[Inside Chodong] Subcontractors Rightfully Demanding from Prime Contractors

[Asia Economy Reporter Kim Jonghwa] As the government and the National Assembly push again for the introduction of the 'Delivery Price Linkage System,' the debate over pros and cons is intensifying.

This system automatically reflects raw material price fluctuations in delivery prices in transactions between prime contractors (large corporations) and subcontractors (small and medium-sized enterprises, SMEs). It was initially proposed in 2008, led by the SME sector during the US financial crisis, but was scrapped due to opposition from large corporations and the Fair Trade Commission, who argued that mandatory price adjustments conflicted with market principles.

The reason this system has resurfaced after 14 years is well known. With the prolonged COVID-19 pandemic and the Ukraine crisis causing continuous raw material price increases, SMEs are in dire straits as they have to absorb cost increases as profit losses without any price adjustments for 6 months to a year as per contracts.

Instead of the failed delivery price linkage system, the 'Delivery Price Adjustment Consultation System' was introduced in 2009. This system includes price adjustment clauses in contracts, and if adjustments are needed, the Korea Federation of SMEs negotiates with the prime contractor on behalf of subcontractors. However, its effectiveness has been low.

There is no enforcement, and subcontractors had to risk losing business if they applied for adjustments and were disliked, so it is not surprising that in the 13 years since its implementation, there have been zero adjustment requests using this consultation system.

Adding price fluctuation clauses to delivery contracts is itself difficult, and even if included, the harsh reality of the dominant-subordinate relationship makes adjustments nearly impossible, as clearly shown in the Fair Trade Commission’s survey released last May.

The survey was distributed to about 20,000 SMEs and construction companies that use raw materials with rapidly rising prices such as steel, aluminum, and paper, receiving responses from 401 companies. Among them, 38% reported that their contracts either lacked fluctuation clauses or explicitly prohibited adjustments.

Only 51% of prime contractors responded to subcontractors’ adjustment requests and started negotiations, and 42% said that even after negotiations, the raw material price increases were not reflected at all in the delivery prices. Given this reality, the SME sector strongly desires the mandatory implementation of the price linkage system through amendments to the Subcontracting Act.

The Fair Trade Commission and large corporations still oppose it. The Fair Trade Commission is belatedly investigating the effectiveness of the Delivery Price Adjustment Consultation System by surveying price adjustment status among 100,000 companies.

The Korea Economic Research Institute under the Federation of Korean Industries warned in its report titled 'Economic Impact of Introducing the Delivery Price Linkage System' that if raw material prices rise by 10% and this is reflected in delivery prices, demand from large corporations for domestic SME products would decrease by 1.45%, while demand for overseas SME products would increase by 1.21%. Furthermore, if large corporations raise product prices to offset losses from delivery price increases, the consumer price index would rise by 14%, while consumption and investment would decrease by 0.14% and 0.25%, respectively. According to this report, the delivery price linkage system would cause enormous harm to the national economy.

A recently met SME owner said, “Having always endured from a subordinate position, I am still holding on, but it is heartbreaking to have to compromise by raising prices far less than the cost increases while watching the prime contractor’s reactions,” adding, “The linkage system may not be a panacea, but at least it would provide a legitimate basis for SMEs to make demands when they face difficulties.”

With the Subcontracting Act in place, win-win management for mutual growth does not remain just a slogan. It is hoped that discussions on amending the law to introduce the delivery price linkage system will gain social consensus and reach a conclusion swiftly.