Posts|February 23, 2023
Mitigating Supply Chain Issues
By Jase Hamilton
Surety Department Manager CPCU, AFSB
If you can claim you haven’t felt the impact from the stressed supply chain over the past 24 months, I would tell you to stop what you are doing, right now, and buy a lottery ticket. Every industry has been impacted and the construction industry is no different, in fact the impact may be even greater. As material prices continue to fluctuate and certain material lead times are pushed 6, 9 or even 12 months out, it’s no wonder the industry is beginning to see more losses and contractor defaults. Unfortunately, many experts believe these issues will continue for the next several years, and as a result, surety companies are tightening their underwriting guidelines and are maintaining a stronger focus on cashflow and internal controls.
The challenge that supply chain disruption presents to contractors is primarily centered around cashflow; whether it’s mitigating escalation in material prices, managing overhead & delays or purchasing a big-ticket line item. Most contractors are feeling the pain and aren’t sure how to successfully navigate these challenges.
What’s causing supply chain issues?
• Material shortages: The supply chain relies on the smooth flow of materials to keep production lines running. Shortages of critical materials have led to production delays and increased costs.
• Labor shortages: Although the COVID-19 pandemic is essentially behind us, it has led to labor shortages across many industries, many of which have not fully recovered.
• Transportation issues: Global supply chains rely heavily on transportation, including shipping, rail, and trucking. Disruptions to these modes of transportation, whether from congestion, labor disputes, or natural disasters, have continued to accumulate and become worse over the past 24 months.
• Sociopolitical factors: As international relations continue to evolve and seemingly become more complicated, global trade has become more restrictive including several items that are crucial to the building industry.
Many of these issues are out of our control, but if a company can better understand the specific impact that these challenges may have to their project, they can better prepare, improve your internal controls and minimize potential issues.
Improving Internal controls:
• Contract Risk Analysis: During the projection selection stage, it’s critical to review the contract and negotiation favorable terms. This includes; confirming price escalation clauses, delay provision, damages, dispute resolution and payment terms. Many contractors have found success in working with their clients to partially release funds or retention during the course of construction or to allow for early purchase & bill of large or long led-time line items to help mitigate potential cashflow burdens.
• Upstream & Downstream Prequalification: Construction remains a relationship driven industry and “best in class” contractors are implementing comprehensive prequalification processes for not only their subcontractors & vendors but also for the owners they work with. Pre-qualifying the partners both upstream & downstream will help mitigate unexpected challenges and filter those owners/subs/vendors that may be a higher risk to your company.
• Banking Relationship: The increase in uncertainty in today’s market, emphasizes the importance of having a bank line of credit. Although this line should not be used regularly for operations, it is prudent to have access to additional cashflow to help in times of an emergency or cashflow crunch.
• Trusted Advisor Relationship: With the growing complexity of contracts and continued impact of supply chain issues, it’s important to remember to rely on your trusted advisors (Insurance & Surety Broker, CPA and Attorney). These strategic partners should not just be a supplement to your process but a direct participant when reviewing a contract and making your go/no go decision.
Supply chain issues will continue to be a critical part of the economy and current disruptions to it will have far-reaching consequences to those contractors that are not prepared. Understanding the make-up of the project, contract risk, and communicating with your partners early in the process, will allow you better mitigate potential risks and ensure successful project outcomes.
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