The fragile chain: Understanding supply chain disruption

Supply chain disruption is a risk that re-emerges in volatile geopolitical and economic circumstances. We all remember too well the images of empty shelves in supermarkets as the global supply chain faced its ultimate test: a global pandemic.

Another stark example of the vulnerability of the supply chain are the recent cyber-attacks on the British high street, with some suppliers reportedly having to resort to taking orders by pen and paper due to the disruption caused. While certain retailers may have the benefit of cyber insurance to soften losses, others have been less fortunate.

Key risk factors

Although the risk of supply chain disruption may not be new, the complexity of modern global supply chain and the current geopolitical environment is likely to mean that the risks faced by businesses are multiplied.

The multiplication of risk has been highlighted in recent times by the brewing trade war. The fast-moving tariff environment has made it difficult for suppliers to maintain costs when shipping goods overseas, especially when the products are already in transit when new tariffs are brought into force.  This has led to unexpected duties and charges being incurred, making deals less attractive than when they were originally agreed and causing parties to consider whether the deal they agreed is still a commercially viable one. 

The prospect of unexpected tariffs, against the background of an already volatile geopolitical climate, have caused businesses to re-assess their current supply chain exposure and consider how the supply chain can be made more resilient e.g. by diversification in trading partners and markets.

In some cases, supply chain diversification will bring opportunities to establish new trading relationships and potentially renegotiate terms with existing partners. New trade routes may be considered to reduce exposure to tariffs or other risks such as piracy, geopolitical instability and even climate change. Development of new technologies or the use of AI to map the supply chain may also lead to increased efficiency and cost savings. 

However, supply chain diversification and new trading relationships also brings new challenges as parties cannot necessarily rely on trusted and long-standing relations. This challenge becomes particularly acute where new partners are domiciled in emerging markets with limited controls on corporate governance and trade fraud.    

These markets may also be exposed to political risks or business interference. There may also be the prospect of retaliatory measures being taken by governments in response to tariffs being imposed. Such measures could include selective discrimination, licence cancellation or even expropriation. Political violence is another risk multiplier. Local populations were already feeling the strain of the increased cost of living and this will likely be exacerbated if the increased cost to the supply chain is pushed down to consumers. This, plus a rise in nationalist sentiment, could lead to increased political violence events such as strikes, riots and civil commotion which could impact the supply chain further.   
 
Trading with new partners may also give rise to concerns about whether the quality of work is up to the standard that the buyer was previously accustomed to. Similarly, it is possible that some markets will not have the same safety standards and regulations in place as others that businesses are used to trading with. Failure to fully assess these types of risk could give rise to product recall losses including business interruption and reputational damage.   

Liability claims are also a potential risk if defective products cause personal injury or damage to third party property. Delivery of defective goods can also lead to other increased costs of working if contractual deadlines are impacted. Supply chain disruption may also result in an inability to supply goods to customers or projects if the inward supply is delayed. This in turn may result in claims for breach of contract.

Strategies for resilience

Due diligence into trading partners and the general market in which businesses are operating will be even more critical to navigating these multiplied risks. Businesses can mitigate against supply chain risk by undertaking a thorough assessment of their supply chain exposure. This will involve looking at:

1. The entire supply chain (and not just direct, tier 1 suppliers)
2. The location of trading partners and whether this brings about any particular geopolitical exposure 
3. Existing contracts and considering whether it is possible to renegotiate terms in view of rising prices
4. Considering rights in relation to potential force majeure or contract frustration where performance is significantly hindered
5. The credit risk posed by counterparties and whether a counterparty’s business model is particularly exposed to supply chain disruption
6. The potential losses that might arise out of impacts on the supply chain including business interruption and payment default
7. The legal and regulatory environment including whether there are legal protections in place such as Bilateral Investment Treaties when doing business in emerging markets
8. Whether there are rights of recourse in the event of the supply of a defective product
9. Whether risk mitigants such as insurance should still be considered a ‘nice to have’ or a necessity

The development of an agile and experienced response team that is able to respond in the event of a crisis, such as a product recall, cyber incident or similar incident will also be key to limiting damage by communicating with counterparties, consumers, regulators and the media. 

Directors & Offices that do not engage with the new world order and the multiplied risks faced by the supply chain may find themselves exposed to claims by investors.