As the first land war touching Europe in decades, Russia's invasion of Ukraine is what many are calling the start of WWIII—let's hope not. Starr's song lyrics lament the many, many negative impacts of war. Beyond the obvious impacts, this post will focus on the negative consequences war and political tension will have on global supply chains and manufacturing operations.
In 2020 and 2021, manufacturers weathered unprecedented supply chain woes. Now, 2022 is kicking off with additional challenges resulting from Russia's invasion of Ukraine. Given the interconnectedness of the world marketplace, even supply chains without direct ties to the region will be impacted. For example:
- Oil Prices Rising Mean Universally Higher Transportation Costs: Oil prices already leapt 6%. This means higher transportation costs for all, which will have the most significant and pervasive impacts on manufacturers that source from afar.
- Tariffs, Embargoes and Other Sanctions: President Biden already announced harsh sanctions against Russia. Whether they are in the form of tariffs, sanctions, or outright embargoes, they all result in unavoidable additional costs that must be absorbed by manufacturers somewhere in the supply chain.
- Precious Metals Inputs – Even More Precarious: Ukraine is rich in precious minerals, including palladium, nickel and neon gas—all are used to make electronic chips. This region became "Plan B" for a number of companies looking to mine precious metals from locations other than China in the midst of the semiconductor shortage of the pandemic. This will be a big (and negative) impact to the slow, but positive progress that was made in the semiconductor market. The automotive industry, which is continuing to rebuild supplies of and make investments in semiconductors, will inevitably continue to be adversely impacted.
- Wheat Exports: Ukraine is the second largest exporter of wheat. Does this mean that the whole world is going gluten-free? No. But, the disruption will certainly trickle up through the supply chain to result in higher costs for consumers for many products containing wheat.
So, what can companies do to navigate this fluid and ever-changing market in the face of war-related impacts? Continue employing the risk mitigation strategies that they have been honing for the last two years. These include:
- Diversify Supply Chain Inputs: There are undoubted efficiencies associated with sourcing from a single supplier (sole-source supplier), such as economies of scale, cost savings based on volumes, and streamlining logistics. However, a sole-source supplier also makes a company's supply chain more sensitive to interruption. To fairly assess the source of its supply chain, a manufacturer should look at lower layers of it supply chain. For example, even if a manufacturer has a sourcing arrangement with two different suppliers in two different locations, if both suppliers source raw materials from the same Ukrainian sub-supplier, then there could be threats to the continuity of manufacturing operations as the situation worsens.
- Warehousing, Inventory Banks & Safety Stock: For all of the same reasons that a Just-In-Time (JIT) model is incredibly efficient, it is also incredibly tenuous if there are any breaks in the supply chain. Identify key inputs that may be impacted and begin amassing safety stock and inventory where possible.
- Lock in Transportation and Shipping Rates to the Extent Possible: Given the volatile fluctuations in oil pricing, which will have impacts on all forms of transportation, lock in transportation and shipping rates as soon as possible. Many companies are partnering with third-party logistics providers in order to defray some of the increasing volatility across labor, warehousing, transportation and other logistics.
- Review Contract Rights and the Other F-Word: For customer and supplier relationships that could be impacted, it is once again time to get out those contracts to see: (a) whether the contracts contain a force majeure provision; (b) whether the force majeure provisions cover events such as war, embargoes, etc.; and (c) assess whether the force majeure clauses provide termination rights and what the associated notice requirements are. Finally, even if there is no force majeure provision in the applicable contract, the parties may have certain rights to suspend performance under the doctrine of commercial impracticability, depending upon the particular circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
