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Flexible contracting needed for supply chain resilience

Contracts between manufacturers and their suppliers need to be drafted in a way that enables the supply chain to adapt to unanticipated disruptions, experts in managing risk in commercial contracts have said.

Clare Francis and Cerys Wyn Davies of Pinsent Masons, the law firm behind Out-Law, were commenting after a new report published by WMG, a University of Warwick world leading research and education group which collaborates with industrial partners, identified vulnerabilities in UK manufacturing supply chains.

According to the report, three in four organisations are likely to experience a disruption within their supply chain every year. This "fundamental business risk" applies across sectors, but has been brought into sharp focus as a result of the impact of Brexit and the Covid-19 pandemic, it said. Those events highlight the need for businesses to prepare for "volatile, uncertain, complex and ambiguous market situations", said Margot James, executive chair of WMG.

To improve the resilience of UK manufacturing supply chains, the report outlined three solutions. It said manufacturers should assess the current level of resilience in their supply chains to identify vulnerable areas and plan for possible disruptions. Manufacturers should also "manage buffers effectively so as to respond faster". This, it said, should include investment in more localised "spare fixed asset capacity", and not just in maintaining access to short-term inventory, "to ensure that your supply chain can cater for the demand uncertainty caused by your customers and your commercial strategy".

Francis and Wyn Davies explained why the third solution – increasing contracting agility to build a close tie with business partner – is also important.

"The disruption experienced by business and supply chains due to Covid-19 has been unprecedented on a global scale and this has demonstrated the need for greater flexibility in contracting solutions so that they are able to deal with and adapt to any scenario, no matter how unthinkable it might be today," Francis said.

"The fluctuation in demand for products before and after lockdown was vast. Many businesses saw a significant increase in demand occurring very quickly and giving little time to adapt or change processes. An equal number saw massive variances and a decrease in demand. This was, typically, less sudden, but the decrease in demand amplified as the pandemic continued. For businesses, this volume volatility presents operational challenges requiring the implementation of new processes to manage stock and inventory. However, it is frequently also an issue in supply chain contracting, as the contract needs to support changes in practice," she said.

Francis said that the significant increase in collaboration between manufacturing businesses during the pandemic highlighted its role in enabling businesses to "deal with unchartered eventualities". She said "increased collaboration and a contractual framework to support successful cooperation will be important" to address other as-yet-unforeseen disruption risks in future.

Wyn Davies said that a contract needs to be able to deal with and respond to changes in demand "on an agile basis". She said that a collaborative contracting approach, which is focused on outcomes, provides "something more balanced, co-operative and streamlined" for use in the sector than the linear approach to contracting that has been traditionally adopted.

"Focusing on outcomes ensures all parties are incentivised to achieve the best result and to work together to achieve this," Wyn Davies said. "This is a move away from typical penalty-driven contracts with liquidated damages and termination rights, to a more outcome-based partnership that drives better behaviours."

Wyn Davies said that it is important that contracts are drafted in a way that enables them to keep pace with the operational requirements of the business as disputes can arise if they cannot.

"Keeping the legal team fully informed of the business strategy can help ensure contracts are put in place to achieve the required operational requirements and flexibility," Wyn Davies said. "By ‘living the contract’ and employing good contract management techniques there will be less value leakage throughout the supply chain. Should any disputes arise, the contract terms will be there to support the parties and help resolve the disputes promptly rather than hindering those discussions."

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