Thursday, December 16, 2010

Types of Contracts

In Procurement there are a limited number of types of agreements that exist.
The distinction between agreements usually occurs based upon what you are buying or licensing in general, and then there are different variations for the individual commodities and relationships that you establish.

  • Purchase Order
  • Services Purchase Agreements
    • Variations of services purchasing agreements may apply for technical services, non-technical services, training, telecom, travel, meetings, conventions, catering, marketing communications & advertising, facility related services, general business services, repairs, maintenance, support, utilities, construction, consulting, outsourced services, printing, etc.
  • Goods Purchase Agreement. These may vary based upon use of the goods.
    • Internal Consumption
    • Production purchases of products, spare parts, materials, and raw materials. All of these will vary based upon the commodity and nature of the purchase.  For example the purchase of Goods may be done under agreements with Contract Manufacturers that perform a variety of services to create the completed product for sale to the Buyer.
    • New product development, product design, manufacture.
    • Market / Resell / Distribute
  • Product Service Agreements
    • Spare parts, repairs, maintenance,
    • Subcontract service
  • Distribution / Logistics Agreements
    • Carriers, couriers, customs brokers
    • Logistics and warehousing services
  • Equipment purchases
    • Equipment purchase,
    • installation, maintenance, spare parts, repairs
  • Software Licenses
    • Internal use / distribution licenses (object / source code),
    • Software Evaluation
    • Development of new software
  • Confidentiality / Non-disclosure Agreements
    • Technical disclosures or receipts
    • Business disclosures or receipts
  • Lease of products
  • Other Licensing
  • Administrative agreements
    • Electronic Data Interchange (EDI)
    • Loan of product / loan of Software
    • Changes to Parties to the Agreement
      • Assignment /Assumption/Novation
    • Escrow / Escrow Custodial (Software or Hardware)
    • Consignment
    • Replenishment logistics / Vendor Managed Inventory
    • Settlement

Understanding a Product or Service

If you are going to negotiate the price of a product or service on a cost basis, you need knowledge about what you are negotiating.  For negotiating the cost of a service you need to understand all the different tasks that are required to perform the service,  the quantity and type of labor that is required and any tools that are needed. In negotiating the cost of a product you need to know how the product is made, the materials that are used, the process steps it will go through, the equipment that is used and the quantity and type of labor that is required to perform each step during the process. You may not need to know the actual cost,  but as a minimum you need to have a benchmark cost to compare their cost against for them to justify why their cost needs to be different than the benchmark.

The easiest way to understand what’s involved in producing the product or performing the service is to witness it first hand. Have the Supplier take you through all the steps the product or service goes through from start to finish.  Look at who does the work, what skills they have, what equipment they use, how long it takes and you begin to see a little about what it takes. If the Supplier is willing to provide you with a Bill of Materials for a product, read through it to see the types of materials that are used in production of the product as many times the cost of the materials can represent eighty percent (80%) or more of the product cost. 

If you and your team know enough about what it takes to build a product or provide a service even if the Supplier is unwilling to provide you with a detailed cost breakdown, you should be able to create what’s called the “should cost” or your estimate of what you think it should be costing to use to have the Supplier justify why their cost should be any different. If you don’t make the investment of time to learn about the product or service and what it takes to make or perform it, you are left with using the “you need to do better tactic” but you can’t explain to them where or how they need to do better.

The other advantage of learning about their product or service is you can discover that the Supplier is using materials that are greater quality than you need, or they are performing processes or tasks that you don’t need and if they can eliminate them the cost can be reduced.  I had a friend that was hired as a consultant to help reduce cost for engine parts for a large equipment manufacturer. Before he started he was worried if he could do the job as he had no experience in the industry and came to me for advice.  I told him that there are two ways that you can reduce the cost of what you pay. One is to pay less, which means that the Supplier makes less. The other is to look at all the materials and processes used and see whether they were needed, could be changed or eliminated. To do that, he needed to see the item being manufactured. He did, and identified an item that had a number of process steps that he thought were too many.  Then he checked with their engineering staff and found that the requirement was part of a specification that had been in place for a long time, but was no longer needed because of the quality of the materials they were using today versus what they had in the past.  That one change saved the company millions of dollars on their product cost. The Supplier was happy to reduce the price as their cost was reduced so they weren’t giving up profit and on their books it was more profitable. To my friend it meant a multi-year consulting engagement. He wouldn’t have been able to do any of it if he didn’t take the time to learn about the product.     

Understanding the Product or Service and its Position in the Market

In preparing for a negotiation there are several things that you should know about the product or service that you are purchasing
  1. What are the product’s or Services features?
  2. How is it made or performed?
  3. How is it positioned in the market?
  4. Who are the competitors?
  5. What features do their products or services have and how are they positioned in the market.

What does this have to do with negotiation? Purchase decisions are made based upon perceived value.  Suppliers will set their pricing based upon how they perceive their product will be valued in comparison with competitors products.  Whether they hold to their pricing or not will be dependent upon several factors. One is how much they need or want your business. The other is whether they have any product features that are unique that will differentiate themselves from the competition that the Buyer needs or wants.

You have the most leverage if they need or want your business and either they don’t have features that distinguish them from their competition. You have the little leverage if they don’t need your business and they know that you need or want features that are unique to their product, You have almost no leverage if they know that you will benefit from those features as that provides greater value so there is even less reason to discount.

So knowledge about the product and its features versus your needs should tell you whether there is competition and whether you can walk away from the Supplier. That’s why supplier always want to understand what your needs are and how you perceive their product versus the competition. They want to understand who the competition is because they have already mapped the competition and their product on their value equivalence line on price positions so they know what they have and how they will price their product.  For example many times a market may not be just one market, there can be multiple market clusters. For example there can be a no-frills market, and average market and a high end market that differ based upon the perceived value of the product. If they know who their competition is, they will also know what cluster they fall into and what to expect from them with regards to the value offered and the pricing.

There are a number of factors that are taken into account in positioning a product. Price or cost of use is clearly one factor. Differentiation by function or available features is another factor. Target market focus can be another factors such as companies that target niche markets. Where its impossible to differentiate between products as part of positioning companies may use other factors such as inventory stocking, response times, and service experience as part of the value calculation in positioning

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.

Using the functionality of Microsoft Word™ in Negotiating Contracts.

In some companies if you are negotiating contracts you may have a software program to manage and track changes to the documents as they are negotiated. For those that don’t have those programs,  Word™ has certain functionality that you should know about and be able to use.

First, you can set the document up to track changes so that Word™ automatically highlights the change.

            To do that under the Tools pull down menu you click on “Track Changes

You have three options on how the changes will be shown. One uses the Balloons that appear in the margins showing the change.  A second provides a red line version of the changes with items inserted highlighted and items deleted showing strikethroughs.
The third option is to use the Balloons only for comments and formatting, where all other changes are shown as red-line.

To select the one you want to use you click on the Tools pull down menu and under “Options” click on the “Track Changes” page. In the Balloons section select which of those three you prefer.  My opinion is Balloons makes it harder to see what is being changed and where, especially if there are many changes.

Once you receive a document with changes the easiest way to work with that is by adding the “Reviewing” pain to your Word™ Buttons.

To add the Reviewing Button you click on the Toolbar Options Button that is dark and has a downward facing triangle on the bottom.
Select “Customize” and click on the Button “reviewing”.

When you turn on the reviewing functionality it will add a number of buttons to the toolbar that help you navigate through the changes.

To use the functionality you highlight the word, words or section you want to accept or reject. You can do that several ways:
  • By clicking on your mouse and holding it down and dragging it over the change.
  • Double clicking on an individual word will highlight the word

The Button that looks like a sheet of paper with a Pen with a left facing arrow when clicked will move you back to the last change.

The Button that looks like a sheet of paper with a Pen with a right facing arrow when clicked will move you forward to the next change in the document.

The Button that looks like a sheet of paper with a Pen with a check mark on it when clicked will accept that change.
The downward arrow to the right of the Accept Change Button provides additional functionality in accepting changes.  For example, if you highlighted a paragraph with multiple changes in the paragraph you can click on accept all changes shown.
If you want to accept all changes to the document, it allows you to do that such as when the document with all the changes represents the final agreement of the parties and you want to produce a clean document for signature.

The Button that looks like a sheet of paper with a Pen with a RED X on it is the Reject Changes Button and when clicked will reject that change.

The downward arrow to the right of the Reject Changes Button allows additional reviewing functionality.

The Yellow button that looks like a file folder with a star on it is the Comments Button and allows you to insert a comment in the document such as why the change is not acceptable.

The Button in the Reviewing Pane that includes an upward arrow is the reviewing pane. If you click on that it will provide a split screen of the document that highlights the change and who made the change and when it was made.

There are additional things that you do need to be aware of in using Word™. For example, if you sent out the contract internally for review all the changes made will still be retained by Word™ even though you have used the reviewing tool to accept or reject them.  To prevent the Supplier from seeing those internal changes, simply do a save as on the document to another file name and that will eliminate the history.

Word™ has several other tools that you can use as part of the negotiation process.
On the tool bar there is a “display for review” Button that allows you to view the original, the original showing markup, the final and the final showing mark-up. If you want to see all the changes that have been made, click on original showing mark-up.

In the Print functionality you can also decide which version of the document you want to print. For example sometimes there could be a dispute over who made a certain change.  If you click on Print and in the area that says “Print What” if you select “List of Mark-up” what will be printed is all the changes that were made, when they were made and who made them.

The last tool you can use to make sure that you are seeing all the changes that have been made can also be found on Tools pull down menu. If you click on the Compare and Merge Documents it allows you to electronically compare the documents for changes. 
Here’s how to do it. 
In the current document that is under negotiation click on accept all changes and do a save as to a new file name.  This keeps your original document untouched.
Open the new document; make sure track changes button is off. Then click on Compare and Merge documents and Select the Original document that was sent to the Supplier before any changes were made.  Word™ will show the differences between the two and will show any changes that may have been made to the document with the track changes functionality turned off.  Print out that document and use that to compare to your current document in negotiation to ensure that it represents a correct picture of what has been changed

An on line Microsoft course on using the functionality is available at