If one thing has been made clear over the course of the COVID-19 Pandemic, it’s that few things will remain the same. One of the biggest impacts to businesses over the course of the last two years has been massive disruptions to the global supply chain.
In the first of Law Week’s two roundtables this year, we checked in with Dan Harris of Harris Bricken, Robert Hensley of Dorsey & Whitney and Len MacPhee of Polsinelli to get their thoughts on the current state of the supply chain and what they think may be on the horizon for businesses experiencing disruptions.
While they noted the future may still be tangled with inflated pricing and staffing shortages, our roundtable participants discussed a myriad of trends we’ve been seeing in supply chains, staffing, force majeure and dispute handling. Overall, our roundtable participants said they’re seeing more disputes turning into lawsuits.
Harris, Hensley and MacPhee all noted they anticipate agreements and contracts will need to shift to address new overseas supply chain laws, social responsibility issues, pricing increases and delivery delays. These legal experts are also seeing a shift in businesses prioritizing resiliency and diversifying suppliers over negotiating price stability and efficiency.
The transcript of the discussion below has been edited for clarity, length and style.
HARRIS: What are you seeing as your clients’ greatest fear regarding supply chain, and has that changed at all due to the [Russia-Ukraine] war?
MACPHEE: Having resiliency has taken a much higher priority than what used to be price-driven negotiations for supply chain contracts. I think we’re seeing a lot less of the exclusivity or single-source suppliers, and a lot more effort at getting multiple suppliers on particular products, especially core products. They’d rather give a little on price and give a little on the on-demand [ability] and infuse protections into the contract that allow them to go out and have alternative sources of supply and also have multiple suppliers. The geopolitical climate has refocused on what’s coming out of Russia. And digging back into geopolitical concerns that predated COVID, in my estimation, is the prior administration’s fights with China — the tariffs, non-tariffs, added costs — I think those [concerns] are coming back.
HARRIS: A number of our clients are not necessarily succeeding in terms of diversifying. One of the things that has surprised me is how slow companies are to change, especially when things are going well. Our clients, even three years ago, they’d say things like, “we need to diversify; we need to get sources outside of China; we need to come closer to home,” — but very few really did anything. And then they started becoming more worried. People want to get out whether they can or not — whether they will or not, is another question.
HENSLEY: We can draft the perfect force majeure clause on behalf of a purchaser of products. And it really doesn’t matter if the other side just throws up their hands and says, “We don’t care — we can’t get the product. Sue us if you have to, but we can’t get the product, it just isn’t coming.” It really makes you refocus on good contract language.
HARRIS: I had a client call us up, and their regular supplier said, “We can’t get it to you for three months.” So they went off and paid a huge amount to fly it out of China. They called us and said, “We want to sue this company. Can we?” And I’m like, “Yeah, you can. But that’s not going to solve your problem. We need to figure out how we can get this product to the U.S. as quickly as possible.” And it wasn’t that fast and there was no lawsuit because it would have been a terrible lawsuit. Wouldn’t have done a thing.
MACPHEE: Especially in China. Even if you get an arbitration in Singapore, enforcing it is another ball of wax. So let me ask if you guys are experiencing this: For two years, it seemed like nobody was suing anybody. It was a lot of workouts, a lot of cooperation even. In the last couple of months, and it’s only going to increase, we’re seeing less of that and more claims being filed and lawsuits being pursued at least for damages. Do you guys have similar perspectives on where this is headed?
HENSLEY: Yeah I’m seeing a little bit of that. For the first part of the pandemic, people were trying to work together and I’m seeing now there are a little more adversarial relationships. The problem I’m seeing now is that’s causing suppliers to entrench even more because they have somebody that’s threatening a lawsuit against them now and they’re basically saying, “Well we’ll supply it but we can’t guarantee when it’s going to show up. If you find somebody that can, good luck!” So that’s where a lot of my negotiations are right now — suppliers saying, “We’ll get it to you when we get it to you.”
HARRIS: We’re definitely seeing that and I don’t like those lawsuits. But what we’re also seeing is some real knock-down, drag-out fights between our clients and their Chinese suppliers. And some of these Chinese companies are flat out admitting [to charging American companies higher prices]. [Chinese suppliers] just view Americans as trying to get out. So we’re always telling our clients, “Act like you’re in China for the next 50 years. Do not mention that you’re looking at Vietnam, Thailand, Mexico, whatever.” Because once they think you’re on the way out, that’s when the pain starts really hitting.
HENSLEY: So what are you guys seeing though, with prospective clients looking for sources outside of China [and in] other places around the world?
MACPHEE: I would echo what Dan said — they all want to, they want to be more domestic, they want to be closer. But it’s easier said than done. What we’re seeing [is], “We can do that 18 months from now. And oh, by the way, we need you to make some investments or otherwise protect us for the investments we’re going to be making to be able to change that supply line.”
HARRIS: It’s not easy and it’s not fast. I would say, we’ve seen some massive successes. [Some clients are] happy to [pay more to get supply elsewhere].
MACPHEE: It’s more expensive [to alter your supply chain]. But at least there’s some more resiliency.
HARRIS: What countries have you seen people choosing in Europe?
MACPHEE: Scandinavia, Spain, and Poland are three that I can think of that increased their manufacturing capabilities. [But] there’s geopolitical concerns in some of the areas — like we’re seeing with Ukraine now. They’re mostly supplying in Europe, but it’s definitely an option that some [clients] are invoking. And we’ve seen some successes there.
MACPHEE: Another thing that I’ve experienced is the concern that inflation’s going to continue to rise. It‘s harder and harder to lock in any sort of pricing for any sort of long period of time. So we’re negotiating how quickly you’re going to revisit pricing, what are the indexes that are going to be relied upon with respect to increases or decreases in pricing, how do you avoid some of those hidden areas where suppliers have margin — those kinds of regulators on price increases. And it seems like it’s a disproportionate amount of time in negotiating those terms as compared to six months ago or 12 months ago.
HENSLEY: I do a fair amount of renewable energy type of work — solar, wind, those types of facilities — and also cultural facilities, and procuring products for construction of those facilities is difficult, especially given the timeline. Sometimes you’re ordering something to arrive a year or two down the line. And being able to work with people on the pricing of those [materials] is difficult. And people have worked with various types of indexes, different producer price indexes, and otherwise to try to adjust that in the contracts. But no one’s really dealt with this environment where inflation’s 6% or something like that in a relatively short period of time. So I think what I’m seeing is suppliers just hedge their prices the best that they can, and they don’t want to set their price until the very last moment. So they’ll try to throw in the force majeure clause something like, “This is subject to pricing at the time we actually deliver” — well, that’s not force majeure. This is a price escalator of some type. And so you have to be careful to comb through the contract [to find language] that a supplier will add relating to them being able to reprice down the road. And that often results in a fairly long negotiation with them about well, what really is the price you can guarantee? And when can we set that price?
HARRIS: This may sound like heresy. But I’ve always felt that price terms with Chinese companies are overrated. I’m not saying that we don’t believe in putting those provisions in, we do. But a lot of times, I sort of flip it on the client and say, “Look, what we need to focus on is your IP and your ability to move from this factory elsewhere.”
MACPHEE: Totally. If you don’t have it in there though, it’s even less protection than if you do have price controls in your original contract. They’ve got the leverage. And it doesn’t matter what your contract says, if the market’s going up, they’re going to charge it.
HENSLEY: One of the things that always surprises me is how much it costs to get things here. I just did a contract for steel coming from China. It was more to ship than the steel costs. So we’re dealing with little sub-issues like tariffs and pricing of the actual steel and product. And then I look at it and say over two-thirds of the cost is actually getting it here.
HARRIS: And even tariffs can be weird because they’re on the price you’re paying from China. We’ve had some companies that have been very impacted by it. [But] the impact can be so disparate.
MACPHEE: Even in a non-cross border supply arrangement, the transportation costs can be a big source of margin. You may have an Incoterm for a completely domestic arrangement that has the supplier delivering to the buyer, and if you look at their cost structure, you realize a big hunk of margin is often the delivery costs. If you can focus on the commodity index for the actual component parts, you can [help] the buyer with respect to price increases because they can’t hide additional margin in the transportation costs.
HARRIS: What are you seeing in terms of companies bringing manufacturing back to the U.S. for the first time or adding on more manufacturing to their existing [U.S.] facilities?
HENSLEY: One of the things I do is I represent clients that have manufacturing facilities in the U.S. A lot of them are enlarging those facilities and the flip side of this is they’re concerned about if they need a part that breaks, when can they get a new one? So they’re identifying those key components that are the one-time items that they really need to have in inventory — that they used to get in 30 days, and now they don’t know when it’s going to come.
HARRIS: But have you seen any companies open up a factory in the U.S. fresh?
HENSLEY: I have seen [that] on the solar side. There are companies that have opened fairly significant manufacturing facilities in the U.S. and are expanding those facilities. Because customers want it, they want to be able to say, I want to source these [panels] from the U.S. so I know they’re going to show up.
HARRIS: Yeah, I wish I could say that I’ve seen a lot of it. But I haven’t.
HENSLEY: I think one problem that manufacturers in the U.S. do have is getting people to work. My experience is a lot of them need to hire 10-20% more people to fully staff their manufacturing facilities. That’s not something that’s going to get any better.
MACPHEE: [This] raises another question that we haven’t talked about yet, but an increased emphasis on due diligence with respect to suppliers. Do they have the ability to supply what we need? But the other angle on that [is] social responsibility, corporate responsibility, supply chain transparency. I think [there are] like three or four new laws coming or [that] have recently come [out] in Europe [addressing labor practices, environmental protections, etc.]. So are you guys [also] seeing increased due diligence?
HARRIS: We’ve been preaching due diligence since the beginning of time. And there are clients who come in caring about that and then there are clients who don’t really care and I think it’s very much correlative to their size. Small companies don’t think about it, big companies do.
MACPHEE: I 100% agree with that. Both the size of the client or the size of the volume that we’re talking about is a huge variable in whether they’re going to invest in that. Also, I think the larger client with a persuasive in-house lawyer can help convince the business guys that they need to make the investment upfront on the due diligence. But even small clients — it’s not overly expensive to hire a third-party investigator to do even basic due diligence in foreign countries.
HENSLEY: I think one of the things that’s out there is staffing-related shortages. And how’s that impacting people, including on the purchasing side too. What are you seeing there as far as the experience of people doing the purchasing, in-house [for] clients? And what are they doing to try to get people that are knowledgeable in that area?
HARRIS: Well, what we’re seeing is stress. And what we’re also seeing is turnover.
HENSLEY: Yeah, that’s definitely something that I’m seeing is I’ll be working on a contract and the client will forward it to me and I’ll ask, “Does the other side have a legal department and who’s working on this from their side?” And it’ll turn out to be a nonlawyer who — it’s like their first week in purchasing or sales contracting. It makes it a bit more of a hurdle. We start talking about all of these legal terms, but that’s just beyond their capacity.
MACPHEE: It’s just so pervasive. It’s beyond even procurement and supply — our restaurant clients are clamoring for labor. It’s a big issue and — can’t solve it.
HENSLEY: The inflation that we’ve seen at 6%, or whatever the number is right now that we’re looking at — I can only see that number going up. I don’t see it going down in the short term. I don’t see labor loosening up and I don’t see prices going down, I only see more escalation.
HARRIS: So what are the big issues for the future? Force majeure? Litigation? What are you seeing?
MACPHEE: I do think there’ll be an uptick in disputes — and by the way, I think part of that pressure is banks, who had been also willing to let financing ride for a while and they’re running out of patience and landlords are doing the same thing. I think resiliency and a switch of priority on a go-forward basis for purchasers will dictate terms of supply agreements. [They’ll be] different than they were before — primarily price and on close-in-time delivery provisions will be given up for things like redundancy, inventory level requirements and things of that nature as leverage will allow.
HENSLEY: I keep looking at the things on the staffing and employee side and what’s going to happen there. I’ve talked to clients about [how] you need to get a little more creative on how you pay people. The traditional model of “we’re gonna pay you a certain salary and then you’ll get a bonus [that we’ll pay you next] year” isn’t enough to keep people working for you necessarily. They may switch jobs because they’re going to get a sign-on bonus for the next job and what are you doing to try to make something that’s more periodic. I think that even applies to the legal industry. Are you just going to get a bonus at the end of the year from now on, or are you going to make those bonuses more and more frequent to try to incentivize people just to stay on and not just look at that sign-on bonus as an opportunity. I think that’s going to be a long-term issue. Companies in the U.S. are going to have to look at how are they going to pay and train people to be able to keep them longer term when the market is so fluid.
HARRIS: That’s a mind-boggling issue. It really is. Because some people are leaving for reasons having nothing to do with money. COVID has caused people to rethink their lives. And pricing — back to something we talked about earlier — pricing is going to be a big deal. Who’s going to pay the price for this inflation? Some of these huge companies, they’ve dealt with this before, they might have enough of a moat around their products that they can raise prices — others are having tough times.