Wednesday, February 9, 2011

Negotiation - Thoughts on Negotiating The Agreement Term

If you will be dependent upon the Supplier for the products, service or support for a long period, such as occurs when you design a Supplier’s product into your product, you will always want either an extended term, or a combination of other terms, to help you manage the risk of continuity supply in supporting your production or service needs.

Once the term has ended, if you still need to make purchases, the Supplier may have substantial leverage. You always need to think about protecting against potential abuse where they feel you are locked in. That applies to both the price they can charge or the terms they sell under. If you can’t quickly switch sources of supply, you either need a longer term or need to include things in the contract to protect against those risks. End of the term buy options are one way to manage that risk.  Another way to provide protection is to include an option to extend the agreement.  Options for extensions of the terms should be subject to mutually agreed terms. I would push to establish pre-agreed parameters on what of the agreement is subject to re-negotiation and have parameters on changes to the price.

A lot of negotiating the term of the agreement is common sense. Always think about when is it best for you to have the contract end. For example, if you were dependent on a Product to meet revenue, you would never want the contract to end during a critical revenue period. If there could be any possible interruption in supply or services, always think about when is the best time for that interruption to occur as you transition Suppliers. If they are on-going services always consider the impact of any Supplier transition on the Business the service supports. For example when I negotiated a Debit Card processing agreement for a Major Bank the term was tied to when a transition would have the least impact. That meant that the major shopping period prior to the Christmas holidays could never have and transition occur as there was to much potential business at risk, whereas if you had the contract end in a time like mid February it made more sense.  You also would not want a contract term to expire when you had major commitments you needed to fulfill for a customer and were dependent on that Supplier. A better way would be negotiate an extension of the contract  to cover that term or get agreement from the Supplier that the terms of the current agreement will apply on that program until the program is complete.

Your term also needs to take into account the fact that there is a natural lag caused by lead-time that should be taken into account in establishing the term. For example, if you were buying a product with a 16-week lead-time, the first four months of your term would be consumed by lead-time. If you had a one-year contract term from the date you signed the contract, you wouldn’t get delivery for four months, and you would have to stop ordering four months prior to the end of the term because deliveries after that would then extend beyond the term. If you need time to evaluate the Supplier’s performance prior to any extension of another term or before deciding to change Suppliers, make sure the initial term is long enough. If you have a Supplier with the 16-week lead-time and it would take four months to qualify a replacement, you would have only four months of actual performance before you were forced to make a decision.

Your term should take into account the time you need to negotiate a renewal with an eye on how long it would take to source from an alternative source if needed.  If it will take you six months to quality an alternative source, you need a term that is long enough so you can both conduct negotiations with the current Supplier and if your aren’t successful still have the six months needed to source from an alternate source, or you need to have the ability to make a last time buy to cover the interim period before you can bring the other Supplier up. If you have ways in which to manage competitiveness of the Supplier and are not obligated to make purchases, a longer term may make sense.

Suppliers will look at the length of the term from several perspectives. If they are making an investment to win the business, or are discounting substantially to win the business they will want a term that is long enough so they get a return on their investment or to protect them from competition. Supplier’s main concerns with the length of the term are either financial risk (e.g. how long do they have to offer the product at the price) or business strategy (e.g. how long are they required to continue to produce the product). The longer the term, the more the Supplier may look for ways to either be able to adjust pricing to cover their exposure for changing costs, or be able to end of life the Product if it no longer is consistent with their business strategy.

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