Strategies to secure supply chains: effective contractual approaches to overcome scarcity challenges in the supply of drugs, medical devices and other essential goods

Dr Christoph von Burgsdorff
Luther, Hamburg
christoph.von.burgsdorff@luther-lawfirm.com

Luisa Kramer
Luther, Hamburg
luisa.kramer@luther-lawfirm.com

In a world of ever-growing complexity and uncertainty in regard to business operations, the importance of a dependable supply chain cannot be overstated. This security is vital not just for ensuring the smooth flow of essential goods, but also for maintaining the overall stability of corporations. Dealing with global adversities like natural calamities, pandemics or geopolitical conflicts makes the task of safeguarding and upholding these supply chains increasingly intricate and pivotal. For instance, the healthcare sector is witnessing a surge in prices, materials are becoming scarce and the looming threat of supply shortages is real. The repercussions of these challenges are monumental, affecting both end users and companies, as the latter struggle with the consequences of delivery disruptions.

The reasons for shortages and bottlenecks in the supply chain can be many and varied: from a lack of production capacity to a shortage of raw materials, which can lead to unexpected delays in production and transport, to market fluctuations, quality issues, regulatory hurdles to market access and geopolitical uncertainties. Regardless of the cause, it is essential that companies protect themselves against supply shortages. On a commercial and practical level, there are several measures that can be considered. Artificial intelligence (AI) can be used to develop early warning systems that detect disruptions at an early stage and respond to developments, for example by diversifying vulnerable and crisis-prone supply chains.

However, innovations reach their limits where contractual gaps exist on the company side. That said, the experience of price fluctuations and material shortages also shows that well-considered contractual safeguards adopted by a company also help to protect against the threat of liquidity problems.

Effective contractual approaches that aim to overcome scarcity issues are essential to minimise material shortages and strengthen the resilience of supply chains. With clear agreements that promote flexibility, diversification and risk management, companies can face supply bottlenecks with confidence. However, the exact contractual design often goes awry.

What should companies look out for in their contracts with suppliers?

Even in the event of supply shortages, the entrepreneur is initially bound by the contractual agreement. If they cannot obtain the goods from their supplier as usual, they must procure the goods elsewhere, even if this results in increased costs.

The parties to the contract have a range of contractual strategies at their disposal, offering diverse yet effective mechanisms and tools.

Delivery times and terms

Contracts should contain clear provisions regarding delivery times and quantities to ensure timely delivery. Flexibility and realism with regard to delivery terms are crucial to addressing unforeseen situations.

Diversification

Contractual clauses can provide for changes in suppliers or the use of alternative sources of supply to mitigate risks in the event of supply shortages. A diversified supply chain reduces dependence on individual providers.

Quality and inspection standards

Contracts should outline clear requirements in regard to quality standards and inspection procedures to ensure that the delivered products meet the required specifications. Early quality testing can identify and address potential supply issues, especially if the distributor is subject to strict regulatory requirements for market access.

Price and payment agreements

The company is generally bound by its contractual offer. This means that the company alone bears the risk of a price increase. Companies can limit this risk with the use of contract clauses. Price clauses trigger an automatic percentage adjustment in the current delivery prices, often in connection with a specific price index. The requirements for an effective price clause are often challenging, which is why a legally sound design of the price clause is essential.

Contractual penalties and compensation

Most companies are familiar with the terms contractual penalties and liquidated damages and use them frequently in contracts. However, here too, various legal requirements must be observed when drafting them, especially when it comes to general terms and conditions (GTCs). Whereas liquidated damages are intended to simplify the calculation of the actual loss incurred, a contractual penalty serves to penalise improper performance, in this case short delivery or non-delivery.

Bonus–malus schemes

Bonus–malus schemes, on the other hand, are designed to motivate the contractual partner by promising a bonus, often in connection with key performance indicators (KPIs), if they perform particularly well. Based on these provisions, the contractual partner can be offered a bonus if their performance is particularly good.

Conclusion

In summary, by implementing strong contract strategies, companies are able to manage the complexity of supply chains in the healthcare and life sciences sector. By incorporating clear legal provisions that focus on compliance, compensation and performance incentives, companies can proactively address scarcity issues and foster lasting partnerships in an ever-evolving industry environment. However, contractual arrangements should never be taken lightly.