Thinking | 11 August 2020

Supply management: don’t break the chain post COVID-19

Jacqui Barrett, a Sydney-based partner in our Corporate & Commercial team, examines the importance of managing supply chains and what businesses should consider to ensure their supply chain is sustainable for the long term.

Minimising impact on supply chains became a top priority for many Australian businesses due to COVID-19.

Many industries in Australia rely on a globalised supply chain to ensure that they are able to meet the demands of end customers and remain cost-effective. In particular, Australian businesses routinely seek out international sources of supply for parts and manufactured goods.

COVID-19 led to shortages in supply and increased costs for many businesses in maintaining their supply chain. As a result, those businesses have had to negotiate new arrangements both up and down their supply chain and compromise on quantities. In many cases, businesses have had to seek out alternative sources of supply where possible.

Businesses have also been required to more proactively manage relationships with suppliers and customers to combat (as much as possible) the threats to supply chain continuity. This was particularly the case for businesses operating in essential services.

General feedback from our clients to date has been that COVID-19 has required them to be more innovative, make decisions quickly and be ready to pivot at a moment’s notice. For many clients, building and sustaining good lines of communication with suppliers and customers has also become critical to continued operations.

While we are still in the midst of the COVID-19 response, with the start of a new financial year, many businesses are starting the essential process of reviewing their COVID-19 response to assist with future business planning and to secure their supply chain moving forward.

Options businesses are considering include:

  • Diversification of supply chain sources to include multiple suppliers, both located internationally and locally.
  • Reconsidering contractual arrangements to allow for greater flexibility, including changes to pricing.
  • Reorganising internally to allow for more effective and efficient decision making, and ensure a rapid response to change.

We discuss each of the above options in more detail below.

Diversification of supply chain

It appears that diversification of supply chain sources will be high on the agenda for a number of our clients as they move into a post-COVID-19 environment.

One option will be to move away from exclusive supply arrangements and appoint multiple international sources of supply to create flexibility and mitigate risk. However, businesses choosing this option will still have to contend with what we see as the ‘hidden costs’ of globalisation, which include:

  • exposure to the risk of non-supply and having no effective means of managing this risk due to a lack of proximity to the manufacturer or supplier;
  • the risk of being solely dependent on a particular supplier or manufacturer that is rendered unable to operate or only able to operate at reduced capacity;
  • the inability to import or export due to a lack of access to transport or other logistics support;
  • exposure to exponential increases in prices as raw materials become scarce and manufacturers/suppliers contend are only able to operate with a reduced workforce;
  • exposure to increased tax and tariffs in the country in which the products or materials were manufactured or produced;
  • the risk that a presiding Government in the country in which the supplier/manufacturer operates intervenes to:
    • prevent manufacture or delivery of products and services to the intended customer; or
    • direct that products or materials be delivered to local businesses as opposed to being sent to the intended customer.

As a consequence, businesses have started to analyse their sources of supply and consider locally-sourced products and materials. While locally-sourced products and materials may not represent a cost saving, the benefits of incorporating local operations into the supply chain include:

  • products of a higher quality or standard;
  • local access to raw materials;
  • substantially reduced logistics and transport costs;
  • more ready availability of products and materials;
  • creation of employment opportunities for the local community;
  • operating in a familiar legal and regulatory environment; and
  • potential tax incentives to encourage local industry and jobs creation.

Reconsidering contractual arrangements

COVID-19 has, in some cases, brought to light omissions or errors in supply and customer contracts that meant the parties did not have a ready process to follow (or a solution to adopt) to respond effectively to the impact of COVID-19.

A lack of a force majeure clause (or a force majeure clause that did not contemplate a pandemic or the consequences of a pandemic) was quite common. This meant that the affected parties had no process to immediately rely on to provide some certainty to them in the situation.

It was also identified that many contracts were not drafted to provide for the flexibility required to respond to the unique circumstances that arose because of COVID-19. For example, pricing was an immediate concern for many suppliers as they had difficulty sourcing raw materials. In many cases, the existing contracts did not readily permit a reasonable adjustment to pricing.

Variation clauses were, in some cases, also found to be lacking. For example, a variation clause may only permit one party to propose a variation, or variations were only to be contemplated in certain circumstances. This limited the ability of parties to effectively respond to the changing circumstances by way of varying their contractual obligations.

We are of the view that, moving forward, business take the opportunity to review of their key contractual arrangements to ensure that, among other things, the issues identified above are accommodated.

Internal reorganisation

While not a legal issue, many businesses were required to change their decision-making processes to allow for greater agility and to ensure that opportunities to secure supply chain could be capitalised on during COVID-19.

Moving forward, businesses should reflect on what procedures and systems worked well during COVID-19 and assess whether they can be adopted permanently to create efficiencies and make cost savings.

Matters to consider for post-COVID-19 planning for supply chain

For those businesses that are starting to plan for post-COVID-19 supply chain management, we suggest that Directors and C-Suite officers ask themselves the following questions:

  • What were the positives (if any) that came out of the response of your business to COVID-19 and how will this impact the way in which you do business moving forward?
  • Did you need to make changes to the way you work in order to respond quickly to supply chain opportunities or rapid changes in demand? Do you see any of these changes having long-term application?
  • Where were there blockages in the supply chain? How did you manage these blockages?
  • What opportunities, realistically, are there to diversify your supply chain while maintaining quality and ensuring cost effectiveness?
  • What contract issues (if any) arose during this period in relation to your supply chain? How will you change your contracts to respond to another pandemic or critical event?
  • Did COVID-19 identify any gaps in your supply chain?
  • Did COVID-19 showcase the strength of your relationships with customers and suppliers? If not, what can be done to improve customer and supplier relationships to ensure improved co-operation and compromise should another critical event arise?

Businesses should consider and embrace the positives from responding to the challenges of COVID-19 as they plan for post-COVID-19 supply chain management. By doing this, businesses can use the opportunity to drive change and implement successful supply chain models going forward.

Contact

Jacqui Barrett

Jacqui Barrett

Partner & Head of US Practice

Jacqui assists clients with mergers and acquisitions, corporate structuring, capital raisings and managed investment schemes.

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