3 Contract Negotiation Strategies to Reduce Supply Chain Risk
Businesses around the globe recognize that there is a new normal for supply chain risk management. The pandemic’s impact on global supply chains exposed vulnerabilities, created opportunities, and made embedding resiliency and agility into supply chains non-negotiable.
To weather future crises, supply chain leaders are placing procurement processes under a microscope. Your supply chain contracts should also be reviewed and, where possible, renegotiated to minimize risk. To do so, include provisions to help mitigate foreseeable and unforeseeable risks to your supply chain. Specifically, you should consider the following three provisions to reduce risk in your supply chain contracts.
1. Promote End-to-End Transparency Through Your Supply Chain Contracts
Supply chain transparency helps reduce risk in many ways. It can identify unethical or unsustainable practices in your supply chain, which may damage your reputation. Your efforts to increase awareness of pressure points in your supply chain and to reduce the impact of delays, disruptions, quality control issues, or financial instability of downstream suppliers are also bolstered by transparency.
But with increased transparency comes increased monitoring. As such, transparency and monitoring requirements should be negotiated with flow-down provisions. These require your suppliers to bind their own suppliers and contractors to the same requirements.
Including provisions that require your suppliers to provide transparency reporting helps reduce the burden of monitoring transparency within your supply chains. Here are some examples of such provisions:
- Auditing requirements that include provisions for appointing independent third-party auditors
- Documentation requirements that include an obligation for your suppliers to identify their suppliers, along with their suppliers’ industry certifications
- Review processes that facilitate the assessment of compliance with transparency standards, including penalty provisions that apply when those standards are not being met.
You should also consider mandating in your contracts that your suppliers use advanced tracking technologies. These technologies facilitate a faster response to disruptions, whether they’re due to the Suez Canal being blocked for six days or a global pandemic, and may help minimize the length of the disruption.
2. Mandate Diversity, Sustainability and Ethical Practices from Your Suppliers
Increasing diversity, sustainability and ethical responsibility along your supply chain will help mitigate the risk of reputational damage, litigation or compliance issues, as well as the associated financial impact. Your desire to introduce supplier standards, and the extent to which they will apply to any new procurement partners, should be negotiated as early as possible.
Diverse suppliers provide unique opportunities to produce new solutions to overcome competition. Their smaller size can provide the advantage of being able to adapt more quickly to market changes and business fluctuations. Accordingly, diverse supply chains are more agile, resilient and innovative. Also, ethical sourcing is increasingly being mandated by governments that are enacting modern anti-slavery laws.
Your supplier contracts should stipulate that suppliers must abide by your diversity, sustainability, and ethical standards and requirements, and that they must flow-down these standards and requirements to their suppliers (where possible). Existing supplier contracts can be updated with these standards and requirements through an addendum or in connection with a contract renewal.
Citing authoritative reports about the financial benefits of diverse, sustainable and ethical sourcing is a key strategy that can assist with buy in when negotiating these provisions with your suppliers.
3. Strong Contract Termination Clauses are Essential
Strong contract termination clauses can help protect your company from suppliers’ poor performance by facilitating a fast and cost-effective exit from supplier contracts. This can free up resources for developing relationships with better performing suppliers more quickly.
Your supplier contracts should clearly define a material breach. Depending on your particular circumstances and risk appetite, this could include any one, or more, of the following:
- Delayed performance or payment
- Non-conformity with diversity, sustainability or ethical responsibility provisions
- Non-compliance with insurance requirements
- Bankruptcy or illiquidity
Beyond Your Contracts: Communication and Relationship Management are Key to Minimize Risk
If your supply chain contracts are the building blocks of your supplier relationships, communication is the mortar that keeps the relationship intact. Communication promotes trust, responsiveness, and a sense of shared responsibility that strengthens supplier relationships and business outcomes. So, while your supplier contracts can provide structure for your risk management processes, strong communication channels are just as important to help minimize risk in a crisis.