Businesses have spent years preparing for supply chain disruptions. Few are prepared for a reality where suppliers decide long-term contracts no longer make sense.
In the drawn-out negotiations between the United States and Iran, both sides seem to think they have a relative luxury of time. This calculus is akin to a game of chicken, to see who can best weather the shocks of the effective closure of the Strait of Hormuz, and the pain of short-term market volatility, in order to force a deal in their favor.
As shipping costs have climbed because of renewed geopolitical tensions, some suppliers are reconsidering whether long-term contracts remain sustainable. Despite cost increases, many suppliers are still contractually obliged to provide their goods at price points that might have made sense a few months ago, but no longer do. The longer these conditions last, the more suppliers are tempted to break contracts to renegotiate at more realistic rates. This has broader implications for our entire economy.
Across sectors, a game of contract chicken is taking shape. If suppliers do actually begin breaking contracts, it creates a slippery slope towards the conditions that justify breaking trade agreements. The question remaining is who blinks first: the suppliers keeping our economy flowing, or the politicians prolonging the war with Iran.
The contract crisis runs the gamut from blue-chip manufacturing to consumer goods.
Suppliers have relatively little leeway to react to those realities, as they’re often locked up in multi-year master service agreements, which can provide pricing guardrails for frequent agreements between a supplier and client. In some cases, that might mean shipping goods at an unjustifiable margin, or an outright loss. They may be obligated to do so with no certainty about when, or if, the underlying costs of raw materials and shipping might go down.
But, the longer geopolitically induced price shocks apply, the higher the likelihood that breaking contracts — and running the risk of reputational damage and renewed competition — become worth it in the eyes of operators. If those floodgates open, there are dangerous implications for how we trade and establish trust in our global economy.
What happens if contacts are broken en masse?
The ostensible “positives” are that suppliers can maybe breathe a little, and the more suppliers that do it, the likelier it is that existing suppliers can hold onto their current market share. But without multi-year contracts functioning as an imperfect deflationary measure, price volatility now has free reign, as the costs of many of the inputs that are themselves locked up in loss-inducing contracts can be renewed at higher price points. It establishes a dangerous precedent in which extrinsic pressures that previously were a relatively quotidian cost of doing business (a cyclical downturn, a natural disaster, a ship blocking the Suez Canal) can be used as a justification for going back to the drawing board to establish entirely new trade terms. That, in turn, flat-out compromises the fundamental premise of a contract.
In stark contrast to the positives is the fact that a chain of broken contracts would corrupt the currency that underpins trillions of dollars of trade per day: trust. Such a bankruptcy of goodwill stands to move us into a structural economic crisis, in which clients come to expect failure and inconsistency, disincentivizing the formation of new, untested relationships. From a macroeconomic point of view, that kind of shift can have profoundly recessionary implications, discouraging trade diversification and innovation.
Ultimately, consumers, households and everyday citizens stand to lose the most. With suppliers effectively securing carte-blanche clearance over the terms of trade and the margins they may extract, end-businesses will wind up charging customers a higher price for goods and services, incorporating volatility into the cost passed on to consumers. Suppliers would effectively be leaving consumers with all the costs of a volatile trading situation.
The likelihood of mass contractual attrition is not out of the question. As the United States and Iran seem closer to, or further from, some kind of détente depending on the day, the possibility for long-term economic repercussions grows ever-likelier. It’s easy to focus on the most visible economic impacts, like the price of gas at the pump, or the price of the goods and services that depend on these raw materials. But what’s most concerning is a lot less visible: The way we do business, and the centuries of trust-building that have gotten us to where we are today, are on the brink of being compromised, potentially corrupting trillions of dollars in trade and goodwill.
Sid Malladi is CEO of Nuvo.