President Biden’s recent executive order to review vulnerabilities in US supplies of critical technologies, metals and pharmaceuticals could have long-term implications for US business. It also signals that companies should be reviewing their sourcing ahead of policy actions. The order lays out a medium- to long-term process for evaluating US supply issues and opportunities, analyzing potential solutions and creating a strategy for eventual policymaking. While the order doesn’t point to any near-term policy changes, there are steps we believe business leaders should be taking toward a proactive response.
The order calls for two reviews. The first is a 100-day review of supply chain vulnerabilities in four key sectors: the defense industrial base, the public health and biological preparedness space, the information and communications sector and the energy sector. The order asks several federal departments, including Agriculture, Commerce, Defense, Energy, Health and Human Services, Homeland Security and Transportation to produce reports providing overviews of the most important issues facing US supply chains.
This initial 100-day review will be followed by a second review, concluding with a more comprehensive set of reports to the national security advisor and the director of the National Economic Council. Agency heads are then expected to meet with industry leaders for feedback on a final report to President Biden that will likely include a number of proposed solutions. This is expected to take at least a year to complete and may not be finished until early 2022.
We recommend businesses respond by modeling out the implications of possible legislative or regulatory action that may result from these two near- and longer-term reviews, including engagement with policymakers in a dialogue leading up to any findings. This review period, and interest to integrate industry perspectives, gives business leaders an opportunity to shape thinking ahead of policy by:
For example, data could point to how US competition may be negatively affected, or how the status quo of a company or industry already shows a demonstrable positive influence on US investment. It is important for companies to proactively develop a positive narrative of job growth and skills training relative to how they are contributing to the domestic economy, either through job creation or investments.
The supply chain order, like most of the policies proposed by the new Biden administration so far, takes a whole-of-government approach—emphasizing climate change, diversity, American jobs and cybersecurity. The pandemic already laid bare many of the vulnerabilities in the supply chains of key areas like pharmaceuticals, semiconductors and the food supply. Companies should be (if they are not already) looking at this confluence of policy areas when considering solutions for their supply chain that will shore up these vulnerabilities brought about by pandemics, climate change and geopolitical pressures.
Companies evaluating changes to their supply chain and operating models should fully model out the implications of any realignment from several vantage points, including people, location, process, tax and technology. Now is the time to look at the confluence of COVID-19-exposed supply risks, policies for creating jobs, the rise in use of digital process management tools and increased shareholder requirements for environmental, social and corporate governance (ESG) leadership. These areas should define an integrated system of changes to meet the shift in what can create long-term value.
The supply chain reviews magnify recent challenges for many US companies with securing crucial components and materials, particularly in industries that traditionally keep inventories low or work with long lead times. US automakers, for example, cut production in early 2021 due to a shortage of semiconductors while surging demand for health products set off a scramble in 2020. Acute disruptions like these are rare, but they aren’t unheard of, and they can trigger a range of immediate actions meant to build up supply and manage the impact on cash flow and pricing that result.
Today, shortages are exacerbating perceived threats to US industry posed by supply chains in which much of the production of the product areas under review is concentrated outside the US. For example, in the active pharmaceutical ingredients (API) space, just 28% of APIs for the US are manufactured domestically. The United States barely registers in mining and processing of lithium, a metal used in rechargeable batteries, accounting for 1% of global output. Semiconductor manufacturing capacity continues to shift to Asian economies: In 2019, four of the six new semiconductor fabs opening globally were based in China, and all were outside the US.
Worldwide, governments are serious about rebuilding labor forces as the global economy recovers, about reducing carbon footprints and about asserting sovereignty in technology and pharmaceutical trade. Company boards are asking management teams to evaluate supply chain dependencies, including what degree of supply security customers now expect. Operational leaders are managing inventory and forging supplier relationships to build flexibility rather than minimize cost.
As a result, the executive order will likely reinforce supply chain redesigns already underway, as companies continue to respond to an ongoing global trend of protectionist measures in trade and tax policies and competitive dynamics—like the emphasis on faster fulfillment and sustainability.
Though policy changes may not be immediate, it’s important for companies to align the business implications of their supply chains with possible tax implications. Diversification of the supply chain is already driving the discussion from a business and tax perspective, and any policies that may arise incentivizing onshoring or nearshoring should be factored into those considerations. Companies should engage with their tax departments to assess and model the implications of policy actions that might arise from the implementation of the executive order.
With respect to supply chains, the policies will likely seek to incentivize companies to onshore or nearshore supply chains and source manufacturing—including related jobs— in the US. For example, the government may seek to incentivize companies with tax credits for onshoring, penalize companies with increased taxes on non-US profits or disallow deductions attributable to offshoring. President Biden’s various initiatives during his candidacy and first 100 days, including the “Made in America” and “Build Back Better” plans, have set the stage for such policies.
Any potential realignments of the supply chain can have significant tax implications, either as a material net tax benefit or a prohibitive cost. In choosing where to locate a certain function, for example, companies may face a direct tax cost of choosing a higher tax location versus a comparable lesser taxed jurisdiction. On the other hand, policies providing tax incentives for onshoring or nearshoring, especially if such actions are already part of a business realignment, can integrate tax with overall business strategies. Companies can reap significant tax savings by proactively coordinating business and tax strategies around supply chains.
Thus, companies should consider the tax impact—from both a US and non-US perspective—of relocating each element of their supply chain, including their people, processes and technology. In general, profits attributable to supply chain elements are based on how the assets are employed, the functions they perform and the risks they assume. Changing any of these elements could result in significant tax issues, including:
Recent US and non-US tax reforms have also introduced new and complex rules that need to be considered, including anti-hybrid rules and modified tax treaty obligations. For example, a number of supply chain structures may utilize financial instruments, transactions or legal entities that fall into anti-hybrid rules implemented in Europe, Mexico or elsewhere. Depending on the specific circumstances, companies may be at risk of losing cost of goods sold (COGS) deductions in those jurisdictions. With the stakes becoming higher and the rules more complex, it’s critical that tax departments coordinate with their related counterparts to take into account the many variables, dependencies and decision points of their company’s supply chain planning.
Along with understanding and modeling the tax ramifications of changes to supply chain elements, companies may concurrently want to reassess their tax operating models. You may, for instance, want to consider how the overall tax burden and cost structure changes if your company adopts a contract manufacturing model versus a toll manufacturing model or outsourcing manufacturing completely to a third party. As part of that analysis, we recommend factoring in how additional or new incentives may apply to the manufacturing operation (depending on the option) and whether the manufactured products can be sold through new sales channels (e.g., directly to consumers as opposed to local distributors).
Supply chains for semiconductors, critical minerals and pharmaceuticals will not change overnight, but C-suite executives should recognize that the ground is shifting in supply chain planning. Improving your organization’s abilities to anticipate supply shocks and policy changes, and then coordinate your response, is crucial. Manufacturers across industries learned quickly that they didn’t have enough visibility or control during the pandemic, and they’re making investments in technology to correct that: 58% of US COOs are prioritizing demand forecasting and sensing in their supply chains this year, according to PwC’s Manufacturing COO Pulse Survey.
Don’t wait. Now is the time to rethink your supply chain design. There are a lot of changes that affect supply chains: socioeconomic, trade, climate, customer expectations, resource access and geopolitics to name a few. Companies should continuously reassess their supply chain designs and think ahead. The president’s executive order is a reminder to do so.
Managing Director, PwC US
Principal, PwC US
Global Industrial Manufacturing & Automotive Leader, Principal, PwC US
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