Sponsors should consider leveraging technologies and diligence practices to tackle today’s increasingly complex supply chains.
Global supply chains have come under significant pressure in recent years, compounded by the effects of this year’s pandemic and shifting global policy agendas. In our view, supply chain analysis and management will remain critical for sponsors in the coming year as they seek to avoid risks including reputational damage, loss of revenue, and loss of goodwill. Performing diligence on a target is no longer enough — rather, the target’s value chain and broader supply chain require careful analysis to determine resilience and uncover risk areas, but such review can also identify opportunities.
In the UK and other jurisdictions, supply chains have been under increased media and regulatory scrutiny. The recent government review of the UK’s Modern Slavery Act found many companies were not compliant with the legislation, and suppliers were brought into media focus this year following the exposure of illegal labour activities in the UK.
Heightened investor and consumer focus on environmental, social and governance (ESG) issues has also increased public scrutiny of portfolio company supply chains and their oversight by PE firms.
A New Approach
Supply chain diligence is becoming an integral part of the deal process, and deal teams are embracing new technology to help identify supply chain risks on a broadening spectrum of transactions. Tools such as RiskHorizon (which Latham has helped develop) are being used to benchmark a target’s operations against wide-ranging ESG data, identify supply chain risks, and obtain tailored due diligence recommendations. Further, a growing number of companies are using other new technologies, such as smart devices and blockchain, to enable transparent and end-to-end tracking in many sectors, including minerals and cosmetics.
Aside from these innovations, portfolio companies should consider what legal protections are in place across their supply chain. Having focused on force majeure and termination-related clauses earlier in the year (to determine provision for lockdown-related scenarios or sudden changes in contractual performance), as the economic crisis develops the spotlight is now shifting to include the risk of customer distress. Where a target is a supplier, the implications of recently enacted legislation restricting termination and other contractual rights if a customer enters one of several UK restructuring or insolvency processes, require review.
Obtaining a Strategic Advantage
We expect supply chain issues to be a continuing area of regulatory, investor and consumer focus. Multiple jurisdictions, and the European Commission are seeking greater corporate accountability on a growing range of supply chain topics, including labour infringements, human rights and deforestation.
While many will focus on risk management, in our view, effective supply chain analysis of a target can be viewed as an opportunity to gain a strategic advantage. A strong understanding of value drivers, vulnerabilities, and areas of improvement at the center of a business’ operations (and that of its competitors) can enhance value and performance in times of disruption.