Friday, December 17, 2010

Total Cost Issues in Contract Terms


Total cost issues are in almost every term and each term affects one or more cost issues.

Delivery term
Freight costs, Risk of loss, Duties other potential charges
Delivery Point ownership / risk of loss
Insurance costs, Losses
Payment period
Cash outlay, Time value of money
Advance Payments
Cash outlay, Time value of money
Minimum buy quantities
Inventory cost
Late payment charges
Cash outlay, time value of money
Electronic / wire transfers
Time value of money, Processing costs
Price, Obsolescence, Process costs and Scrap, Increased quality and inspection costs, Impact to production if not equal.
Costs of re-work and recall if discovered after the fact, Cost of re-qualification or redesign to replace with an alternative if not equal.
One time NRE charges
Cash outlay, time value of money
Premiums for Materials pull in (requests shorter than lead time)
Cash outlay, time value of money, premium costs.
Lead times and standard flexibility
Inventory Cost
Reschedules or cancellations
Cash outlay, inventory costs, obsolescence
Excess/ Obsolete material disposition
Costs or cancellations, restocking, administrative costs, sales or re-brokering commissions, reduced value of materials etc.
Same issues as excess/obsolete above
Warranty scope
Warranty costs (returns, repairs, test, package etc) plus associated costs (re-work if populated on a board, costs of board replacement if re-work is not possible).
Warranty length
Warranty costs
Warranty exclusions
Warranty costs
Warranty response period
Spare parts inventory cost
No defect found charges
Cash outlay
Termination for cause
Dollar damages liability, inventory obsolescence, costs
Termination for convenience
Inventory obsolescence, costs,
Indemnification and IP Indemnification
Dollar damages liability, time value of money for payment.
Limitation of liability
Limit on direct damages for all potential causes unless otherwise specified
Cost of insurance (claims affect rates)
Definition of cost terms like direct cost, manufacturing value added, overhead, profit, that define the cost items. Risk based cost factor, where the failure to properly define an item may impact the responsibilities of the parties, who pays for certain costs associated with the item, etc.
Determines the cost of the product. Presents a cost risk is incomplete or inaccurate specifications exist. Cost is the potential for change, and the cost of changes, re-work, or scraping, what had been done.
While time doesn’t impact cost, costs can be impacted by the term and if you are locked into a Supplier, you want a term that provides you price protection.
Liquidated damages limits the amount of cost you may recover for a problem to the agreed or liquidated amount..

While Buyers may think of contracts as a lot of legal “mumble jumble”, what contracts really do is define which party is responsible for performing certain tasks (which have an associated cost) and which party must assume certain risks (which may also have a cost associated).  For example if you agreed to “EX Works” or "FOB Origin" delivery terms you have assumed responsibility for the following costs:
·       Shipment from the Supplier’s plant to the port
·       Export clearance from the country.
·       Shipment from the Supplier’s country to your country
·       Import clearance and duties at your country
·       Shipment from the import location, to your site.
In addition you have also assumed risk for any loss or damage in-transit from the time it leaves the Supplier’s dock until it arrives at your dock and if it lost or damaged that’s a cost to you, or you have also needed to assume the cost of insurances required to protect against that risk of loss. From a cash flow perspective, your responsibility for payment is normally calculated from the time that the Supplier ships the product, not when you actually have it, so it also cut into the value of your payment terms.

Where would you use the Time Value of Money and Cost of Inventory, Cost of Quality and Life Cycle Cost calculations?
  • To evaluate bids from Suppliers where the payment terms quoted vary significantly.
  • When a Supplier quotes a requirement for advance or early payment terms.
  • When a Supplier offers extended payment terms versus other Suppliers to understand the total cost impact.
  • When the Supplier’s requirements would force you to carry un-necessary inventory (e.g. guaranteed volumes, take or pay requirements, lot size, minimum volume or minimum order requirements, less flexibility on cancellations or rescheduling, etc.).
  • When the Supplier’s performance forces you to carry un-necessary inventory (e.g. quality problems, delivery problems, field failures and reliability problems)

From a negotiation perspective what you do is:
  • Talk about requirements or performance in terms of real dollars.
  • Highlight how their terms are impacting them from being competitive under a total cost perspective (using a value of money or cost of inventory analysis).
  • Highlight how their performance is impacting them from being competitive (under a total cost perspective using a value of money or cost of inventory analysis).
  • Show them that to get or keep the business they need to change both to be competitive, or they need to reduce their price so that when those factors are added in, under a total cost perspective, they will remain competitive.
  • Seek a price reduction from the Supplier every time they do anything that drives up your costs, inventory levels etc.

No comments:

Post a Comment