So, you are a buyer and received a demand, looked for new suppliers if needed, evaluated the best source of supply, negotiated the commercial conditions, registered the item properly in your system and … done? Not at all! If the item in question is classified as an "A" or "B" item on your ABC curve, the development and signing of a Supply & Purchasing agreement is essential.
A properly written contract is one that clarifies to the parties “who does what.” Ideally, the contract should be negotiated, signed, stored and hopefully it is not necessary to consult it during the relationship with the supplier. However, as in any personal relationship, the parties often take different paths. At some point the partnership may no longer make sense. Then it is knowing “who doesn't have to do what,” is more important than knowing “who does what.” Check below the main clauses, which can seem daunting due to their technical terms. Let's start with the least complex clauses:
Price Adjustment - Perhaps the simplest of the clauses in a commercial contract, however, it is one of the most helpful tools to avoid headaches in the future. This is the clause used to define how and when the price will be adjusted. For example, it can be determined that an index will be used (inflation, LME, and many others depending on the category traded) for an annual adjustment, or maybe it can be determined that a formula price will be applied. It can also be negotiated that the adjustment will be applied using an index, but only when the variation is less than or greater than "x%" — also known as a “price trigger." Whatever your pricing mechanism is, it is imperative to clarify it in the contract. This will certainly save time for both parties when the adjustment is required. This clause is classified as being of low complexity because suppliers expect this clause to be part of the contract. You may encounter some resistance to negotiating with the supplier, but hardly to add this clause to the contract.
Rebate - The application or not of this clause is part of commercial negotiation with the supplier. For example, let’s say you work in a perfume industry and buy glass bottles from Supplier X. Your company's goal is obviously to make a profit from a large volume of perfume sales. If your company sells more and more perfume, consequently more and more glass bottles will be needed, and the volume from Supplier X will increase. By increasing the purchase volume, you increase the quantity of bottles produced by the supplier (and then, you must pressure the supplier to optimize their production), increasing scale and generating a cost reduction for the bottles. This difference between the original cost of glass bottles produced with a lower minimum order quantity and the cost considering the new (and higher) minimum order quantity, is commonly returned to the buyer, which is called a rebate. You can define rebate as an incentive to sell. The difference between a rebate and a simple discount is that normally the simple discount is received at the time of purchase (or sale), while the rebate is received after a certain period – for example, in the contracts I manage, the rebate is normally received every 6 months or 12 months, when the supplier sends a “refund” to the company. It is considered a low complexity clause because its application is tied to a sales increase, which is one of the objectives of both parties.
Force Majeure - Is also considered to be of low complexity, since the probability of this clause being executed is generally low; however, it exists and Coronavirus is here to prove it. During the pandemic, I had to enforce some force majeure clauses, especially with Asian suppliers. If you recall, the pandemic started during the Chinese New Year, between 25 January and 11 February 2020. During this period, many Chinese workers left their homes to visit family members in other provinces (which obviously increased contamination by the hitherto unknown virus). The Chinese government prohibited the movement of people as a way of containing the disease, so workers were prevented from returning to their homes and jobs. A few days later, China's suppliers began to declare force majeure, as they could not meet their contractual obligations. In this case, they did not have enough workers to produce and deliver the quantity of items previously agreed upon. The Coronavirus is just one of the potential reasons — we can also mention hurricanes, floods, fires, and explosions among others, as causes of force majeure. This clause is mainly used to protect both parties in case something extraordinary happens, and it is not possible to comply with the obligations of the contract. But beware, it is forbidden (as well as illegal) to enforce a force majeure clause if this is not really the case. For example, if you had a problem with your production and you have excess inventory for a particular component, you cannot and should not declare force majeure and ask the supplier to stop delivering these components, just so your excess inventory is exhausted while you continue to receive differennt items from other suppliers. Normally, the supplier can request an audit at your company to prove force majeure. And finally, thinking about risk mitigation, the buyer must understand which of the items are strategic, and develop a contingency plan with new suppliers preferably in different geographic regions.
Contingency Plans - This clause is used primarily to protect the buyer, and is usually added as a sub-clause of the force majeure clause. It allows us to require the supplier to share their contingency plans in case it is not possible to purchase the raw materials necessary to manufacture your item through its original source of supply. Let's go back to the example of the glass bottle used to exemplify the rebate: If you buy the glass bottle (whose main raw materials are silica, limestone and alumina) from Supplier A, then Supplier A must inform what his contingency plan is for when his silica suppliers production is impacted due to force majeure. It is up to you, the buyer, to assess the risk involved in your supplier's contingency plans, to determine whether in addition to the contingency plans, you need other suppliers to mitigate your own risk. Typically, product suppliers share their contingency plans more easily, while service providers are more resilient, for fear of the competition they may generate.
In the next post, we will discuss the medium complexity contract clauses: Exclusivity, Non-competetion and Right of First Refusal. It is important for you, a purchasing professional, to understand your role in contract negotiation. All the clauses mentioned, and those that we will still discuss should reflect how you want to manage the category and the supplier. It is important to consult the company's Legal department in case of doubts; however, the final word must be from the supplier relationship manager.