Coronavirus: managing supply chain failure risk as lockdown eases

In the UK, many products and services depend on fast, efficient supply chains which are highly integrated and often operate cross-border. The coronavirus outbreak has disrupted supply chains around the world, many of which ground to a halt during the lockdowns imposed by global governments in response.

As we saw during the global financial crisis, any supply chain is only as good as its weakest link. Companies should act promptly to assess the risk of supply chain failure as a result of pressure from the Covid-19 pandemic.

Prevention is better than cure

The damage caused to your business by unforeseen supplier insolvency can be serious. It is potentially damaging to brand and goodwill, and an unwelcome drain on financial and management resource.

Pro-active planning is critical to maintain continuity of supply and to avoid your business facing production line failures, delayed deliveries to customers, inefficiencies and increased costs. There may be downstream penalty payments to be made to customers unsympathetic to your situation and all too willing to lay the blame for the disruption at your door. Still worse, such delays can result in significant damages claims for breach of contract.

The following steps will greatly enhance your prospects of identifying any risks inherent in your supplier base, so that you can do something about them.

Identify your ‘business critical’ suppliers

Score each supplier on the impact their sudden failure or insolvency will have on your business. Use a ‘traffic light’ warning system to prioritise and flag problem suppliers. Where critical suppliers are identified consider how quickly, easily and cheaply they could be replaced and whether back-up or dual suppliers could be put in place now to reduce the risk of failure.

Prioritise cross-border supplies

Where supplies are crossing borders the risk of disruption and impact of Covid-19 are increased. You will also need to consider carefully the timing and pace at which lockdown is being lifted in the territory of the supplier. Can any critical supplies be brought onshore or is it appropriate to stockpile any goods or parts to avoid short term disruption?

Don’t forget logistics providers

It’s not just suppliers themselves but logistics providers that will be critical to keeping goods moving. Work with logistics providers to ensure that routes keep as free moving as possible. Maintain an open dialogue with providers and consider back up providers or contingency options in the event of delays on critical goods or products.

Review your contract terms

You should have a clear understanding of what contractual terms apply with your suppliers in respect of any issue. For example, who is responsible for delivery? Who bears the exchange rate risk? What terms will apply in the event of an insolvency, particularly around payment, passage of title and risk, set-off, assignment and termination? Knowing these in advance provides an opportunity to potentially renegotiate any critical terms, as well as a competitive advantage in a time-critical situation.

We would recommend that a log is kept for each supplier, particularly those identified as business critical. This should include:

• a copy of the signed contract;
• flagged key terms; and
• any practical considerations for that supplier - for example, do you have any tools or other materials on site with the supplier which will need to be recovered? What stocks are in place? Which customers are serviced and what downstream payments may be required in a failure situation?

This will increase the chance of minimising impact and maximising recovery should a supply chain failure occur.

Consider financial distress and corporate resolution planning

For critical suppliers, you should consider incorporating financial distress and corporate resolution planning measures into your contract. This is a contractual mechanism by which suppliers are obliged to notify you of certain financial distress events or corporate changes, and to put in place a plan to mitigate these.

These terms can be a very effective way of giving you early notice and ensuring you are part of the conversation around recovery plans. This helps avoid the failure in the first place, putting you in a stronger position and solidifying relationships with suppliers.

Understand your suppliers’ financial position

Ongoing access to and reviews of current financial data in the form of management accounts or cashflow records will help you spot the potential for problems. This may require going beyond the day to day contact between your procurement and their sales team and getting a line directly to their financial director.

Understand your suppliers’ KPIs

Knowing what makes your suppliers tick is vital. What promotes their success. Where is their break even point on volume? Are they overexposed to loss of a particular customer or the failure of one of their own suppliers? Are they at risk on major litigation or a bad debt?

Build strong relationships with your suppliers

How likely is it that your suppliers would speak to you openly in the event of difficulties? Consider whether you can improve this.

Put in place strong internal reporting mechanisms

Much of the information you need may already be reaching some of your organisation, but not the ears of those who can do something about it. Consider who in your business has contact with your suppliers. Are they the right people? Are they aware of the importance of reporting relevant information to the right people internally?

Monitor for early warning signs

Businesses should ensure they have processes and procedures in place to spot difficulties, and act on them, early. Some of the largest supply chain failures in history came about because early warning signs were not aggregated through an official business process and therefore no action was taken.

Businesses should be particularly vigilant about:

• requests for changes to payment terms – requests for accelerated payment, deposits, up-front pre-payments or reduced retentions can indicate cash flow problems. The reasons behind any requests should be explored fully and quickly;
• ·non-delivery – supply chain members not delivering in accordance with agreed schedules or contract terms can be an indication of deeper problems. Investigate this early and ensure that lenience is only applied where appropriate so that performance of suppliers does not slide;
• re-negotiation of prices - unexpected price rises or attempts to renegotiate pricing or other terms through repeated invocation of any variation or change regime can be a sign of a supplier considering many options to avoid difficulties;
• lack of communication – silence, particularly after persistent enquiry, can indicate that the supplier is avoiding contact and busy focused on other things;
• sector problems – your suppliers may operate in markets and sectors other than your own. Over-exposure to problems in these sectors may affect their ability to fulfil your orders;
• high staff turnover - if you are finding the supplier has constant changes in personnel or your key contacts this can be an indication of internal difficulties or demonstrate that they are not prioritising your account;
• market intelligence – rumour and gossip must be treated with caution and are best supported by information received from more authoritative sources. However, market intelligence may give a real time indication of events occurring at your supplier. This may come from sources as diverse as contacts at the supplier, other customers or even the media and the internet;
• withdrawal of credit insurance cover – many businesses rely on credit insurance to protect against the risk of their customers' insolvency. Evidence that your supplier has lost the support of the credit insurers who cover its suppliers, whether removal or reduction of cover, is often a clear indication of underlying financial problems;
• signs of insolvency or trading difficulties - as well as profit warnings and other company announcements, there are a number of public sources you can monitor in order to identify early warning signs that may indicate a future insolvency.

Consider strategy and next steps

It is one thing to have internal systems in place to pick up relevant information on your suppliers, but another to use them effectively. Being proactive and ahead of your customers can make all the difference in these situations.

Some specific actions businesses can take include:

• staying close to your suppliers - a strong relationship, with a good flow of information from your suppliers, is one of the best means you may have of avoiding exposure to sudden insolvency. This may buy you time to plan and mitigate your risk;
• collating evidence – ensure records are kept of the evidence of difficulties and their impact. It will be particularly important to document any steps taken to mitigate the impact, and the decision-making process and justifications in respect of any actions not taken;
• re-sourcing wholly or partially – risks can be reduced or removed if you have a viable alternative which can be implemented quickly. Consideration should be given to the lead times for re-supply and how these fit with existing inventory. Be careful, as re-sourcing may be in breach of existing supply contracts;
• building up stock levels – increasing your inventory levels is a 'buffer' measure which may buy you some time to re-source or otherwise respond to issues which may arise. Bear in mind that this won't necessarily remove the underlying risk;
• funding – consider if you need to accelerate funding terms, provide additional funding to suppliers or even consider acquiring critical suppliers to avoid a supply chain failure;
• terminating contracts – this may only be available if the terms of the contract permit it. Careful consideration and advice is needed about whether termination is possible, and the best strategy;
• recover assets – you may have supplied tools to your supplier or they may be using certain assets under licence. Equally, they may have stock or other materials on site which belong to you. The terms of any applicable contract will strongly influence your ability to recover these items.

Specific, appropriate advice should be sought before taking action in relation to any of these options.