Hello purchasing professionals! Welcome to the last post about contractual clauses. Previously, we talked about the less complex negotiation and execution clauses (Price Adjustment, Rebate, Force Majeure and Contingency Plan). We also discussed the medium complexity clauses (Exclusivity, Competition, Initial Right of Refusal and Take or Pay), so now we will finally close this series with the most complex clauses: Most Favored Consumer and Meet or Release.
Most Favored Consumer: Since we are good purchasing professionals, we are always looking for long-lasting partnerships that make sense for both parties (A Win-Win partnership). Now, if we decide that our strategy for a certain item or category is to concentrate volume with a supplier or even make it the exclusive supplier — of course we have already done our homework and evaluated the risks involved in this decision — then we expect the supplier to grant us something in exchange for this loyalty. Through the Most Favored Consumer clause, also known as MFC, we negotiate for the supplier to apply its best conditions to our contract. Let's use an example: Let's say you buy all your pallets from a single supplier and pay $22 each. When deciding to negotiate the inclusion of the MFC clause in the contract with the pallet supplier, you are asking that the list price of this pallet to be at least $22.01 for normal customers, making it so you benefit from the best unit price. Attention! The MFC clause does not imply that only you can buy for $22, that is, the best commercial condition can be applied to more than one customer. The tricky part of inserting this clause is how it should be written and that it is necessary to go to the company's Legal department. If the writing is very generic, in case it is necessary to discuss the implementation the MFC clause, the supplier can use arguments such as "The pallet I sell at $ 21.90 has a lower quality than yours” or "This other customer of mine buys larger lots,” or even “The price of $ 21.90 per unit contains a rebate negotiated with the customer,” among many other arguments.
The most complex aspect of implementing this clause is obtaining information. You need to be sure about validity of your source of information before calling the supplier. The buyer cannot simply inform the supplier that he “heard” that company X is buying pallets at $21.90. Another important point to be considered: When adding a MFC clause, the focus of the contract becomes the price, which we already know is only one of the cost components. If you realize that you are spending a lot of time negotiating this clause with the supplier, it may be worth changing the focus to another issue, such as cost breakdown or a TCO (Total Cost of Ownership) assessment. This will certainly bring you an advantage and greater cost savings.
In addition, the existence of this clause may "discourage" the supplier from improving its price, since a possible reduction should be passed on to all customers who have this clause in their contract. If your company works with annual price reductions, you will encounter resistance from the supplier. There is another point of view to be considered: Some articles and literature claim that there is a contradiction between antitrust laws and the MFC clause since the objective of antitrust laws is to ensure competition between market players, while the MFC clause determines that the lowest price for a product or service is passed on to all consumers who have this clause in their contracts, thus restricting their competitive power. If you followed the first and second posts about contractual clauses, you should remember that I suggested a conversation with the marketing area in case you want to apply the Competition and Exclusivity clauses. The suggestion remains valid when it comes to the MFC clause; however, you should consult the company's Legal department. While this clause is essentially commercial, this is one of the cases in which the company’s Legal department must have the final say. If it is understood that the application of this clause in your contract is restricting competition, you can cause serious problems for your company despite the best of intentions.
Meet or Release: We will use the previous example of pallets to facilitate understanding. Let's say the list price for pallets is $22, and after committing to buy 10,000 pallets for one year, the supplier reduced his unit price to $ 21.50. It is extremely important to include in your contract the Meet or Release clause, which basically means that if you find another supplier that sells exactly the same type of pallet for $ 21, you can inform your original pallet supplier about the offer that you obtained, and then they have two options: Sell the rest of the 10,000 units traded under contract at $21 per unit (Meet) or release the buyer's company from the obligation to buy the rest of the 10,000 units (Release). Points to consider (and reasons why your application is considered to be highly complex): By executing this clause, the buyer will be immediately threatening the relationship with the existing supplier, and the buyer should keep in mind that they are unlikely to be considered a priority for this supplier after that. Those suppliers who do not yet have a relationship with the company tend to lower prices and sometimes sell with a negative profit margin, just to be part of the supply base, practice what we call “Buy the business.” To protect against this supplier action, it is important that the buyer understands the cost composition of their supplier, which can be obtained through cost breakdown. In addition, it is worth remembering that the unit cost of an item should never be the only parameter evaluated, and that the reduction in unit cost offered by a new supplier may not compensate if there is a greater impact on freight costs, quality, product availability and many other parameters. As with the MFC clause, it is important to remember that the verbiage must be very well evaluated to avoid arguments. It is also common to refer to the product specification in the text of the clause and attach the specification to the end of the contract.
In both clauses, the most important thing is to keep in mind that its execution will certainly harm the relationship with the supplier, so there is a need for a very well-designed plan and strategy. One should also remember that the contract and all the clauses that comprise it must be treated as a protection mechanism (especially against team changes — who has never had a problem with an agreement made by someone who left the company?). Whatever the deal with the supplier is, the buyer must use the contract to formalize the terms and conditions, then hopefully expect no need to review the contract, except for renewals. Now, we come to the end of this series of articles on contracts, I hope that the negotiation and application of the discussed clauses has been facilitated. Good luck!