Inflation impacting supply chain: Fruit salad, inequity aversion and how to deal with a supplier’s termination notice

Figures recently released by the Office for National Statistics show that UK consumer price inflation remains stubbornly in the double-digits for the seventh consecutive month. As anyone that’s tried to make a fruit salad lately can attest to, suppliers are showing little hesitation in passing increased costs through to their customers.

Barring a raspberry pie or two, fruit prices are unlikely to be particularly high on agendas in the tech sector, but the broader inflationary trends should not be ignored. From chips to energy and labour, many of the largest input costs for technology projects and supply chains are on the rise. We set out some basic principles for customers with particular supplier dependencies to consider, when dealing with a critical supplier looking to force price increases.

Check your agreement

Step one is information-gathering. How does the land lie? Does your supplier have a right to vary prices under your agreement? If so, when and by how much? Are there audit rights attached to pricing or price increases (or just general audit rights)? Are they required to consult, or agree increases? What other formalities are required?

Forewarned is forearmed and it’s much better to go into pricing negotiations with a clear idea of what your current agreement allows your supplier to do. However, the reading should not stop there. Traditionally, suppliers have been reluctant to use termination for convenience rights, break clauses or rights to refuse renewal for fear of putting off other customers. Lately, though, and particularly in low-margin sectors or those highly sensitive to labour and fuel costs, we are seeing more suppliers willing to play hardball to create leverage.

If your agreement includes a break clause, is due to expire soon or possibly allows your supplier to terminate early for convenience, the situation may be more challenging.

Sometimes it’s better to pay

It can feel unfair to be forced to agree price increases. Sometimes though, the best option available is to dissipate the issue financially (see a demonstration of this solution by a monkey suffering similar inequity).

This can be especially true if you are dependent on a single supplier, if there’s no other suppliers that can handle your volume, or if disruption is imminent and there’s just no time to switch.

The key in these cases is to get some bang for your buck – if you’re going to be dragged into negotiations and need to make concessions, what can they be traded for?

• Firstly, the pricing mechanism needs to be right. Without sounding too much like 2021 Jerome Powell, it’s unlikely that current conditions will continue forever. If you’re adding a clause that allows for price increases when costs go up, consider also requiring price decreases when costs go down. A cost-plus model can account for this automatically, but will largely be driven by the price your supplier is able to negotiate. Think about including periodic benchmarking to ensure prices remain competitive for certain types of readily comparable services. Audit rights will also be key – don’t assume you’ll be able to get the information to verify prices unless that’s spelled out clearly in your agreement.
  
  
• Think about the current supply relationship. What’s going well, what isn’t? Perhaps service levels need to be adjusted to make sure deliveries are made on time, or defects are resolved quickly. There’s a logical appeal to paying more to receive a better service and it may be that price increases could come with increases to KPIs or a new liquidated damages regime.
  
  
• Think also about the future. If a break clause or termination for convenience right has created leverage for your supplier, maybe it’s time to ditch those in favour of a longer term commitment from your supplier. If getting ready to switch suppliers would have taken too long, maybe you need to look to strengthen your exit assistance clauses, potentially you could include an exit plan that can be implemented at short notice.

The M&A option

Fortune, they say, favours the bold. For Standard Oil in the late 19th Century, fortune favoured vertically-integrated supply chains.

For those fortunate enough to have the resources, M&A should also be on the table. Vertical integration can allow you more control to reduce costs and increase quality, eliminate any leverage that your supplier had and may even open the door to new revenue streams. It’s the ultimate power move – if it pays off.