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Dealing with Outsourcing Supplier Instability

Dealing with Outsourcing Supplier Instability

There’s no question that a certain amount of risk is to be expected when discussing suppliers.  Instability happens. But there’s no reason you can’t manage the potential for supplier instability effectively.  

While you may not be able to eliminate all the risk inherent with respect to suppliers, you’ll certainly be able to mitigate it by approaching it mindfully and with a strong plan to insulate yourself at least partially.

Let’s discuss dealing with outsourcing supplier instability and how to reduce the risk this really represents.

Doing the due diligence

Outsourcing agreements demand due diligence.  You need to have the highest level of confidence in the supplier you’re dealing with and to know that they’re as stable as possible.

Take the extra step of establishing the financial status of the supplier.  If they’re a subsidiary of a publicly-traded parent company, that information should be forthcoming.  You shouldn’t need to source information from the internet. In fact, a failure to provide you with that information when you ask for it is an obvious red flag.

In the case of a subsidiary, it’s not excessive to request a guarantee from the parent company as a schedule to your contract.

But establishing the stability of a supplier isn’t a one-time deal.  It’s an ongoing effort to ensure the integrity of the supply chain. This practice supports seeing potential problems before they become big uglies.

This is another part of your contractual agreement.  Putting it in writing establishes the fact that you intend to continue due diligence with respect to stability moving forward – something suppliers should readily comply with.

Other contractual concerns

We’ve discussed due diligence above and the imperative to include mechanisms to allow this in your contract.  But for due diligence to be effective, the remedies available and the rights of the customer when issues arise should be clearly stated.

When due diligence unearths a potential problem, your contract should include triggers for the right of termination, transition assistance (ideally with no extra financial obligation on your part), access to and training in the source code for the supplier and removal of restrictive covenants.

Prepare to negotiate for these and any other contractual protections.  Most suppliers want to limit triggers to bankruptcy, force majeure (natural disasters, for example) and other huge impediments like injunctions related to intellectual property.

Your purpose is to enshrine in your agreement the ability to act on what your ongoing due diligence reveals about potential risks, so be tough and get what you need to protect your company against potential instability.

Termination triggers should also be clearly stated and broadly defined.  While suppliers will litigate against these, you’ll be protected against events like sudden bankruptcy or supplier intransigence, like threatening to cease carrying on business.

Your company’s legal department is the key to dealing with outsourcing supplier instability.  Clear contractual definitions which protect you from the outfall of supplier instability are your best defense.

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