Complex supply chains put businesses at risk

Complex supply chains put businesses at risk

The last few decades have seen a huge growth in the complexity and geographical spread of supply chains. Yet, as consumer awareness of supply issues increases so does the risk posed to businesses and investors.

Complexity is growing not just for large multinational product or goods focused firms, but also for SMEs and services networks. It has long since been a question of products made overseas and shipped to their point of sale. With e-commerce increasing, component production, assembly, sales delivery and after-sale services can all be outsourced to different firms in a variety of geographic locations.

Obviously, this has its advantages: reducing costs by taking advantage of lower wage rates, allowing flexibility, enabling small businesses to take advantage of technology or services they may not be able to afford internally, and encouraging FDI in developing countries, to name but a few. However, as consumers become increasingly attuned to supply chain issues – climate change, CSR and commercial ethics – it is also clear that their diffusion can pose serious threats to businesses and investors.

The ‘horsemeat’ scandal that swept Europe in February 2013 found several UK supermarkets to be selling products containing horse meat acquired through a supply chain moving across five countries and involving four major European food suppliers.

On April 24, 2013, the collapse of a factory in Bangladesh used by at least six businesses – in turn supplying over 30 clothing retailers – killed more than 1,000 people. An investigation into the collapse revealed that the building had been constructed ‘with substandard materials on unsuitable land,’ bringing down huge recriminations on the head of global brands that had sourced products from the factory, including Primark, Mango, Benetton and Bonmarche.

More recently, Rolls-Royce have found themselves the subject of an investigation by the UK’s Serious Fraud Office into possible bribery and corruption. As part of their response to this, the aerospace and defence company announced in their annual report on March 5, 2014, that they would be cutting down on the number of middlemen they use, in other words, shortening their supply chain.

Governments are increasingly seeking to control foreign activities in domestically incorporated companies and more protectionist impulses are appearing in new legislation. In 2010, the UK government adopted a new Bribery Act specifically addressing the bribery of foreign public officials and the failure of commercial organisations to prevent bribery.

In late 2012, the US Congress passed the Magnitsky Act prohibiting any US entities or individuals from doing businesses with a list of Russians accused of involvement in the death of Sergei Magnitsky, ‘fraudulent transactions…and other gross violations of human rights…’. Although driven by more commercial instincts, the new Foreign Account Tax Compliance Act (FATCA), designed to increase compliance around assets held by American citizens outside of the US, is also likely to shine a more intrusive light into complex supply chains.

As increasing amounts of information around commercial operations becomes available online – and indeed is demanded by consumers – it is likely that this trend towards regulating corporate ethics will continue. Companies also face greater internal pressure to improve their ethical compliance thanks to the strengthening of legislation protecting whistleblowers.

The US 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act provides incentives for employees to hold their companies to the highest standards of compliance by authorising the SEC to financially reward those providing information on violations of federal securities laws.

Investors are likely to demand improvements in supplier due diligence procedures, either from their portfolio firms or from their own fund managers. They are also likely to expect their investments to have strong crisis management plans in place.

Lyndon Lea, founder of Lion Capital which held a 30% stake in Findus foods at the time of the horse meat scandal, emphasised the importance of transparent communications and crisis management in an interview with Sky News. Lea stated, “within hours [of finding out] I sent an email to the chairman stating that Findus needed to step forward and accept responsibility, apologise to the consumer, restore trust in the brand and be very visible in managing this crisis.”

Businesses that are unable, or unwilling, to guarantee greater transparency, prove their thorough engagement with continuous risk assessment processes, institute and practice crisis management and communications procedures, and adhere to higher standards of accountability are likely to encounter increasing reticence from investors.

Categories: Economics, International

About Author