A lack of computer chips is reportedly continuing to disrupt the production of new cars.  According to recent media reports, Toyota has shut down production lines in China, Fiat Chrysler has temporarily stopped production at plants in Ontario and Mexico, and Ford has said that it is idling production in the US and Germany because of the shortage.

Carmakers don’t just depend on chips for adding luxury features, such as touch screens and Bluetooth connectivity.  Today’s cars are computers on wheels, with everything from engine controls and transmissions to collision avoidance systems relying on the tiny electronic components.

The shortage appears to have been caused by three things. When coronavirus hit, carmakers cut-back orders for chips in anticipation of lower car sales.  At the same time, chip manufacturers shifted production to meet an increase in orders for chips used in laptops, tablets, smartphones and gaming machines, which were booming due to more people working (and playing) from home.  Then, a quicker-than-expected rise in orders for new cars caught-out some carmakers and chip manufacturers. The PlayStation has hit production of the station wagon, and the Xbox has put the brakes on delivery of the X3.

The news of the chip shortage and its impact on carmakers highlights the importance of ensuring that long-term supply contracts include terms dealing with security of supply.

Given the dependency that will arise under a long-term supply arrangement of the type typically entered into between carmakers and chip manufacturers, it may not be satisfactory (or possible in the short term) to seek compensation and go elsewhere. More sophisticated measures may therefore be necessary to identify and resolve supply problems before there is a major issue.

Things to think about in your supply contract:

  • Forecasts:  Include arrangements covering the provision of forecasts for your requirements for products.  Oblige your supplier to tell you as soon as possible if it anticipates that it will not be able to meet forecast demand so that you can make alternative arrangements.
  • Exclusivity:  Check that any exclusivity provisions in your contract with your supplier allow you to source products from other suppliers where your normal supplier can’t meet demand.  Consider whether you want to make your supplier responsible for any losses you incur in obtaining substitute products from elsewhere.
  • Force Majeure:  Ensure that your supplier’s obligation to provide you with products is extended only due to circumstances that are actually beyond its reasonable control.  Local industrial action, defaults by the supplier’s subcontractors or other third parties, and events already in existence, such as the coronavirus outbreak, should be excluded wherever possible.
  • Business Continuity:  Oblige your supplier to have in place agreed business continuity procedures to deal with the risk of operational issues that may impact on its ability to supply products.
  • Performance:  Set-out a robust performance regime which disincentivises late manufacture and delivery of products.

That said, working closely with your suppliers to resolve supply issues should always be the top priority before turning to the contract.  Good working relationships and open lines of communication can mitigate the impact of most supply issues before the chips are really down.