These are undoubtedly difficult times for businesses with exposure to international supply chains.
Already faced with:
- the well-publicised pressures that the COVID-19 pandemic has placed on international supply chains;
- the fragmented picture presented by virtue of Britain’s less than seamless withdrawal from the European Union; and
- a muted global economic outlook predicting continued inflation, falling household spending power and central banks in many major economies plotting out further increases to interest rates,
Aside from the obvious humanitarian crisis the conflict in Ukraine is also now placing additional pressures on businesses, causing them to look yet more closely about how they are able to build resilience into their supply chains and manage the risks presented by a hugely turbulent geopolitical and economic landscape.
In this update we set out our thoughts on the key areas of risk for businesses engaged in the manufacturing & supply chain sector today, and possible steps that could be taken to mitigate these risks and build resilience into supply chains.
1. Managing the Cost of Trade
The spikes in oil, natural gas and grain prices around the globe in response to the conflict in Ukraine have rightly grabbed headlines, but these rises actually fit into a wider trend of rising prices for raw materials across the global economy since the onset of the pandemic.
Aside from spiking costs for raw materials and the ongoing need for businesses to navigate additional tariffs on imports and exports resulting from Britain’s withdrawal from the EU (particularly in respect of goods which originated outside the UK or EU) there are plenty of other pressure points within supply chains which will directly affect the cost of doing business (and which businesses need to be alive to now).
A good example of this is the increasing cost of shipping goods via sea, which are being passed on to consumers of these products. The shortage of empty shipping containers resulting from pandemic-related backlogs at ports internationally had already pushed container prices to record levels. In addition, the conflict in Ukraine has led to many shipping companies cancelling routes through the Black Sea and wider Aegean/Mediterranean shipping corridors given the inherent risks to staff and the unmanageable insurance premiums involved with passing ships through an active war-zone, which has resulted in further inflationary pressure on the cost to businesses of moving goods by sea.
The rising cost of international trading is not a problem which is going to disappear in the near future, though there are certain steps that pro-active business leaders could be looking at in order to reduce its impact on their supply chains:
- Businesses may consider whether M&A / joint venture opportunities could serve to mitigate their exposure to rising costs of trading. For example, where a business is reliant on a key material which is imported, could the acquisition of (or formal joint venture with) a more local supplier provide greater security of supply or even better value for the acquiring business? Could a company’s physical inventory storage capacity be increased through M&A opportunities?
- Businesses should be actively reviewing contracts with problematic providers of materials to assess whether such contracts be brought to an end prematurely. For example, could contracts with providers based in Russia / / Belarus / China be terminated on the basis of ‘force majeure’ provisions in the contract?
2. Supply Chain Disruption and Resilience
It has been well reported that the pandemic affected (and continues to affect) every part of the supply chain, from the sourcing of raw materials through to delivery to end-users.
Despite the widespread removal of restrictions by major economies, the risk of logistical disruption arising from COVID-related measures must remain at the forefront of business risk management. For example, recent COVID lockdowns in key Chinese industrial hubs such as Shanghai and Changchun have necessitated the closure of their globally significant seaports and airports. The potential ripple effect of such isolated lockdowns on global supply chains cannot be overlooked – data taken since Shanghai went into lockdown shows that, globally, (i) suppliers are facing the longest delays in more than two years in delivering raw materials to their manufacturing customers, and (ii) inventories of finished goods worldwide have climbed to their highest level in more than a decade.
The need to increase visibility and flexibility across their operations during the pandemic (as supply chains began to buckle) undoubtedly led to increased adoption by businesses of digital supply chain solutions. Whilst this has undoubtedly brought substantial benefits to businesses, it is also true that it has also increased business’ exposure to cyber threats. In fact, experts are warning that the risk of cyber attacks on the infrastructure underpinning ‘digitised supply chains’ has been increased as a result of the conflict in Ukraine – if, as expected, cyber attacks between Russia and Ukraine continue to escalate, there is a corresponding risk that malware intended for use in the conflict could spread into the global network.
These factors will only serve to increase the risk of logistics disruption across supply chains in the coming months and even years. In order to mitigate the effects, all businesses should, more closely than ever before, look to “map out” the supply chain from a ‘resilience’ perspective. Key considerations here include:
- Where are labour and components featuring in the supply chain situated / originating from? Businesses need to drill down into their supply chains to understand their potential exposure to countries where instability / further disruption are more likely. Can supply chains be restructured so as to divert them away from problematic countries or at least create capacity in other jurisdictions which can be utilised in the event of acute disruption in one supply chain flow?
A failure to fully appreciate potential exposure to geopolitical tensions can lead to unexpected pressures for businesses of all size. By way of example, many businesses which utilise cardboard packaging within their supply chains are facing increased prices and supply shortages as a knock-on effect of the limited supply of wheat being exported from Ukraine since the onset of the conflict (which is a key raw material in the production of cardboard).
- Is the business overly reliant on any particular supply chain inputs (or a single ‘dominant’ supplier)? Although there are clearly cost-efficiencies in sourcing one material from one supplier, a risk-averse approach would be to try to diversify by reaching arrangements with alternative/multiple suppliers which can be called upon if there is an issue with the primary supplier. Taking this a step further, could there even be opportunities to ‘near-shore’ or even ’on-shore’ alternative supplies?
- How can supply chain resilience be bolstered by investment in technology? There are clear opportunities for businesses of all shape and size to incorporate new technologies into their supply chain in order to build resilience. For example, intelligent automation technologies can be used to increase the operational efficiency / safety of warehouses and factories, whilst AI-driven analytics tools can massively increase real-time visibility within supply chains, enabling businesses to be far more responsive to disruption within their domestic and global markets, as well as to the needs of their customers.
With this needs to be an appreciation for the increased importance of cybersecurity in digitised supply chains – businesses which are reaping the benefits of digitising elements of their supply chains should likewise be undertaking comprehensive cyber-security risk assessments and investing in appropriate safeguards to reduce their exposure to increasingly sophisticated threats.
3. Sanctions and Reputational Risk
The introduction by western countries of a comprehensive set of economic sanctions in response to Russia’s invasion of Ukraine has brought into sharper focus the reputational (and financial) risks faced by businesses of trading (even inadvertently) with disreputable partners.
Again, properly mapping out the supply chain will enable businesses to identify their exposure to parties with whom they may not wish to be associated (and the reputational risks that this could entail). Where problematic areas are identified within a supply chain, this enables a business to take action to cut a problematic party out of the supply chain (for example the severance by many western companies of ties with Russian exporters since the onset of the conflict in Ukraine), but also enables it to manage and get ahead of potential risks (for example Nike’s recent announcement that it had undertaken a full due diligence exercise on its global supply chain to ensure that neither it nor any of its multitude of suppliers were utilising materials or textiles sourced from the Xinjiang region of China).
Businesses with global supply chains should also be keeping abreast of the scope of the international sanction regime against Russia and Belarus, which remains an evolving picture. Businesses which are up-to-speed with the sanctions regime, and which are routinely undertaking simple ‘know-your-customer’ checks on trading partners, should be able to mitigate the risk of falling foul of sanctions (which we estimate will remain in place for a significant period of time even once the conflict has been resolved).
On this note, UK businesses should be alert to the effect of the Economic Crime (Transparency and Enforcement) Act 2022 (ECA 2022), which received Royal Assent on 15 March 2022. Among other measures aimed at tackling economic crime in the UK, the ECA 2022 materially amends the sanctioning power of the Office of Financial Sanctions Implementation (OFSI) against businesses in the UK by introducing a standard of strict liability for civil breaches of sanctions which the UK has imposed internationally. This means that the OFSI will be able to impose a monetary penalty on a person who breaches sanctions legislation irrespective of whether the person knew or suspected that they had committed a breach. The ECA 2022 also empowers OFSI to publicly name persons who have breached sanctions but who have not been fined.
Final Thoughts
The conflict in Ukraine has and will continue to exacerbate the pressures that have been placed on global supply chains during the pandemic years. Businesses should be actively reviewing their supply chains now to understand where they are exposed to pressure points globally, and what solutions might be available to them which may help to mitigate such risks / increase their scope to be pro-active in response to further disruption.
If you wish to discuss any of the issues raised in this piece, please contact Roy Barry or Alexander Thow.
