NAFTA is headed for a renegotiation. Changes could range from adjustments to the rules of origin for product content, and more-stringent labor standards, to the extreme of withdrawal and a return to World Trade Organization most-favored-nation tariffs. These shifts will have important implications for the supply chain and profitability of U.S.-based companies. However, there is a high level of uncertainty about the ultimate outcome and consequences for companies, in part because the effect could be offset or aggravated by how currency rates adjust.
Notably, the proposed “border adjustment” that is part of a tax reform package Congress is debating could cause the U.S. dollar to appreciate relative to other currencies. Under the plan, companies would not be able to deduct the cost of imports from their revenue, a move that today enables them to lower their overall tax burden. At the same time, exports and other foreign
would be made tax free.
The uncertain nature of trade policy has left many leadership teams reluctant to act. But waiting for a clearer sense of the future is the riskiest option. Successful companies thrive in uncertainty by incorporating change into their strategy. Leadership teams can limit the negative consequences of a possible NAFTA withdrawal and currency moves by adopting an approach that anticipates several future scenarios. This approach also applies to companies based in Mexico and Canada, as well as other countries, such as China, with trade agreements that may be vulnerable to U.S. political upheaval.
Senior leaders who have learned to manage in uncertainty focus on the few risks that matter most. They assess each potential scenario and identify the critical trigger points — we call these signposts ― that signal a swing from one outcome to another. That approach helps determine a clear portfolio of actions that balance commitment and flexibility. Instead of basing a strategy on conditions at a specific point in time, leaders engage in a continual cycle of execute, monitor, and adapt, redirecting the company toward the best opportunities over time.
How Different Industries Might Fare
Bain & Company has analyzed the possible NAFTA scenarios, including no change, minor adjustments, and full withdrawal. Under the withdrawal scenario, we estimate it could reduce net income of the largest U.S. companies in the automotive, agricultural, and textile industries by as much as one percentage point (assuming no pass-through of higher costs to consumers). Companies in these industries tend to rely heavily on imported parts and raw materials from Mexico or Canada traded at NAFTA terms. For example, California-based berry producer Driscoll’s has invested extensively in Mexican berry operations because of the year-round availability of high-quality fruit, lower labor costs, and local know-how.
Should NAFTA withdrawal and the border adjustment both occur, the combined effect would weigh most heavily on the oil and gas, automotive, and aerospace sectors. For oil and gas and aerospace companies, most of the downside stems from the border adjustment. Although these industries have a high level of imports, a relatively low share of them flow through NAFTA. Automotive companies, by contrast, would suffer mainly from a NAFTA exit, since so much of their imports flow through NAFTA and they incur a high most-favored-nation tariff.
The anticipated rise of the U.S. dollar against foreign currencies might offset much of the impact of both of these changes, due to a higher demand for the dollar. When Americans demand fewer imports, they also provide foreigners with fewer U.S. dollars. This reduces the supply of dollars, makes them more difficult to get, and pushes up their relative value. Any export subsidy would allow U.S. producers to lower their prices in foreign markets, raising demand for U.S. exports, which further spurs demand for dollars in order to purchase those exports.
Currency effects could take years to materialize in certain industries, however. That’s because many suppliers sign five-year contracts in dollars, not pesos. No matter when a new trade agreement is signed, and currency effects start to kick in, those suppliers could adjust their prices only after the contracts expire.
Three Types of Action to Consider
Companies that develop a strategy for these uncertainties will be able to pivot faster than the competition when details about a new trade agreement become clear. Timing is key, no matter which scenario unfolds. While planning actions for each possible outcome, companies should pair each action with a signpost that triggers it. Companies can choose from three types of action:
- No-regret moves. Some actions will increase a company’s competitive edge, no matter what scenario plays out. They include improving cost management or operational effectiveness in procurement, supply chain, and inventory management. NAFTA renegotiations heighten the urgency to look for new operational efficiencies, as they give companies greater flexibility to face new treaty restrictions. For example, a retailer that becomes more efficient will have the option of not passing on cost increases to consumers — without hurting its profit margins.
- Options and hedges. Leadership teams that develop strategic options and hedges for a variety of future scenarios navigate better when new developments unfold. These could include expanding procurement options or increasing volume sourced from competitive local suppliers. For example, back when NAFTA was being negotiated, several Mexican companies, such as auto parts supplier Rassini, seized the opportunity to invest in modernizing their operations so they could expand beyond their local customer base to compete globally. One option today is automating operations to some degree. If NAFTA is repealed, it would be easier to move a partially automated production line back to the U.S. than a highly manual line. The option value lies in the cost of moving, relative to paying the border adjustment and higher World Trade Organization import tariffs that would kick in under the withdrawal scenario.
- Big bets. The most challenging balancing act involves large-scale investments that have different payoffs depending on how future uncertainties play out. Any company that keeps its supply chain and manufacturing footprint plans for North America may be making a big bet, and management teams should assess their investment plans from this perspective. Companies could go even further by expanding production capacity or switching suppliers from foreign- to U.S.-based companies. Or they could make a contrarian bold bet, as is being contemplated by Ammex, a disposable-glove distributor based in the U.S. that sells to labs, hospitals, and other companies around the world. Ammex is looking to invest in e-commerce and double down on Mexico, a key developing market for the firm, while nervous competitors draw back from the country. If a big bet looks too risky to take immediately, companies can wait for greater clarity and move quickly once changes look likely.
Companies can monitor a wide range of signposts and map them to possible strategic moves with their supply chains. No-regrets moves can be launched regardless of signposts, but a regular check of relevant information will precede the implementation of options and hedges or big bets. For instance, if other free-trade agreements are either withdrawn or signed, that could prompt some companies to increase the volume of parts or material sourced from competitive local suppliers that have previously been vetted and placed in reserve. Once NAFTA negotiations begin, an important signpost would be an announced term sheet that establishes the boundaries of the negotiations — say, agreement to review regional content rules and include new sectors but not consider quotas or withdrawal of any sector. Under those boundaries, expanding local supply would shift from being a hedge to a no-regrets move for some industries.
It may take a couple of years to know what changes NAFTA negotiations will bring and how they will affect supply chain speed, costs, and inventories. Developing a strategy for uncertainty provides leadership teams with the tools to anticipate multiple outcomes ahead of the competition, and before the relevant governments make their decisions. By incorporating change into the strategic process, companies can correct course quickly as new trade deals unfold.