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Navigating Subcontractor Risk in Supply Chain Networks (Part One)

Subcontractors are essential to supply chains but present significant risks that require active management and modern tools to ensure safety, compliance, and project success.

• By Avetta Staff
• Sep 17, 2024

Key Takeaways:

• Subcontractors are crucial for efficient, specialized, and sustainable project completion but introduce significant supply chain risks related to qualifications, safety, and financial health.

• Almost one-third of supply chain disruptions originate from subcontractors, highlighting the need for rigorous subcontractor management and risk mitigation strategies.

• Effective subcontractor management requires clear definitions and responsibilities for prime contractors and subcontractors, emphasizing the importance of communication and oversight to ensure project success and safety.

• Subcontractor risks can be addressed with modern tools and integrated systems, enhancing visibility, accountability, and overall network stability.

Subcontractor Risk in the Supply Chain

Subcontractors have become more important than ever in today's complex supply chains. Subcontracting allows client organizations to engage in local sourcing, diversity, and environmental initiatives as well as complete projects more efficiently with specialization. However, it also introduces risks such as not knowing subcontractor qualifications, safety practices, labor practices, and financial health. This is because in subcontracting, one or more prime contractors always stands between the client organization and the subcontractor.

Almost every company uses subcontractors. It's estimated that 60-70% of contract work is outsourced to subcontractors, who handle most kinds of tasks. Considering how vital they are, it’s concerning that 32.3% of supply chain disruptions come from subcontractors. An Avetta client experienced this recently when an unlicensed subcontractor worker ran a forklift into a newly installed water tower on their site, causing a puncture that required a replacement, resulting in a six-month delay and millions in additional costs. In another tragic case with a different Avetta client, a subcontractor failed to ensure safe trenching operations, resulting in a fatality from a trench collapse.

To maximize the potential of subcontracting—mainly to complete work more efficiently and sustainably—client organizations must maintain visibility into subcontractor management and be accountable to their investors for their decisions. Likewise, prime contractors and subcontractors can go a long way in reducing risks by mapping their practices to ESG initiatives, quantifying their ESG value proposition, and making those metrics visible to their supply chain network.

This post aims to help clients, prime contractors, and subcontractors understand the importance of managing subcontractor risk in supply chain networks. It explains key terms, responsibilities, and common challenges. It also points to how modern tools can help each entity address their specific challenges.

Key Terms in Subcontracting

Understanding subcontracting in supply chains starts with these definitions:

• Client: The company that hires and pays a direct supplier for work or materials.

• Direct Supplier: A company hired by the client to provide materials or services. They may also subcontract work.

• Prime Contractor: A supplier who hires subcontractors to complete work for the client.

• Subcontractor: Performs specific tasks or services as directed by a contractor. They don’t have a direct relationship with the client.

• Subcontractor Management: The process of hiring, training, and overseeing subcontractors. The more layers between the client and subcontractor, the greater the risk.

Roles and Responsibilities in Subcontracting

Managing subcontractors effectively means understanding roles and responsibilities within the supply chain network. Each organization is a "node" in the network, which itself is a shifting web with no single center point. Roles often change as a prime contractor may be a client in one agreement and a subcontractor in another. This fluidity means everyone must manage risks to maintain stability in the network.

One of the critical mistakes a hiring client can make is to assume that a subcontractor’s problems don’t affect them or that investing in subcontractor success doesn’t help the client, prime contractors, or investors succeed. Without a dedicated strategy to manage these risks, liabilities can be easily transferred between the client, primes, and subcontractors and remain unaddressed. These assumptions also fail to tap into the power of supply chain networks. By taking on more responsibility and gaining more visibility within the network, each entity will find more growth opportunities.

Responsibilities of Clients

• Define Project Scope and Requirements: Clearly outline project details, including technical specs, quality standards, timelines, and budget.

• Set Standards and Expectations: Communicate standards to the prime contractor and ensure they are applied to subcontractors.

• Monitor and Oversee: Regularly review and inspect progress to ensure alignment with objectives.

Responsibilities of Prime Contractors

• Act as the Agent: Engage subcontractors and fulfill contractual expectations.

• Maintain Licenses and Insurance: Fulfill all legal obligations.

• Vet and Train Subcontractors: Ensure subcontractors are qualified.

• Manage Relationships: Keep clear communication with subcontractors and clients, manage performance, and keep projects on time.

• Eliminate Hazards: Implement safety measures and manage risks.

Responsibilities of Subcontractors

• Maintain Licenses and Insurance: Meet all legal and regulatory requirements.

• Complete Necessary Training: Ensure workers are properly trained to reduce the risk of injuries or death.

• Provide Work or Materials: Deliver quality work per the contract.

• Report Problems and Progress: Communicate issues and updates to the prime contractor.

Common Challenges with Subcontracting

Subcontracting in supply chains has many benefits, like diverse sourcing, flexible responses to needs, access to expertise, and local benefits. However, it also brings challenges, often needing technological solutions.

Challenges for Clients

Clients face risks such as reputational damage from subcontractors without a direct contract. They may assume the prime contractor handles everything, but without subcontractor intelligence, they can’t manage these risks responsibly.

Major challenges for clients include:

• Contractual Assumptions: Assuming the prime contractor's responsibility protects clients from all risks and consequences is risky.

• Reputational Risk: Clients may not be legally or financially liable but can suffer reputational damage.

• Organizational Risk: Without an integrated systems approach, cybersecurity, health and safety, and business risks originating with a subcontractor can impact the client. Such risks multiply across the client organization and can even spread to partnerships across the supply chain network.

Challenges for Prime Contractors

Prime contractors require the same degree of insulation from financial risk and project disruptions as hiring clients. If primes do not prequalify subcontractors and remain accountable to their clients, they will be unable to protect themselves.

Major challenges for prime contractors include: 

• Prequalifying Subcontractors: Difficulty in identifying responsible subcontractors makes it challenging to fulfill contracts and distribute liability properly.

• Lack of Technology: Many prime contractors lack technology to streamline subcontractor risk management. Without integrated tech support, communication lags and issues are more challenging to manage.

• Meeting Client Standards: Prime contractors often struggle to understand and implement client standards. This is exacerbated by the fact that clear channels of communication between the layers of clients and subcontractors usually do not exist.

Challenges for Subcontractors

Subcontractors do not have direct access to clients and may feel less accountable due to the lack of visibility. They may not meet high compliance standards, or even know what they are, due to signal attenuation.

Major challenges for subcontractors include:

• Lack of Supervision: Insufficient oversight from prime contractors and lack of access to the resources needed to problem solve and manage changes.

• Accountability Issues: Not adhering to standards can lead to health and safety risks, rework, and lost contracts.

• Lack of Technology: Without integrated tech support, communication lags and issues are harder to manage.

Conclusion

Clients, prime contractors, and subcontractors share the responsibility for a strong, efficient supply chain network. Managing subcontractor risks is crucial for everyone's success and stability, as each node in the network has both a part to play and something to be gained. That said, clients play a central role in setting and communicating clear expectations for their contractors and subcontractors to ensure each level of their supply chain adopts responsible practices and answers for them. Successful and sustainable outcomes are the goal for everyone involved. Using modern supplier risk management tools and clear communication strategies makes this possible.