Building sustainable relationships in the supply chain
Two big news stories in the first half of 2018 have highlighted the growing importance of building resilience into the supply chain of any business.
First came the collapse of Carillion in at the end of January, the second biggest construction company in the UK, which led to many predictions of a rise in the number of construction companies going bust as subcontractors in the firm’s supply chain missed out on payments. Carillion’s failure caused ramifications across a sector in which profit margins are typically low.
Then, in February, came the story that fast food outlet KFC was being forced to close almost two-thirds of its UK branches as a result of the breakdown of a new supply contract for chicken with delivery network DHL. In one of the worst logistics failures of recent years, more than 560 of KFC’s 900 UK restaurants simply ran out of chicken, as DHL took on a new delivery contract and hit teething problems.
What both stories highlight is how critical it is that management maintain close visibility across the supply chain, keeping close to both customers and suppliers and using contractual terms to monitor risks and build preparedness into their own business strategies.
At the same time, there is a lot more customer interest in the supply chain, and particularly in the provenance of products that have often been sourced and produced all over the world. Retailers, in particular, are closely scrutinised on the strength of their relationships with their suppliers and their local communities, and are expected to make efforts to maintain fair working conditions and promote fair trade.
Marks & Spencer, the UK food and clothing business, has a lengthy supplier management section on its corporate website, setting out what it sees as its responsibilities to suppliers. Customers want to know these things, as do regulators, with the UK’s Modern Slavery Act 2015 introduced to tackle slavery in the UK, and placing new requirements on UK businesses to report on steps they are taking to ensure that slavery and human trafficking do not take place either in their own businesses, or in their supply chains.
Alison Chivers, a partner in the Trowers & Hamlins corporate practice, says:
"Due diligence is extremely important at the outset of any relationship with a supplier or customer. You shouldn’t just be going along with whatever you are told, but from the outset of your business relationship should be doing your due diligence, not just with a view to ensuring the financial longevity of the relationship, but also because of the importance of business ethics.”
If things do go wrong with the solvency of a customer or supplier, by the time that liquidators are called in it is too late to act. At that point, the law takes over in asserting what payments can be made and the order in which creditors can be reimbursed.
It is therefore important to be monitoring profit warnings and any other indicators of financial problems: “Remain vigilant and take the time to monitor how your suppliers and customers are doing,” says Chivers. “If things do look like they may be going south, consider strategies such as shortening payment terms, making sure you have reservation of title clauses in place, and securing upfront payment wherever possible. You need to prepare and look to be owed as little money as possible in the event of an insolvency.”
One indicator that businesses are advised to pay close attention to is the availability of business credit insurance. Adrian Jones, partner in our corporate practice, says: “A lot of big supplier contracts will require a customer to have in place credit insurance. Often that’s the first sign of problems, if a company is not able to renew their credit insurance. If it is not possible for a company to secure that insurance, that should be an immediate red flag.”
A requirement for customers to have insurance might be one of the policies set out in a supply chain resilience strategy, and all businesses are advised to put such strategies in place. Typically seen as defensive documents, focused on risk management, they can in fact make a huge difference to resilience and long-term business success, and so should also be seen as offensive, according to Tim Nye, another partner in our corporate department. Nye says:
"A supply chain resilience strategy has a number of benefits to it. One is defensive, about risk management, but the second is part of an offensive strategy. If there’s an adverse event that happens and affects your business as well as your competitors, then having a resilience strategy in place can allow you to potentially react quicker and more effectively than your rivals, and grow your market share.”
He adds: “Businesses looking at supply chain resilience should not just see it as a defensive play, but also as potentially a very positive route to growth.” The first thing to address when designing a supply chain resilience strategy is an understanding of the risks that apply, which means looking at what could upset the supply chain, the likelihood of that occurring, and how that risk might be mitigated.
Next, transparency should be sought around those risks, which requires engagement with suppliers and collaboration to discuss ways in which risks might be managed.
Another key element of any strategy is supplier due diligence, as well as the use of contractual protections. Further examples of best practice include supplier diversification and introducing spare capacity into the supply chain, through the storage of extra inventory or the maintenance of idle facilities for use in the event of disruption.
Nye explains that company directors have a duty to consider these issues: “People often overlook the fact that a director’s main responsibility is to act in the best interests of members of the company, which includes fostering sustainable relationships with suppliers, customers and others.
There is a link between directors’ statutory responsibilities and potentially putting in place a supply chain resilience strategy. It’s about understand your counterparty’s issues, having transparency, and maybe using your combined expertise to overcome or prevent issues.”
Carillion and KFC have merely highlighted an issue that should already be front of mind for managers of supply chains today.