Numerous obstacles stand between companies and success. The strength of a company’s supply chain is one substantial hurdle. A supply relationship can make or break a company.
Even were this observation not already obvious, food and other companies need look no further than the recent European horse meat scandal to realize how supply relationships may affect brands, influence reputations and impact the bottom line. Numerous European companies have been ensnared by the fraudsters who used horse meat to turn a ground beef supply chain into a massive swindle. As a result, brand names have been tarnished. Millions of dollars have been lost. And, consumer bewilderment, anger and mistrust, fueled by social media and other tools that ease the ability of consumers and consumer advocates to communicate, are on the rise.
Susceptibility to such fraud is not a malady unique to companies that may have limited resources and options for selecting and monitoring supply partners. To the contrary, the supply chain underlying the horse meat scandal, which started at remote farms and worked its way onto forks located in many major metropolitan centers, has ensnared numerous corporate titans throughout Europe. Nor is that problem unique to the food industry. Different sectors grapple with supply chain fraud. Simply stated, any supply relationship is rife with risk.
But companies and consumers should not despair. Those who would engage in fraud can be kept in check, and risk of intentional supply chain fraud or inadvertent mistakes can be mitigated. The ultimate goal is transparency at each link of the supply chain. Simply stated, then, do you know with whom you are dealing? And, do you trust them? If not, the potential for difficulties increases.
Achieving transparency is no small or easy feat, especially where a supply chain is complex. To that end, as an initial matter, companies should assess whether, from both economic and practical perspectives, they can keep new supply chains simple and simplify existing supply chains. Typically, a more straightforward, shorter supply chain makes it easier to achieve transparency.
But regardless of the ultimate supply chain length, the strive to obtain transparency and form strong supply relationships requires:
- Due diligence in preparation for supply relationships;
- Thoughtful negotiation and precise drafting of supply agreements; and
- Vigilant management and oversight of supply partners and, if necessary, their supply partners.
Each undertaking is itself multi-faceted and complex, and likely will vary in some, and perhaps even great, measure depending on the nature, length and complexity of the supply chain and the considerations and businesses involved. Those undertakings are not covered in detail here. Rather, following are several key strategies that companies should consider when seeking to form strong and productive supply relationships and to mitigate supply risk.
Internal Assessment of Supply Needs
Mismatched expectations between supply partners make it easier for a supply relationship to fail. A company should assess and understand its internal needs before attempting to form a supply relationship. That assessment includes product need, market demands, cost factors and practical considerations. It also requires an understanding of the laws and regulations that may govern a business and affect the requirements of any supply relationship.
For example, the Food Safety Modernization Act, enacted in 2011, imposes numerous food-safety-related requirements on food companies, and demands that those companies hold each entity within their food supply chains to the same exacting standards. Without an assessment and understanding of those requirements, a food company is less likely to be able to form strong supply relationships that satisfy those safety requirements, absent pure happenstance.
Plan for the Supply Relationships
After assessing its needs, a company should prepare a blueprint that sets forth how it intends to meet those needs through the formation of supply relationships. Among other things, that plan should specify the company’s objectives, detail the products and services to be supplied, define the company’s expectations of its supply partners, set forth quality standards, detail other needs the company expects its supplier to meet and define metrics against which to measure potential supply partners.
A company should utilize its supply relationship plan to perform due diligence on potential supply partners and, in the process, answer the critical question of knowing with whom the company is dealing. Setting clear expectations for both the company and suppliers establishes a framework by which to assess suppliers for competence and fit, including assessment of potential suppliers against operational, technical, financial and cultural metrics.
A successful framework also requires that the company test and audit each metric as part of pre-relationship due diligence and during the term of any relationship that follows. Where a potential supplier is located in a different jurisdiction, additional consideration should be given to conditions unique to that potential partner’s locale that may affect performance, including laws, regulations, workforce, and custom and political landscape.
Due diligence should not stop with assessment of potential direct supply partners. Where a supply chain involves one or more links below the direct supplier, the company should similarly evaluate those entities in order to assess if they too are a match. In addition, the company should assess the supplier’s supply agreements with its suppliers and the rights and remedies of the direct supplier should its suppliers fail. In other words, who will be held accountable if the supply chain fails somewhere below the company’s direct supply relationship? And, in an effort to avoid such a situation in the first place, the company should determine during due diligence whether it will be able to directly monitor and audit the supplier’s suppliers, including having access to their facilities and records, if needed.
Where feasible, both high level business people and technical personnel should interview and assess potential suppliers in determining whether a potential supplier is a match. Considerations about personnel do not end with due diligence. Rather, experienced personnel, whether employees or independent contractors, are needed to carefully manage, monitor and audit supply relationships. Critically, such employees or agents often are the first to know something with the supply relationship may be amiss, and often they have the technical expertise to help fix supply problems before those problems become catastrophic.
Carefully Negotiated and Precisely Drafted Supply Agreement
A well-negotiated and precisely crafted supply agreement is critical to forming a strong supply relationship. Such an agreement must encompass, with specificity, the company’s needs and expectations. Although certain concepts may be common to many supply relationships, boilerplate should be avoided; a company should err on drafting terms and provisions that fit the particularities of the supply relationship to be formed and the business needs and other considerations for which it solves.
When effectively crafted, the supply agreement will, among other important concepts:
- Specify the criteria for the product or service to be provided;
- Lay out metrics by which supplier performance will be measured;
- Describe the method by which the supplier, and its suppliers, will be monitored and audited;
- Set forth the process for dispute resolution;
- Provide clear remedies for breach; and
- Eliminate, mitigate, and otherwise anticipate and address potential risks in the supply relationship.
Ultimately, then, with whom are you dealing? Companies must continuously ask and answer that critical question in order to achieve a transparent supply chain and foreclose the type of circumstances that would allow for the supply chain fraud Europe recently experienced.
John T. Shapiro is a partner and a member of the Food Industry Team (http://foodlaw.freebornpeters.com) at the Chicago law firm of Freeborn & Peters LLP. He concentrates his practice on litigation and counseling on business matters, including supply chains, for food and other companies.