Hello purchasing professionals! In the last post, we talked about the contractual clauses considered of low complexity (price adjustment, rebate, force majeure and contingency plan), now that you already know them and understand how important their application is to protect your company and your supplier, let's discuss the medium complexity clauses, which are: Exclusivity, Competition, Right of First Refusal, and Take or Pay.
Exclusivity: This is commonly mixed up with the competition clause, so let's try to clarify the difference between them once and for all! A request for an exclusivity clause can come from either the buyer or the seller.
Let's use a practical example to facilitate the understanding of the exclusivity clause requested by the buyer: Say the supplier has an innovative technology that allows him to produce a component that is allocated inside a shower mechanism that controls the amount of water released by the shower and mixes it with an exact amount of air, thus producing an unexpected sensory effect and bringing a different feeling when the water touches the consumer's skin during the bath. The company that buys the component that is placed inside the shower mechanism, and mainly its marketing area, can take advantage of this sensation in their advertising actions. Have you ever noticed how many advertising pieces (in magazines, newspapers, internet, television, etc.) contain the phrases "unique to the market,” or " exclusively in this product," in their highlights? In order for the marketing area to use these arguments, an exclusivity clause with the supplier is necessary. Generally speaking, this means that if I am the buyer of the component that is used within the shower mechanism, I can negotiate with the supplier that it will produce and sell this particular piece only to my company and no one else! This is the main difference between the exclusivity and competition clauses: to whom the supplier can or cannot sell. In the case of exclusivity, when asking the supplier not to sell to any other company, we are somehow restricting his ability to expand the customer base, and so my dear colleague, this will certainly have a cost. This cost is the reason why an exclusivity clause is considered as having a medium complexity of execution. Generally, the supplier tends to agree with the insertion of this clause so long as it is rewarded, either through a monetary contribution at the beginning of the contract, or the commitment to acquire a certain number of parts during a certain period of time. The problem here is to understand what the cost should be to reward the supplier fairly. Thinking holistically, the supplier not only potentially loses customers who would buy the exclusive piece, but also loses customers who could be attracted through the exclusive piece and end up buying other pieces from its portfolio. A conversation with marketing is worth it to understand the value of this exclusivity on the part of the supplier.
Now let's see how the exclusivity clause that comes from the supplier works: During a negotiation, the supplier can ask the purchasing company to buy a certain product only with him, that is, you buyer will not be able to "go to the market," to seek alternative sources. It is a risk that you can decide to accept based on your category management. In any case, the exclusivity clause is a strong Currency that must be used well during a negotiation. Remember to also apply the price adjustment clauses and contingency plan to protect yourself, in case you decide to accept an exclusivity request from the supplier.
Competition: We will again use the example of the internal component of the shower mechanism to facilitate understanding. Let's say that in this case, the piece can also be coupled to the hoses used in pet shops to bathe our 4-legged friends. In this case, you can restrict the customer segment that the supplier can act on. You can negotiate that the supplier does not sell to your direct competitors, that is, he cannot sell to other shower manufacturers, but he is free to sell to hose manufacturers. It is common for the buyer to develop a list of direct competitors with the company's marketing and legal departments. This list is usually attached to the end of the supply contract.
Again, the clause is considered of medium complexity of negotiation due to the difficulty in reaching a monetary value that compensates the supplier for possible sales lost to other potential customers. Similarly to the exclusivity clause, a conversation with marketing area is recommended to understand the real need to restrict the supply of a certain component to your competitors and what will be the value perceived by the end customer.
Right of First Refusal: Also known as RFR or ROFR. How about we go back to our example of the component that goes inside the shower mechanism: Let's say that the purchasing company has developed another type of shower mechanism and needs suppliers to manufacture it. If there is a preference clause with the current supplier of the exclusive component (we will call them Supplier A), that means the buyer must first send an RFQ (Request For Quotation) to Supplier A, and only if they decide that they have no interest in producing the new mechanism can the buyer then start the RFx process (Request for Information, Proposal or/and Quote) with other suppliers. It is considered of medium complexity, since in this case the buyer's independence is restricted. In addition, the minimum term of a contract is 1 year, and many things can change in 12 months, including technology. It is also a strong negotiating Currency, and the buyer must ensure that he is receiving something important in return if he decides to grant the preemptive right to a supplier.
Take or Pay: This last clause is considered of medium complexity of execution, but relatively easy to negotiate.
Sometimes, in order to obtain a lower price (or a greater gain in scale), the buyer undertakes to buy a certain number of parts — or requests the performance of a certain service for a certain period of time. The supplier then does all of its budget and resource planning based on this volume commitment. Let's say your company's sales forecasts don't go as planned. If you have a Take or Pay clause in your contract with the supplier, then even if you don't need the material or service, you can choose to receive anyway (Take) or simply pay the supplier and not receive the goods or service (Pay) — This is very common in companies with restricted inventory control.
Take or Pay is a clause with medium complexity of execution because often, the buyer assumes this commitment, but does not always communicate to the other areas involved (Finance and Planning, for example). In companies with strict budget control, the process is usually done in August or September for the following year. Imagine if, at the beginning of the second semester, the supplier decides to execute the Take or Pay clause and your company is obliged to pay an unexpected and unplanned amount in budget. Chaos!
Ideally, the buyer should accept the Take or Pay clause only as a last resort, when all other exchange Currencies have already been used and you have not yet reached the desired point. Also, be sure to communicate your commitment to other departments. Take or Pay must be a risk taken by the company, not just by the buyer.
It is worth remembering that purchasing is the management area of the contract; however, the requesting area is the Owner of the contract, and thus responsible for measuring and reporting the performance indicators that are part of it.
In our next and last post in this series on contracts, we will talk about highly complex contracts for negotiation and execution: Meet or Release and Most Favored Consumer.
It is worth remembering that purchasing is the management area of the contract, however the requesting area is the “owner” of the contract and thus responsible for measuring and reporting the performance indicators that are part of it.
In our next and last post in this series on contracts, we will talk about highly complex contracts for negotiation and execution: Meet or Release and Most Favored Consumer. Don't miss out!