertainty as it negotiates its new trading relationship with its neighbours. The US has initiated the renegotiation of trade agreements and has imposed sweeping tariffs and other trade barriers on select products with almost no exceptions for its economic and military allies. Countries around the globe are reacting by imposing tariffs on US goods. The US is responding with additional tariffs on a wider range of products. The escalation continues, and a trade war is now underway.
No company in modern times has had to deal with trade policy risk of this magnitude. Our most relevant example is from 1930, when the US initiated protectionist policies against Canada and other countries, which retaliated in kind. Those tariffs are seen as having aggravated the Great Depression and as initiating a chain of retaliatory protectionist measures around the world that led to the decline of global trade. What will unfold in today’s economic environment, where so many of the goods people purchase cross multiple borders? Nobody knows – we’re in new territory.
Adjusting to the situation
The effects of trade changes on Saskatchewan depend on two main issues.
First, the economy will undergo a transition. Whether there is a long-term shift to protectionism globally (or even just in the US) or if recent trade barriers are a tactic to negotiate favourable free trade agreements, real damage is being done to businesses around the world. Higher costs, limited market access, and ambiguity around the rules of trade have caused companies to rethink their business plans.
As a result of this trade war, Saskatchewan will produce new goods and services for different customers than we serve today. Capital will be invested in different areas and we will require different employee skills. There will be a great deal of change.
Second, the ability of local companies to be nimble will define how we emerge, either after a few rough years or after a long-term return to protectionism. Trade with companies in other countries over the next decade could be full of ambiguity and uncertainty.
As an entrepreneur, it is difficult to know the impact the trade war will have on your business. But rest assured, your competitors are confused and scrambling too. Now it’s time to identify your options and work on strategy. Some of the steps you take will be defensive as you mitigate risk. Keep in mind that it’s difficult to prosper when you are hoarding your assets. As the competitive landscape shifts, consider where pockets of opportunity exist.
Consider your options
The difficulty in knowing what will unfold, and adapting to it, stems from a lack of information. How can you make decisions in your business with no clear understanding of how trade relations with other countries will change? In a period of uncertainty, the most effective step is to map out the information you have that can serve as a basis for strategic decisions. This requires asking the right questions. Start with these.
1. Do you understand how your value chain will be affected?
To understand how trade changes will affect your value chain, you need to track the various companies involved, from the final consumer product right back to the first step in production. How do you think each company will be affected? What risks do you face in your supply chain and with market access? How will consumer behaviour trends influence demand for your products?
2. Have you exercised caution with suppliers?
If you are working out a supply contract now, given the current political environment it would be wise to consider a relatively short timeframe or flexible conditions that would accommodate changing trade rules. For example, if a price is fixed, do the terms of the contract allow for costs related to trade barriers such as tariffs?
3. How will you leverage your advantages?
It is possible that your company has a new advantage over competitors in this evolving economic landscape. For example, on the list of 1,333 Chinese products that the US announced in April would be subject to tariffs, 20% were referred to as “parts.”[i] That means American finished goods manufacturers will be open to replacing Chinese suppliers. Depending on Canada’s market access to the US once NAFTA negotiations wrap up and on the length of time tariffs imposed on China are in place, Canadian companies may have a cost advantage over China and could fill the void.
4. Can you identify new markets?
Most Canadian companies do not take advantage of the various Canadian trade agreements. Which countries have customers that need what you sell? How is the competitive environment in those countries evolving?
5. Are you looking for quick wins?
Search for situations where American companies will be hamstrung by tariffs and other trade restrictions. If your primary competitor manufactures in the US and ships to Canada, you may have a window of time to capture that competitor’s Canadian customers.
6. Are you looking to identify threats?
How are your core customers affected by trade changes? Imagine a Saskatoon-based information technology services company that generates 50% of its revenue from two local manufacturers that export nearly all of their product to the US. If those two manufacturers need to scale back operations, will they reduce or stop purchasing services from the local IT company?
7. Are you working on predicting changes in the competitive environment?
What are your competitors and potential competitors likely to do to adapt to trade barriers? Germany began courting the iconic American brand Harley-Davidson after Harley’s announcement in July that it was moving more of its production out of the US to avoid US steel tariffs and subsequent retaliatory tariffs imposed by the European Union. Another example: US tariffs increased the price of washing machines imported to the US from China by 19.9% in three months.[ii] Will the Chinese manufacturers aggressively pursue customers in Canada, where they can be price competitive? What does this mean for Canadian appliance retailers? This change may distort the current market price in Canada. It may also mean opportunities – Canadian retailers may be interested in taking on new lines of equipment manufactured in China.
8. Will you be able to predict trade policy moves?
Nobody knows what will happen next in global trade relations, but it’s in your best interest to try to predict the future. The current trade situation seems like it came up overnight but there were actually clues about major changes like Brexit (Britain’s exit from the European Union) and the US’s tariffs on China. Inform yourself. What’s being said about industries you sell into? For example, the Canadian government’s purchase of the Trans Mountain Pipeline from Kinder Morgan must pass a US national security review. This means the American administration has the authority to block the purchase, which would negatively affect Saskatchewan’s steel and oil industries.
For decades, countries all over the world have been reducing trade barriers. But adapting and restructuring when trade rules change does bring considerable pain and long transitions. The upside is that change always presents opportunity. So educate yourself about what is likely to unfold and how it will affect Saskatchewan.
Download a discussion paper titled Ripple Effects: What Saskatchewan Companies Can Expect from the Trade War by Banda Marketing Group.
9. What will you do if you can’t travel to a particular country?
Trade agreements define labour mobility rules. There are implications for Saskatchewan companies that may want to send a mechanic to another country to install equipment or an engineer to a branch office to work on a project. When NAFTA was first signed, it reduced barriers for travel between Canada, the US, and Mexico. But rules are applied subjectively. Access can depend on a customs agent’s interpretation, seemingly influenced by that person’s mood of the day.
Recent American immigration policies oppose labour mobility. Consider the consequences to your organization if you are unable to hire American employees to work in Canada or if your Canadian employees are unable to travel freely across the US border. Could travel restrictions be imposed, even temporarily, as an American negotiating tactic? If so, doing business in the US would become extremely difficult. The same situation applies to markets in other countries you may be trying to access.
10. Do you conduct scenario analyses?
Analyzing scenarios really means considering how your situation might unfold in a few different ways, under different circumstances. In a period of uncertainty, strategic plans tend to be fluid and it’s best to identify options rather than sticking to a rigid plan that may quickly lose its relevance. What are the most likely scenarios if a specific chain of events were to unfold? How will you address subsequent issues, such as managing internal costs, replacing customers, and locating alternative suppliers?
A recent example of changing circumstances can be seen in China’s 25% retaliatory tariff on US soybeans. At first glance it seems that Canada’s soy price should rise now that China will have to consider new suppliers. However, Brazil’s soy production is much higher than Canada’s, and Brazil is more likely to fulfill Chinese demand. Also, Canada’s commodity price is tied to the US and there is potential for US product to be redirected from China to compete with Canada for customers. As a result, the Chinese tariff caused the price of Canadian soybeans to decrease.[iii] Then in late July the European Union and the US announced an intent to work toward a comprehensive trade deal. One primary driver seems to be that Europe would purchase American soybeans that were previously destined for China. Where does this leave Canada? Supply chains and markets are integrated. It can be difficult, but valuable, to think a few chess moves ahead.
Most businesspeople are paralyzed by ambiguity. In the absence of clarity, it’s human nature to avoid a decision. What we know for sure is that the current trade war is a catalyst for shifts in the competitive environment. Keep in mind that when the competitive environment is changing, there is opportunity. Asking questions such as these will shed light on your situation and help you identify the core decisions facing your business.
What is a Trade War?
If Saskatoon and Regina were countries, here’s how a trade war might unfold.
A trade war occurs when two or more governments impose a series of escalating barriers to trade to protect local companies.
Here’s how such a war might unfold.
Let’s say Saskatoon and Regina are neighbouring countries. Their citizens can purchase freely from either country. Companies in both cities manufacture electric cars; competition is fierce. To encourage immigration, Regina’s government decides to grow its economy and attract workers by subsidizing local electric vehicle manufacturers that invest in research and development. Companies normally increase prices when costs increase, but with the subsidy, Regina manufacturers can sell a better product (improved through R&D) at the same price as vehicles manufactured in Saskatoon.
Saskatoon’s electric car manufacturers protest in the streets! They can no longer compete! Saskatoon’s government tries to negotiate, but Regina refuses to change the subsidy. Saskatoon retaliates and imposes a 25% tariff on electric vehicles imported from Regina: for every Regina-built vehicle sold in Saskatoon, the Saskatoon government collects a 25% tax. But Saskatoon does not actually collect much money, because Regina electric vehicles are now more expensive than those manufactured in Saskatoon. Most Saskatoon residents now buy from local manufacturers. Facing declining sales, Regina manufacturing companies are forced to lay off employees.
Regina manufacturers pressure the Regina government to fight back against this unfair tariff. Regina imposes a trade quota on saskatoon berries. This drastically reduces the volume of berries that can be imported into Regina from Saskatoon. Berry producers in Saskatoon are caught off guard. They have commitments to fill with bakeries in Regina, but cannot export the product. The laws of supply and demand apply, and the price of Saskatoon berries soars in Regina.
Berries are rotting in the fields of Saskatoon. With no customers, some berry producers go out of business, but savvier entrepreneurs know never to waste a crisis. They begin selling in Calgary, targeting Albertans who had fled Saskatchewan in the 1990s. Sales skyrocket. The madness continues. Saskatoon imposes new trade restrictions to defend its manufacturers, claiming it needs to ensure the safety of residents: companies selling electric vehicles in Saskatoon must now submit a lengthy form verifying that the batteries do not leak acid. Regina companies, burdened by red tape, give up on the Saskatoon market.
Politicians decide to begin negotiations. Both sides make concessions, and they emerge with the Saskatoon-Regina Free Trade Agreement (SRFTA). Barriers to trade are lifted, but the economic landscape is forever changed. The berry sector now has fewer competitors, but they are much larger companies that serve multiple export markets. Laid-off Regina employees found other employment, and without access to its skilled labour, Regina’s electric vehicle industry never fully recovered. Entrepreneurs from both cities, however, are undeterred. They launch new ventures and companies expand aggressively into new markets, happy to leave the great trade war of 2018 behind.
[i] Chad Brown. “The element of surprise is a bad strategy for a trade war,” Harvard Business Review, April 16, 2008.
[ii] Bob Bryan. “Hold on to your wallet: Trump’s trade war with China is about to start hitting the goods you buy most,” Business Insider UK, July 12, 2018.
[iii] “‘China has crashed the price’: Canadian farmers collateral damage in China-U.S. trade war,” National Post, July 10, 2018.
First published in the September 2018 edition of The Business Advisor.