Thursday, December 16, 2010

Using Percentages as Triggers

In using percentages in a contract you always want to see if the percentage really works in all instances.

For example, if the Supplier or Buyer had to provide a remedy if a certain percentage was exceeded that can be problematic if the percentage is measured an activity that can vary substantially during a measurement period.

For example, a 1% measurement for defective products at incoming inspection may be the right trigger if there is la volume of 10,000 units in a measurement period, but what if there were only 1,000 delivered in that period. Instead of the remedy triggering at 100 it would trigger at only 10.

There are several ways to deal with the potential concerns a party may have for triggering a remedy at a small effective quantity. One is you could negotiate different percentages for different volumes so the actual number required to trigger a remedy is consistent with the real impact. A second alternative is to require the percentage and an actual number of units to create the trigger. When you use the word “and” it means that both requirements must be met so both the percentage must be exceeded and the number must be exceeded.   

For example if you Buy 1,000 in a month 1% would be only 10 which may not be an appropriate volume to trigger the remedy. If you said 1% and 100 units, it wouldn't trigger it at 10, but it would trigger it when both criteria are met (over 1% and at least 100 units).

Many times the natural tendency of a Supplier is to either want to protect themselves by trying to negotiate a higher percentage, which is not good for the Buyer when the volumes increase.  Another approach is lengthen the measurement period. The impact of lengthening the measurement period is it significantly increases the effective number to trigger the remedy.
For example, at 1,000 a month with a 2% rate if you changed the measurement period to three month instead of having to have 20 to trigger the remedy, you would need sixty. If you were to go with a longer measurement period you would need to reduce the percentages. If you are purchasing the product in volume, the increase of the measurement period creates a much large effective volume to trigger the remedy.  For example if you were buying 100,000 a month, 1% is 1,000 units. If you extended the measurement period to 3 months, there would need to be 3,000 failures to trigger the remedy.

When you use the percentage and a minimum quantity for a trigger it protects the Supplier against having the remedy trigger at very low volumes. It also provides the Buyer with greaer protection for higher volumes than would be achieved with either a increased percentage or longer measurement period.

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