Managing Supplier Performance

While it would be nice to nice to transfer all risks and costs to the Supplier, even it the Supplier would be willing to accept the risks, the potential cost to do that could be prohibitive. There will always be costs and risks that the Buyer needs to accept and manage. The contract is where you provide some of the tools to manage those costs and risks. There are seven ways to manage a supplier’s performance. Every contract should have five ways of managing performance: Structure, Control,  Financial, Structure to Drive Performance and Express Conditions for the Performance.

The first is what I would call Relationship management where you build a strong relationship with the Supplier’s account team so that they know and understand what you need, want and what will impact them getting future business awards if they don’t perform.  This does not need to be addressed in the contract.

The second method to manage the Supplier’s performance is Structural.  In the contract you would include all the structural tools you need to manage their performance. The larger or more complex the purchase, the more you need the structural tools as part of the contract requirements that the Supplier must meet.

Examples of structural tools that would be used to manage performance are:

• Having clear specifications or a statement of work that makes it clear what they must deliver.
• Establishment of a team to manage performance and Supplier contacts.
• Identify tasks required.
• Establish schedule, milestones and deliverables
• Have a clear process by which the work will be tested and accepted
• Establish a strong program review process
• Establish meeting review schedule, frequency, attendees.
• Implement action item lists
• Identify content and frequency or required reposts
• Have rights to audit any on-site work being performed for quality and performance,
• Establish Senior Management involvement and reviews
• Establish formal escalation process
• Include ability to back charge management costs for significant problems, delays or resources provided.

The third method is Control.  If you have agreed to assume a cost or risk, you simply can’t let the Supplier do its own thing, so your contract terms need to provide you with the necessary control over what the Supplier can do over the things that can impact your cost or risk. Control is a way of managing behavior or performance. Examples of control type of provisions would include:

• Control over the Supplier’s team that performs the work and any changes to that team.
• Control over where the work is performed
• Control over subcontracting of the work
• Restrictions against assignment of the work
• Control over changes to the product or service
• Control over changes to the process.

For example, lets assume that the Supplier will only agree to sell to you on Ex-works delivery terms.  What this means is that from a cost and risk perspective you are responsible to pay for all the costs to get it from the Supplier’s dock to your point of use. If further means that you would also be responsible for any loss of damage that occurs while it is in transit. So to manage this potential risk you require that they comply with packing and packaging specification you provide that are designed to reduce the amount of damage that may occur in transit. You could also specify that you must either select or approve the carrier and lane used, as the potential for loss or damage may vary by carrier and by shipping lane. You could also require the Supplier to ship it with pre-paid insurance that would be reimbursed as a separate line item.  If you didn’t have the controls they could take whatever actions were the cheapest for them which could increase your potential risk of loss or damage.

If you can’t transfer the cost or risk of problems that the Supplier has control over back to the Supplier, then to manage the risk you should require strict control about what the Supplier can or can’t do with all the various factors that may impact risk. For example if the supplier was unwilling to assume the major risks and costs of quality problems they could create, you would require approval of subcontractors, material suppliers, restrict any assignment, not allow them to make any changes to the product or service without your advance approval, etc.

The old axiom is that anything that is not managed will cost more and if the Supplier isn’t going to bear the cost or risk of an item, in most cases they won’t make the investment to manage those risks for you unless you force them to by the contract terms or specifications.

The fourth aspect of managing performance is Financial.  The four main financial ways that manage performance are:

1.     The remedies that you have in the event of a breach of the agreement (the types and amount of damages you may recover).

2.     The costs of any remedies the Supplier is required to provide for failing to meet the specific obligation.

3.     Any pre-agreed impacts to price for non-performance such as liquidated damages or price adjustments for being late with deliveries.

4.     Impact to their payments and cash flow. For example, a term that would allow the Buyer to not make progress or interim payments if the work was behind schedule would be designed have the cash flow impact to try to drive the Supplier take necessary actions to get back on schedule.

As I say elsewhere, correcting problems is an investment decision on the part of the Supplier. If the financial approaches that are included in your contract won’t have a significant financial impact on the Supplier, the Supplier probably won’t make the investment to correct the problem.

The fifth aspect of managing performance is structure terms to drive the desired performance.  A classic example of this is many times a Buyer will want the Supplier to help you reduce the cost of the work. Which approach will work better in meeting that goal?

1. Fixing their overhead and profit amount and sharing in the savings, or
2. Paying them a fixed percentage for both overhead and profit based on the cost of the work?   

To me the answer is clear.  "A" provides the Supplier with an incentive to perform, whereas "B" provides a negative incentive. How much help would you expect to get if helping you penalizes them by reducing the amount the Supplier gets paid for their overhead and profit?

The sixth aspect of managing performance is making sure that you include and negotiate express conditions for that performance.

1. Make it an express commitment in the Agreement.
2. Use language that establishes it as a firm commitment .
3. Avoid any softening or qualifying language that would reduce the commitment.

Any commitment that includes “efforts” as part of it, whether its Best Efforts, Reasonable Efforts or Commercially Reasonable Efforts doesn’t guarantee performance. All it does is require the Supplier to extend that level of effort in trying to perform.

A seventh and last way of managing the Supplier’s performance is Contract Administration.  The amount of contract administration you need will be dependent upon the Supplier and the risks. There are three main focus to contract administration. One is to manage the delivery of any Buyer deliverables. That is to avoid claims by the Supplier. The second is managing Supplier performance with the goal of obtaining products, supplies or services, of requisite quality, on time, and within budget.  For contract administration to be successful you need the structural management tools to be in place.  The last focus on contract administration is maintaining the working contract file. A good contract file should consist of the following:

1. A record copy of the contract, highlighted to show any amendments made and when those amendment were made.

2. A record copy of the applicable statement or scope of work, annotated to show any changes agreed and the effective date of those changes.

3. Copies of all amendments

4. Copies of any change requests and their disposition.

5. An action item log.

6. Copies of all correspondence to and from the Supplier

7. Minutes from all meetings and calls with the Supplier

8. Copies of any inspection reports on the progress of the work, site visits, audits, etc.

Whether you win or lose on a claim or a law suit will be dependent upon being able to establish who did what and when and what the requirements were at a specific point in time.  Below are two examples of what I mean.

When I worked in construction I once had a claim by a site work contractor for additional costs to bring in new soil to make the necessary elevation grades that were called for by the drawings and specifications. The first thing I did was to review our on site inspector’s daily reports that included all on site activities including deliveries and things being removed from the site. There was a clear record of the Contractor being delivered all the soil that he claimed. A further review of earlier reports disclosed two things. One was the contractor had previously removed substantially more soil and that was taken off the site. The second was the architect instructed Supplier to not remove broad segments of topsoil and expose the remaining soil to the elements where if it got wet it would need to dry out before use. I was also able to see from the daily reports the weather and their progress and how the rain made some of the remaining soil unusable. Based on my findings I refused to pay any amount toward the claim based on the position that 1) there was an excess of soil on the site and had they not removed it, they would not have needed to bring in new soil. Their actions of uncovering too much soil they created the problem that required new soil.

In another situation we had a situation where a electronic circuit card that was supplied by a Contract Manufacturer had a specific component on it that was failing and costing significant field costs. The Contract Manufacturer argued that because it was a component that we had specified and they had purchased from our approved Supplier they should have no liability.  The component supplier was currently approved and the CM was authorized to purchase from them. We did research on what the dates of those purchases were that were failing. We then went back to our agreement to see at what point in time the specific part number was added to our agreement. What we found was that these purchases were made by the Contract Manufacturer before that part was ever added to our contract.  Under the terms of our contract with the Contract Manufacturer these would be considered as parts they directly sourced for which they assumed full responsibility.

The more you have changes in the personnel that will manage the contract on both sides the more important it is to document and maintain this type of information so it isn’t lost. It also doesn’t hurt to have a running summary of all the problems that the Supplier caused that cost you extra money and have that documented and available for use at the end of the work. That’s when Suppliers may come in with a claim for extra work and extra costs. It’s at that point when you would present your list of counter claims and use it to reduce or offset their claims and recover any excess costs.

Modifying Contract Templates To Manage Risk

Most companies have a library of standard contract templates for procurement people to use. Standard templates are designed to deal with average risk purchases from average risk Suppliers. While the best protection is to deal with reputable, financially sound, experienced Suppliers, you may simply not have that luxury every time.

When you deal with higher risk purchases or higher risk Suppliers, those templates may not provide the degree of protection needed. Most templates are also structured based on the Supplier accepting all of the terms and risks. This means that if one term gets negotiated or changed where the Supplier is unwilling to accept certain costs or risks, those changes may require changing other terms or adding additional or different terms so the Buyer can manage the cost or risk they accepted. A simple recipe for disaster is to have known or potential risks where the Supplier isn’t responsible and the Buyer doesn’t have the necessary tools and controls to manage against the cost or risks.

Here’s a description of a number of different types of clauses that might be added to help manage against risks that may exist with the Supplier, or the item being purchased. Below that are examples of changes you may want to make based on risks that you could assume in the negotiation: 

Financial Risk of Supplier.

There are a number of things you could include in a contract to manage against potential financial risk or the Supplier:

• You could require Performance Bonds in the event they fail to complete the work where the amount of the Bond goes toward your cost of completing the work
• You could require payment Bonds to prevent against subcontractor liens on the work.
• You could require the waiver and release of liens as a condition of payment to ensure the Supplier is paying their subcontractors.
• If they are a Subsidiary of a larger company you could require a Parent or Company Guarantee.
• As they may be susceptible to being acquired, you might want change of control terms so you can control who you may be forced to deal with in the future.
• If you will be consigning or loaning the Supplier items, you would need protection of your ownership rights in that material and you may want offset rights so you could deduct anything that they owe you from your payments to them.
• You could require information be held in escrow and be released to you in the event of certain events or triggers such as a change in their credit ratings.
• You could require licenses in the event of certain triggers, such as licenses to make or have the item made, or license to any software along with the right to make any necessary changes or improvements.
• If you have an assignment provision you want to make sure that it prohibits things such as assignment of receivables.
• You also might want different termination without cause rights that trigger if certain conditions exist with reduced or no liability,

Control over charges

If your standard template doesn’t already have them you would want:

• Audit or Examination of Books and Records rights to verify costs charged.
• A formal Change Management Process that includes pricing formulas for changes, additions, and deletion of work.
• Purchase options - Rights to purchase additional quantities, options.

“Bait and Switch” risks.

 To avoid problems with Suppliers that have the tendency to promise one thing and provide another you would want:

• Rights to approve Subcontractors. Material Suppliers and any changes to them
• Approval of personnel assigned and any changes to personnel.

Performance Risks

In managing performance there are tools you may want:

• Inventory stocking and Alternative Logistics Model requirements if certain problems occur
• Escalation Procedures so their management is aware of the problem
• Licenses and Manufacturing rights if there are significant performance problems.
• Downtime management tools  - Acceptable levels of downtime. Downtime credits.
• Disaster recovery requirements
• Rights to inspect Facilities
• Termination rights.
• Service Level Agreements – Periods, Response times, Service level credits
• Performance / Risk Management Tools - additional controls, reviews, approvals, and any other requirements you need to manage them.
• Alternative Payment Terms to help provide incentive to perform such as progress or milestone payments, rights of retainage, rights to withhold Payment if work is behind schedule.
• Warranty of a Specific purpose. 
• Additional types of damages that may be claimed, such as liquidated damages

Loss or theft Risks could require

• Background Investigations
• Fidelity bonds.
• Employee Dishonesty and Computer Fraud Insurance

Concerns over character or actions that could negatively impact the Buyer’s image could require:

• Restrictions For On-Premise Operations.
• Control over Supplier, Supplier personnel or Supplier Subcontractors performing other work or activities at Buyer’s site

Competitive Risk Concerns may be managed by

• Restrictions on work that would be a “Conflict of Interest”
• Key Employee Restrictions
• Ownership / Exclusivity Rights in developed materials
• Limitations on sales to others for a specified period.
• Prohibitions against Recruiting/Hiring of Employees

Continuity of Supply

• Guaranteed availability of products, service
• End of life requirements
• Requirements for multiple production locations.
• Requirements for dual source

During the negotiation any change to what the Supplier is willing to accept from a performance, cost or risk perspective needs to be evaluated before you agree. Ask yourself the following questions:

• What is the potential impact of the change?
• Does it impact other sections that relate to it?
• What’s the potential performance impact?
• What’s the potential cost impact or risk?
• Do you have the tools to manage the cost or risk either in our apart from the agreement?

Here are a few examples.

1.     The Supplier wants to sell the item Ex-works their dock.  As that makes you responsible for any loss or damage in transit, do you have the tools in place to do that?

a.     Do you have the right to specify how the item will be packed and packaged?

b.     Do you have the right to select the carrier?

2.     The Supplier wants to have limited liability for defective items.

a.     Do you have control over things that can impact the quality such as:

                                                 i.     Who makes it,

                                                ii.     Where it is made,

                                               iii.     How it is made.

                                              iv.     What changes can they make to the product?

3.      The Supplier wants the Buyer to mitigate the costs of recall. Do you have anything in your agreement that says that they will pay you all reasonable costs associated with mitigating the cost?

4.     The Supplier wants to be free to change their product without your approval. Does your agreement require them to provide you notice and a sample to determine whether the changed product will work in your application?

Suppliers want to be free to do whatever they want. When they propose changes to terms where they want the Buyer to assume some or all of the risk, the Buyer needs control over what they can do as a way of managing the risk.  My position has always been it needs to be one or the other, but never both. If they want the Buyer to assume the risk the Buyer must have control. If they are willing to assume the risk the less control you need. 

When you need to have control to manage the risk, you can't accept language that would limit your control. For example a Supplier may want to propose that changes won’t affect the form, fit or function. What control does that provide? It really is only a minor limit on the types of changes that can be made. For example “form fit and function” would allow the Supplier to make changes in the materials used and significantly cheapen the product. It would allow changes to the process used that could impact the quality of the Product. If the required reliability weren’t spelled out in the Specification, “form fit or function” would allow the Supplier to make changes that impact the reliability of the Product and that impacts your life cycle cost. If the item you are purchasing needs to work with another item, form, fit or function doesn’t protect you against the item not working in your application unless the specific application is spelled out in the specification. The more risk the Supplier wants you to accept the more control you need!

Negotiating Concessions

To be successful in negotiating concessions requires;

·       The Supplier must want or need your business. If they don’t want or need it, they will want to do it on their terms, not yours.

·       The Supplier must believe there is competition they have to beat. If there is no perception of competition, there is no threat of losing the business to a competitor. Competition is what that drives a Supplier to make concessions. Expectations of competition must be set early so the salesperson sets the same expectations with their management.  If their management thinks it’s an easy win, they won’t support concessions.

·       The Supplier must perceive an immediate benefit. They are in no rush to concede today for business in the future. Supplier’s who are generally represented by their sales team concede to meet their immediate needs like revenue, quotas, bonuses.

·       The Buyer’s team must support the competitive nature of the activity. Comments showing lack of competition or preference will impact success.

·       The Buyer’s team must show conviction in their positions. Everyone must show the conviction in getting the concession. If Suppliers perceive they get the business without a specific concession they won’t make it.

·       The Negotiator must be able to successfully explain why it’s needed and the impact to the Supplier if it isn’t met in terms the Supplier can quickly understand and relate. Good explanations will:

o   Highlight the immediate impact on their competitive position (The threat of losing the business);

o   The potential impact the position has on current or future business and volumes (The threat of getting less business)

o   The Total cost impact that would require additional price reductions (Tie pricing to terms

 To get concessions you need to know how to persuade the other party to agree.

Persuasion In Negotiation

There are four primary elements in every form of persuasion: the source, the message, the channel and the receiver. (From “Persuasive Business Proposals” by Tom Sant)

• The Source. The key with the source is it must be credible.
• The Message. The message must be tailored to the needs and circumstances just like a sales person will tailor their sales presentation depending on who they are presenting to. The message comes in two parts
• What is the problem or need?
• What makes it worth solving?

The things that make the problem worth solving is usually either the potential  loss of business or the ability to increase business.

• The Channel. The channel is the method by which you deliver the message.
• The Receiver. The receiver must be able to receive, understand and process the message in a way that will get action and be one that is able to look at the big picture.

Here’s an example of persuasion in negotiating a price reduction:

The Source may be a highly respected consultant or benchmark study that would be readily accepted by the Supplier as credible.

The Message would be the Supplier isn’t competitive (The Problem).

What makes the problem worth solving could be described as likely results:

At the current price their volumes will be reduced or they won’t get the business.  

If they offer a reduced price they will keep and possibly increase their volumes.

The channel for the message would be conversations with the Supplier about future business. In those discussions you begin to set the expectation of the need for a price reduction. You could provide your credible information in advance to reaffirm the expectation. Most parties do not like or respond well to surprises during the negotiations, so its not recommended to wait until the negotiation to provide the message. The exception is in situations where there is newly discovered information.

This leaves the Receiver. Many times Procurement negotiators don’t do a good job of managing the Receiver part of persuasion. To be successful the receiver must be able to receive, understand and process the message in a way that will get action and also be one that is able to look at the big picture. If you deal with too low a level within the Supplier’s organization, there is a strong likelihood that the individual you are dealing with cannot make the needed concessions. Most sales people at lower levels are armed with a standard playbook they are told to manage to, and anything different requires higher level of management approval. They may not see or even care about the big picture unless they are personally impacted or benefit. For example, if they already made their sales quota for the period, they may not want to push their management for the exceptions you need, because it simply doesn’t do anything for them. Your deal, the annuity stream that it may represent may be of little importance to them simply because they look only at what’s important to them personally. In managing the receiver, it is important that if you don’t feel that you are being heard or adequately represented to the Supplier’s upper levels of management, always request an escalation to be heard at the next higher level within the Supplier’s organization. Understand that there will always be levels whose job it is to tell you no, and you need to get around them to decision makers that can look at the potential revenue and risks and look at it from the bigger picture and be able to weigh it on how it fits into the overall scheme of things. I’ve seen things that were treated as major issues at lower levels in a Supplier’s organization vanish when you deal at the right level. The key it to make sure you’re selective in escalating issues and only bringing forward what’s really important. Don’t waste their time on what they will view as miniscule or nuisance points.  

The other frequent problem in managing the receiver is if the negotiator hasn’t set the right expectations along the way. Setting the right expectations early on is very important with the Receiver. Frequently the receiver will also need to report to and set expectations with their management on the business. If you don’t set an early expectation of what you need, they will not have relayed that issue or problem to their management as an obstacle they need to overcome. If your position in the negotiation then conflicts with the expectations they have set with their management, it creates a problem for them with their management. It may be easier for salespeople to say that they lost a deal than it is for them to have to go back to their management to admit they had misread their customer and additional unplanned concessions are required. The point at which you sit down at the negotiating table should not be the first time a Supplier has heard a specific issue or goal. Set the expectations of what you want and need early and often. If they know it’s a problem in advance they can deal with it. If it comes to them as a surprise at the negotiating table, the odds of getting it will be reduced. The more frequent and earlier you can channel your expectations and needs to the receiver, and the higher up you go in their organization, the more likely you will be in achieving your goals.

It is in the persuasion activity that you use the tactics that are available to you based upon the circumstances and leverage you have..

Negotiation - Thoughts on Acceptance

Acceptance is an important concept in purchase contracts. Except for fraud, it is the point at which you can no longer return the product as defective and get a refund and must look for all protection under the warranty provisions. Acceptance may also be the activity that triggers when Buyer’s responsibility for payment commences or when the warranty period starts.

The Supplier’s motivation under acceptance is to make the term short, for several reasons. Their primary concern is financial, as under most revenue accounting rules they can’t take credit for the sale as long as you can return the product. Once there is acceptance, you no longer have the right to return the product for a refund. Other motivations may be more sales motivated such as to ensure that the sale occurs so they get their revenue, commissions etc.

In negotiating acceptance the Buyer should always allow for a sufficient period for the product to be received and thoroughly tested to ensure compliance with the specifications or testing and acceptance according to the agreed acceptance procedure. If you were purchasing software or equipment you might, as part of the acceptance have a specific acceptance and test requirement that must be met so you can ensure that it is operating as promised under all conditions, loads, etc.. Since acceptance is usually expressed as a time period after delivery, in negotiating the time period for acceptance, you need to take into account the delivery point, any in-transit times and other supply chain times prior to your receipt and ability to test the product.

In acceptance terms production Buyer’s traditionally also want to reserve the right to reject products by lot. The rationale in negotiating this is simple. You paid the Supplier to ship you quality product meeting the specification. If a reasonable sampling of any shipment highlights a problem, you should be able to return the entire lot to the Supplier. Without lot rejection rights, you would be forced to screen out all of the bad products from the shipment at your cost, and then only return the actual bad parts. Since the Supplier wasn’t supposed to ship you bad products in the first place, why should you assume the added cost to screen out the good from the bad? If a Supplier doesn’t want to provide you with the right to reject by lot, offer them the alternative to pay you for all your costs associated with the screening. The only reason why you have to screen out the lot is because they had problems with their final inspection and allowed bad product to be shipped.

Suppliers may want to propose a no problem found or no defect found charge as a means of protecting them against Buyers that would reject a product lot simply to manage their inventory levels or to delay the payment.I would never agree to a No Problem Found charge unless the Supplier agreed to pay me for every time they shipped a bad product that had to be returned. Both companies should have quality control programs.The Supplier should have a quality control program to prevent defective product from being shipped to the Buyer. The Buyer should have a quality control program to prevent good product from being returned to the Supplier as defective. If the Supplier wants the Buyer to pay them every time the Buyer returns a good product as defective because of the costs they incur in inspecting and testing the product and finding that it is good, shouldn't the Buyer want the Suppler to pay them the costs the Buyer incurs when the Supplier ships defective product.Those Buyer costs could vary from simply testing and returning the product, in a situation where the buyer does no inspection could include the cost of re-work to remove the defective product the Buyer is building In both cases the party is incurring additional cost as a result of a problem with the other party's quality system.  

Negotiation - Thoughts on Confidentiality Obligations

When a party receives the confidential information of another company, it exposes the receiving party to potential claims from the disclosing party. There could be claims for breach of the confidentiality obligation should the confidential information be disclosed to a third party. You could also be subject to claims for misappropriation of trade secrets if you used the confidential information in an unauthorized manner.

To control the risk you should control:

·       What information the other party can provide. You control the information the other party can provide as the less information you receive, the less exposure you have. If you are the receiving party you want it to be limited in scope, and be only that information that was requested by you.

·       How it is provided. You are being made aware that the information is confidential so it will be properly managed

·       Who it must be provided to. Its best to have a single point of receipt so you can identify what has been provided.

·       What the requirements are to identify information as confidential.

o   For written or electronic documents how they must be marked.

o   For oral conversations, when and how their confidential nature must be identified and document.

·       What the specific confidentiality obligations are with respect to the information

o   The standard you need to use to manage the information.

o   Who it may be disclosed to without breaching the confidentiality obligation (such as Governmental Authorities); and

o   How long the information must be maintained as confidential.

As exceptions to the confidentiality obligations, you want to be absolved from inadvertent disclosures or for managing information that becomes public or is provided to you through another means. You also want to have a limited period during which you need to hold it as confidential. Most confidential information really only has a limited period in which it has value. For example, information about unannounced products should only need to be held as confidential until the product is announced. As technology changes, technical design information will also have limited value because it is either replaced with other technology or once it is for sale in the marketplace it may be easy to evaluate what the product does and how it does it.

Suppliers usually want broad coverage for their information and want the term to be long. In negotiating the term, use the product life cycle to keep it the term short. In negotiating the scope, limit the information to only that information for which you have an absolute need to know and limit it to only what you request, not what they want to give you. The more they give you the greater the potential exposure. The more technical the information the more you need to control the flow of information within your company so the Supplier’s ideas and concepts are kept separate from engineers and groups that may be developing alternative or competing products.

Highly sensitive information requires strict controls on the management of confidential information. I’ve worked in programs where there was a limited number of copies that could be maintained, All copies were controlled by a central administrator. Access to the information was limited to the program team who had a need to know and copies of the information could not leave the area or be copied. Individuals could only read the information.

As another way of managing against the risk of claims for misappropriation of trade secret information, some companies may include the right to use disclosed information in any manner within the company as long as it isn’t disclosed to a third party. Many Suppliers won’t agree to such broad use and frequently what may get negotiated is having the right to use information that is "retained in the minds" of individuals who were exposed to the information. If there is a retained information right there may also be an obligation to either return or certify the destruction of the information at some point in time so the receiving company will only have "retained information".    

Negotiation - Thoughts on Negotiating Delivery And Remedies For Late Delivery.

There are many reasons why a Supplier could be late in delivering you a product or service.  Sometimes the delay in delivery could be caused by the fact that one of their Suppliers was late in delivering. It could be caused by a production problem. They could have an emergency where they need to be working for another customer. The one area that you need to be concerned about is when your delivery is late because of a financial business decision made by the Supplier.  When there is limited supply Suppliers have a choice as to what customers they ship product to. Different customer sales, and sales to distribution may be more profitable than their sales to you. The natural tendency of any company will be to ship available product to customers that provide them with the highest profit and revenue. The less pain they have in doing that, the greater the potential risk. Other times the decision to delivery product late could simply be an investment decision. The supplier could be weighing the additional cost that would be needed to deliver on time (such as paying workers overtime) against the risk and cost if they fail to deliver on time.

Many times standard contracts have language that provides the Buyer with the ability to cancel the order or exercise the right of cover that would allow you to collect from the Supplier any additional cost of re-procurement. If you really need the product, neither of these may be adequate remedies. Ordering from someone else just places makes delivery even later as you have their lead-time to take into account, so that may not be

a good remedy. If the product or service is custom there may be no one else that is able to provide it.

In negotiating on-time delivery the key points negotiated are:

1) What is the delivery point at which you are measuring performance?

2) What (if anything) is acceptable in terms of early or late delivery?

3) What are the remedies the Buyer has in the event the Supplier fails to ship on time?

4) What is the maximum Supplier’s liability in the event of late delivery?

The point at which you measure delivery should be tied to control. If the Supplier manages and controls the shipping,  I would measure it when it is delivered to your receiving location. If the Buyer manages and controls the shipping, it should be tied to delivery at the Supplier’s location.

For early or late delivery parameters you need to consider the impact. I might agree to a small window that they may ship early if that didn’t cause a problem and as long as the payment obligation in that instance runs from when it was scheduled to be delivered. What you want to avoid is having the Supplier ship a high quantity well before they are needed simply because the Supplier has them so they transfer the cost of inventory from them to you. I’ve always been of the position that there be no tolerance for late delivery as part of the standard of measurement.

In negotiating the remedies the Buyer has you may need to consider whether alternative remedies will provide the Supplier with greater incentive to ship on time. In some situations having liquidated damages for late delivery may be appropriate. In other situations, you might include requirements that if they are late, they pull product out of any distribution channels they may have and ship it to you at no cost. You always would want the right to require the Supplier to ship late deliveries by premium freight at their cost so it isn’t delayed further.  You could also consider including different remedies based upon how late the delivery is as incentive for the Supplier to pull in your delivery. For example if the delivery is only a day or two late you could require payment for premium freight, if its longer then liquidated damages apply.

Suppliers frequently want to cap their liability for late delivery to some small amount such as the value of the purchase. The thing to consider is what your direct damages would be if they were late. For example if the same product could be purchased through distribution what would the cost be? It could be a multiple of what you had contracted to pay and that would be the minimum I would want.

The last thing to remember when negotiating delivery remedies is there are costs to you from a total cost perspective in both situations.  In situations where you have early delivery you may be accruing an inventory carrying cost. If a supplier is frequently late in delivering you probably are carrying a higher safety stock inventory as a result.

Negotiation - Thoughts on Insurance

Insurance is a language all its own and it’s always wise to involve your company’s insurance expert in any insurance negotiations. Individual countries will have different requirements and may describe things differently. This is based on U.S. insurances coverages.  As a negotiator there are a number of things that you should know about insurance. Insurance is described by the types of “Lines” that are required.  Think of a line as a form of risk or risks the insurance policy is designed to provide financial protection against. There are a number of different “lines” that provide protection against different risks. Most contracts will include indemnifications and many losses would be a breach of the agreement. What insurance does is provide financial backing behind indemnification for the types of risks the insurance is designed to protect.  It also means that you aren’t solely dependent upon the assets of the Supplier for certain recoveries.

Here’s a listing of the most common types of insurances that may be required:

Comprehensive general liability is a policy that is designed to protect a business from a wide variety of potential liability such as accidents on their premises or operations, liability from products they sell or services they perform, liability for operations completed and  contractual liability.

Comprehensive Automobile Liability is a policy that covers potential liability for bodily injury or property damage caused by an automobile.

Workers Compensation is a policy that that covers potential liability of an owner that is imposed by a workers’ compensation law for injuries sustained by the worker in the performance of their work.

Employers Liability is a policy that covers against common law liability that an employer has for accidents and injuries to their employees.

Crime or Employee Fidelity is a policy that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees. These policies protect from losses of company monies, securities, and other property from employees who have intent to cause the company loss.

Property Liability is a policy that covers loss of damage to real and personal property caused by something your business does or doesn't do damages someone else's property. Even if you don't physically injure that property, you may do something that actually prevents its owner from continuing to use it. Coverage usually includes the physical damage to the property; or the loss of use of that property.

Professional Errors and Omissions is an insurance which gives physicians, attorneys, architects, accountants and other professional coverage for claims by patients and clients for alleged professional errors and omissions which amount to negligence.

Umbrella Liability is a policy that covers losses above the limits contained in underlying policies and coverage may be broader than the underlying policy. An umbrella policy is issued under the same terms and conditions as the policy(s) is sits above.

Excess Liability policy covers losses above the limits contained in underlying policies. Coverage may not have the same terms. Like an umbrella policy it provides coverage amounts over and above the primary liability policies.

As other potential risks arise, many times insurance is sought to provide protection against the risk. For example a recent requirement that I have seen is coverage for loss of Personal Data that was entrusted to a company.

The main issues in dealing with Insurance are:

a)             Coverage limits. The primary issue is making sure that the coverage limits are adequate enough to protect against the risk. Coverage limits may be expressed in different ways such as total liability, total liability within a limited term or liability on a per incident basis.

b)             Financial Stability of the Insurer.  Insurance is only as good as the financial stability of the Insurer. Therefore its important that the insurance be from a viable insurance company.  There are companies that provide financial ratings of insurance companies such as AM Best. When an insurance provision requires that the insurance carrier have an AM Best rating of A- or better, it is requiring that the insurer must have that independent rating.

c)             Additional insured.  As an additional insured it makes you a party to that agreement. Being a party to the agreement, you would need to be notified of any cancellation or non-renewal of the insurance.  In the event the primary insured was fraudulent in their application for the insurance, their insurance may be cancelled, but as an additional insured, and provided that you were not fraudulent, you would remain protected even though the insured would not.

d)             Buyer as a loss payee.  This would create the situation where in the event of a loss, the insurance company would pay you directly so you are not dependent upon getting subsequent reimbursement from the Supplier

e)             Primary and non-contributory. A request that insurance be primary and non-contributory is seeking assurance that the Buyer’s own insurance policies will not be asked to contribute to a covered loss such as under a theory of contributory negligence.

f)              Waiver of subrogation. Subrogation is the right of an insurer who has paid the insured’s loss to pursue remedies against third parties.  As a condition of the payment the insured needs to assign all rights to the Insurance company who can then make a claim against any parties that contributed to the loss. As a Buyer would be a third party to that insurance loss claimed by the policy holder against the insurance company, a waiver of subrogation is needed to protect the Buyer against the Supplier’s insurance company pursuing remedies against the Buyer. In a waiver of subrogation the insured would give up the right of subrogation against the Buyer but would still be free to pursue remedies against other parties involved.

g)             Severability of interests. Buyer’s requesting that insurance coverage include severability of interests is requesting that each insured’s interest under the policy are treated separately for purposes of coverage under the policy.

h)             Subcontractor Coverage:  Many Buyers request that Supplier’s subcontractors maintain the same coverage and conditions as required.  Most Supplier policies do not cover Subcontractors so this requirement is more of a contract obligation than and insurance requirement.

i)               Copies of Insurance Policies:  Buyers may request copies of the actual insurance policies or “certificates of insurance” which are the standard industry method of evidencing insurance coverage. 

j)               Insurance Coverage Period:  Virtually all insurance policies have a one year term. This is because insurers transfer risk to other insurers via re-insurance agreements that are renewed and re-negotiated annually.  As a Buyer you will want the coverage to remain in effect for the term of the agreement. Suppliers may want to avoid the responsibility by having the requirement subject to coverage being commercially available.

k)             Notice of Cancellation and/or Notice of Material Change:  Buyers often request that Suppliers provide notice of cancellation of, or notice of material change in insurance policies within 30 days. If the Buyer is named as an additional insured this is not needed as Buyer, as an additional insured will get such notices.

l)               Limitations of Liability vs. Insurance. Potentially the parties could agree to higher insurance limits than they agree for a limitation of liability between the parties.  As a Buyer it is important to ensure that the Limitation of Liability does not limit the insurance liabilities and that any payments under insurances not be counted towards a total cap on liability for breaches. To do that as part of the section of the agreement that required insurance you can make the intent of the parties clear by saying  “The provisions of this section are in addition to the other rights and obligations of the parties in this Agreement."  or as part of the limitation of liability you could specifically carve the insurance section out of the limitation.

m)           Companies that self-insure.

Some companies, especially large companies will self-insure against certain perils. In that situation, it is only the assets of that Supplier that you can look to in the event of a problem. The requirements for the insurances should be the same, the only difference is that you allow them to self insure to provide that coverage. To ensure that they have the finances to meet those commitments you would require them to provide evidence of their ability to self insure. Further a commitment for self insurance will usually require that the Supplier provide a bond or other financial guaranteed acceptable to the Buyer in there is a claim. The amount of the bond or guarantee would be either the amount of the claim or the amount of the self insurance limit, whichever was less.

Negotiating Insurance.

 

One of the most frequent issues that arise in the negotiation of Insurance provisions is the amount of the individual limits that the Buyer may require for individual coverage or the applicability of certain insurances to the business. For example, a Supplier may not carry the required amount of coverage and may want Buyer to pay for any additional premium cost to meet the limit.  Before rushing out to do this the first thing you want to do is see if the Supplier has either an Excess or Umbrella liability policy. If they have an umbrella policy where the insurance policy has the same term as the other policy the values of the two can be added to see if they exceed the desired amount. If they do simply include the requirement for the Umbrella Liability policy as part of your insurance section, If they have an excess liability policy I would have your insurance person review it to see if you will still be protected under the different terms that could be in the excess liability policy. If they agree, add that insurance as a requirement for the agreement.

A second common issue is Supplier’s may say that they do not carry a certain policy such as Automobile liability as they don’t use vehicles in performance of the work. Rather than delete the requirement you could simply include a pre-condition such as “In the event vehicles will be used in the performance of the work….”.  This doesn’t force them to have insurance that they don’t need, or won’t use, but provides you with the protection that if they ever use vehicles in performing the work contractually they are required to carry the insurance.

Many Suppliers in negotiations want to avoid

1)    Having the Buyer named as an additional insured.

2)    Having the Buyer named as a loss payee.

3)    Having the insurance be primary and non-contributory

4)    Waiver of subrogation

The best way of dealing with their objections it to explain why you need the individual requirement.

·       You want to be named as an additional insured so you get notices of changes or cancellations. You want to be protected in the event they fraudulently applied for the insurance.  You also want it so the Insurance Company can’t come back and sue your company as they can’t sue a named insured.

·       You want to be named as a loss payee simply because you don’t want to be concerned about if or when the Supplier would pay you the proceeds.

·       You want the insurance to be primary and non-contributory to avoid all the time and expense determining contributory liability.

·       You want waiver of subrogation simply because you don’t want to receive the insurance proceeds only to turn around and be sued by the Insurance company.

Insurance coverage provides protection based upon when the cause of action arose. If a third party was injured, they have a statute of limitations in which to bring the claim. The insurance that would cover that is the insurance that was in effect when they were injured, not the policy in effect when the claim is made.  If the Supplier went bankrupt and no longer had insurance coverage that shouldn't impact your recovery as the claim would be made against the insurance policy that was in effect when the injury occurred.  That may be one reason to ask for and maintain copies of insurance certificates.