Paris Smith LLP associate solicitor Emily Sadler shares how businesses can prepare smarter sourcing contracts for more resilient supply management
2020’s barrage of challenges exposed the risks and limitations of traditional supply and procurement contract models. In response, organisations are reviewing how they can amend or prepare more strategic contracts that embed flexibility to better support all parties to manage major disruptions. This approach can be broken down into three keys areas:
1. Prioritise resilience
An overreliance on China emerged when Covid-19 first took hold and Chinese manufacturers sent their staff home, sending shockwaves through global supply chains. While value for money remains an important consideration, it can no longer be the primary focus – it’s worth paying slightly more for greater resilience in the long term. In order to improve business continuity you must choose your supply chain partners carefully, and bear in mind the following practical steps:
- Move away from the common practice of using a few key suppliers to drive economies of scale
- Switch to multi-location sourcing and perhaps add in more local supply chain, using local labour
- Stockpile to create a buffer
- Reduce the number of product lines offered to lower complexity in the supply chain, and
- Consider changes in consumer buying habits, in particular the increased attention on origin of products.
2. Flexibility versus certainty
Having flexible rights to terminate and vary the terms of a sourcing contract has always been important. Recent events highlight this. Can you exit the contract ‘for convenience’ if your circumstances change or some external event occurs outside your control which makes contract fulfilment impossible, or at least financially very difficult? Your rights to vary or terminate a contract will likely depend upon your bargaining strength but they are always an area to focus on.
A shift away from rigid contracts that tie parties in terms of duration, exclusivity and expenditure is likely over the next few months and years. Supply chain contracts will need to ensure they allow you to ramp production up or down to meet changes in customer demand. Well-drafted and effective forecasting provisions enable collaboration with the supply chain to ensure supplies remain on track while preserving an appropriate buffer for short-term disruption.
This needs to be balanced against contract certainty – a fixed contract term or minimum spend commitment, for example. Here there is likely to be a conflict between a supplier’s wants and needs and those of the customer. Careful consideration is necessary as to how this balancing act is achieved without either party being exposed to unacceptable levels of risk.
3. Effective contracts and governance
Contracting parties should prioritise the inclusion of decent governance and dispute resolution provisions within their supply contracts, giving a robust framework to discuss and resolve issues as they arise. This will also help ensure a long-term relationship between the parties that can weather any disruptive periods.
Businesses should consider including relevant contractual terms and audit rights. These provide early warning signs if a supply chain member is in potential financial difficulty. This can include practical steps such as the supplier providing regular management accounts or notifying the customer if there is a downgrade in its credit rating. This can assist a customer’s oversight of any supply chain issues, allowing it to be proactive with any actions it might take in response.
As a backstop position for appropriate supply chain partners, step-in rights might be beneficial – as negotiated by the government’s taskforce for the procurement of Covid vaccines. These allow for the use of the supplier’s premises, equipment and IP, as required, in order to continue manufacturing where there is a supplier failure. Such clauses can be a fast and effective way of mitigating the exposure for the benefit of both parties that is practical in nature.