Clifford Chance

Too many butterflies are flapping somewhere in the global supply chain, threatening tech companies with disruptive tornados. How are they responding?

Multiple causes

The supply chain in tech industries is (was) a complex network spreading through regions across the entire planet: huge investments and extremely valuable know-how have built each segment of the chain across decades. This perfect network starts with the gathering of raw materials (natural resources or chemical derivations); crosses the various phases of the semiconductors creation and ends in the delivery of chips to the manufacturers that embed them in the devices ordered by the tech companies and employed in all market sectors. In certain areas, the system was designed to ensure the best efficiency in timing and efforts required: the so called "just-in-time" model (originally conceived in automotive sector) It succeeded by basing its fortune in saving inventory, because the supply chain was so punctual that you could count on the delivery of the product even without filling your warehouse with spares.

A complex and perfect system, an astonishing example of the global market that (once) connected the world. With only one big weakness: it was conceived to work only in the sunny days. The absence of valid alternatives, resilience and remediation plans emerged clearly few years ago when a virus stopped the magic. The fragile balance did not resist the pressure deriving from the lockdowns and the other government measures that interrupted the ordinary cycle of work and the sudden fluctuation of the demand, with the simultaneous collapse of orders in the automotive sector and the skyrocketing demand for personal computers and other devices for home working and schooling.

But the causes of the disruption of the supply chain are not attributable only to the pandemic. Natural disasters, in certain areas, forced strategic players in the semiconductor chain to stop production: earthquakes and various local fires in Japan in 2020, as well as the exceptional snowstorms in Texas in 2021 lead to power outages; unprecedent drought in Taiwan in 2021 required the country to save water which is essential in the work cycle of semiconductor production.

In addition, the US-China trade war, with reciprocal export bans started in 2019, increased the overall pressure on the markets, forcing (apparently) irrational behaviors such as stockpiling, further altering the market balance between supply and demand.

Global shortage is a real thing and there are no short-term solutions

Tech companies – the end of the supply chain, and those ultimately responsible for the delivery of tech goods and services into the market – are thus struggling with their suppliers delaying supplies, cancelling orders, and renegotiating prices. They are also under pressure on the customer side, experiencing difficulties in fulfilling orders in a timely manner, with sometimes unpredictable knock-on effects. We have already seen some of them: due to the delays and uncertainties in supplying new cars, the second-hand car market has rapidly soared; new gaming consoles are often very difficult to find, making the fortune of an enclave where, for various reasons, these are still available (such as Gaza). In general, the absence of chips can considerably slow down the plans for the green and digital transitions, for which, evidently, technology is the main enabling factor.

The problem is, there are no short-term solutions. In fact, it is a very closed market, with strong barriers to entry: large amounts of capital are necessary to build up a semiconductor plant; the highly sophisticated technology deployed requires strong and difficult to replicate know-how; and long production cycles imply business models based on solid and long-lasting commercial relationships. In short, it is difficult to quickly create alternatives that are capable of ensuring returns on the investments.

The difficulty in having market responses to the crisis is pushing governments to investigate public measures, which are vague and hard to design. These measures seem to be aimed at protecting the "national" aspects of the chain, rather than addressing the broader problem.

Against this background, what can do tech companies do in the face of this emergency? Basically, a mix of legal and commercial measures in order to mitigate the exposure, as well as exploring possible new opportunities that every crisis brings.

Operating through the chain

More than ever, this is the time to return to the contract drafting, rethinking templates and procurement processes. The new arrangements should reflect the flexibility required by these fluctuant times (for instance, with mechanism of price adjustments based on objective variables) as well as certainty in volumes, timeline and obligations (with penalties and/or bank guarantee more suitable to encourage correct performance or, at least, mitigate the loss for under-or-no-performance). Perhaps, it is also the time to redesign some "boiler plate" clauses, such as force majeure, which have became hot topics in the last few years (more on this below).

Furthermore, it is important to find models to ensure more visibility and transparency through the chain. For the tech companies it is becoming crucial not only to know the supplier of their supplier, but also to select and even directly engage the supplier of its supplier. This is something that is already happening in automotive sector, which has been one of the first to suffer the shortage emergency. This process of transparency throughout the chain may lead eventually in the integration of certain phases, with mergers and/or direct investments to ensure immediate control and cutting off competitors in the demand side. Although any such moves would also bring companies into the sights of the competition authorities.

Litigating in the chain

This scenario may also be the right occasion to start strategic litigations. When the market and external landscape are stable and certain, trying to solve tensions between partners amicably is reasonable. However, now that nothing is stable and certain a company may want to consider, for example: obtaining judicial interpretation on force majeure and other clauses designed to address emergencies like this.  In the last two years, the pandemic and global shortages have often (and lazily) been associated with force majeure and invoked by suppliers to excuse underperformance; but after two years of unforeseeable events, these events are ceasing to be so "unforeseen". Litigation on this point may be the venue to encourage the proactive approach of other suppliers and restrict the (legitimate) excuse to what is really (and is also proved to be) unexpected and out of the control.

Thinking out of the box (and the chain)

Finally, companies must be awake to the opportunities that may arise from this crisis. As said before, the "classic" global chain was a perfect system designed to ensure the best efficiency in timing and efforts required. Now, the evolution of the 'just-in-time' model may be not necessarily be a regression to the 'just in case' own warehouse age.

Thanks to the incredible advancements made by the e-commerce, there are plenty of operators specialized in logistics and this may be the dawn of the logistic-as-a-service sector to address the needs of tech industries to reinforce resilience into the supply chain. Similarly, the other vulnerability represented by the exposure to the underperformance of the supplier (and the downstream exposure in the customer side) may be minimized with insurance products specifically tailored to better allocate (also in the balance sheets) such a risk. Insurance-as-a-service as well?