In the manufacturing sector, businesses can be highly dependent on supply chain; whether it be in sourcing materials or components, or delivering finished goods. A business’ ability to deliver on its promises can often be in the hands of third parties, as the recent high profile KFC case has highlighted. In November 2017 KFC awarded a new company its contract to manage its British supply chain, ending its relationship with the existing provider. Less than a week after the new contract went live in February 2018, hundreds of KFC branches were forced to close due to a number of deliveries being incomplete or delayed. The publicity surrounding the incident was damaging to KFC and the knock on effects costly, but it provides a timely reminder to all in the manufacturing sector, that properly negotiating key supply chain contracts is critical to business continuity. Three key thoughts to keep in mind.
Often businesses can feel under pressure to award a supplier exclusivity, on the basis it will lower costs. In particular small businesses should take care when putting all their eggs in one basket in this way. If you need to offer exclusivity, make sure that your supply contract contains provisions to allow you to source from third parties in the event that your supplier has issues. If you can, include provisions allowing costs of alternative supply to be recovered from the failing supplier. You may also wish to consider including a provision allowing you to terminate the agreement in the event that supply is disrupted for a specified period. A right of termination and compensation for breach lessen the exposure a business otherwise faces through exclusivity.
Choosing measurable service levels and setting out the metrics of success or failure are critical, but this hard work is only effective if it is properly incorporated into a service level agreement. One of the common issues with SLAs is that the agreement doesn’t deal clearly with what happens when service levels are not met. A service credit regime may seem like an appropriate remedy, but these credits are often based on very low percentages, so may not be enough of a “stick” to guarantee performance. It may be that other obligations such as escalation or a performance improvement plan provide a more practical way to manage your supplier. However, in the event of persistent breaches of the same service level or breaches of certain ‘critical’ service levels, it is sensible to include a loss of exclusivity, or a specific right to terminate.
The start of any supply relationship is the best time to think about what is going to happen on exit. If you have no exit plan, you are at the mercy of an outgoing supplier on termination or expiry of a contract, when they have little commercial incentive to assist, absent a contractual obligation. A detailed exit management plan containing transitional service provisions could be key to ensuring you have the support required from the exiting supplier for smooth transition to a new provider. A well drafted exit clause will set out the scope, length and cost of the support you are likely to require in the agreement itself (as opposed to obligations to agree an exit management process at a later date prior to exit).
Our team are able to advise on all legal aspects of supply chain management and can advise on all aspects of contracts and agreements.