Cost Management Programs

Procurement has seen a number of changes and new programs that have come into vogue. Some started with a huge fanfare and ended quietly with relative degrees of success. Others have become more ingrained in what you do and how you do it. Virtually every one of these programs has a goal of reducing cost. They seek to either:

1.     Reduce certain costs;

2.     Eliminate different investments, which reduce the cost associated with those investments; or

3.     Reduce the resources and expense of managing the procurement of goods and             services.

Let’s look at each strictly from a cost perspective at what the cost goal was:

 JIT / Kanban, Pull Replenishment.  A pull replenishment, JIT or Kanban program is designed to reduce the inventory levels a Buyer must carry and push the cost of carrying and managing inventory back to the supplier. This reduces the Buyer’s investment in inventory and other potential inventory related costs such as space, risk of loss, obsolescence.                     

Supplier Certification. Supplier certification is a method by which Suppliers are evaluated to ensure they have the requisite capability and processes to consistently provide products of high quality. A goal of Supplier Certification is to eliminate the Buyer’s incoming inspection activities with those Certified Suppliers and the resultant cost.                                                                    

Six Sigma. A Six Sigma process is designed to reduce or eliminate defects that occur which in turn reduces the costs associated with those defects. The reduction of defects can be targeted to reduce the cost of manufacturing or other processes. For example, if the quality or a product can be substantially improved, it allows you to reduce the costs associated with poor quality such as carrying additional inventory, increased inspection, rework and scrap costs. Eliminating a defect that causes reliability problems further reduces field costs such as spare parts and repairs inventories, or field service calls.

Benchmarking: Benchmarking is the method by which you compare prices, processes against other Buyer’s with the goal of identifying where there may be opportunities to reduce prices or reduce the costs associated with the process. The cost goal of Benchmarking is to identify where savings to either parts prices or processes may be made to reduce cost.

EDI: Electronic Data Interchange is a method by which orders, changes, etc. are communicated instantaneously, and reducing the impact that delayed communications could have on inventories, cancellations, forecasting, and flexibility. Etc. The cost goal of EDI is to eliminate the cost and errors that can occur with manual ordering processes. It also reduces the time to react to orders, changes etc., where delays can mean additional inventory or liability.

Total Cost: The concept of “total cost” was to create an understanding that there are a number of factors, other than price, that effect the cost of a supplier relationship such as the cost of inventory, cost of quality, other performance related costs, and other costs of doing business with a specific supplier, supplier’s terms, supplier’s business process and requirements or performance. The cost goal of Total Cost is to make sourcing decisions based on the total cost, thereby reducing the total cost, or using those total cost factors to improve supplier performance or cost reductions to offset the incremental cost of doing business with that supplier.

Strategic Cost Management: In many companies the concept of Strategic Cost Management was a signal of their intent to move away from reliance on the competitive bid process as the primary method of selecting suppliers, to a negotiation process in which individual segments of the supplier’s cost are negotiated with the help of detailed costs estimates by cost engineers and consultants, competitive benchmarks, analytical formulas, etc. The cost goal of strategic cost management is to ensure that you purchase at a competitive cost with lesser impact from the marketplace and also facilitate early supplier involvement in programs where their expertise may further reduce the cost of the design or manufacture of the product.

Strategic Supplier Management, Alliances and Partnerships: While all these programs are designed to build a closer relationship with supplier so that thing like early supplier involvement may occur, most of these programs also recognize the fact that Power and Leverage changes as the situation changes which can impact you cost. If the Supplier has the power, you pay more. If you have the Power through competition, you will pay less. If you create strategic suppliers, alliance or partnerships, one of the cost goals is reduce the impact of changing leverage in favor of more consistent price formulas that are designed to provide the supplier with a reasonable profit, while consistently providing the Buyer with competitive cost. 

Credit Card Purchases: Credit Card purchase programs were designed to not so much to reduce the cost of the product as much as it was to reduce the purchasing and accounts payable infrastructure associated with procurement of low value items. While some cost improvements may occur through creation of limited product menus and limited suppliers, the real cost savings occurs through the elimination of the transactional activity associated with those low value orders and either the reduction of resources or the focus of those resources on higher value added work such as negotiating volume purchase discounts with the preferred suppliers.

Supplier Reduction Programs: Supplier Reduction Programs were designed to reduce the number of suppliers which the Buyer did business with to both eliminate all the costs associated in managing the supplier, but also to combine the volumes purchased with other suppliers to leverage better pricing on the higher volume. When supplier reduction programs are managed in a manner where the primary goal is to reduce the number of supplier and not reduce them to increase leverage, a Supplier Reduction Program can have a negative cost impact by reducing competition.        

TQM: TQM or Total Quality Management programs were focused on improving the quality of the products purchases. From a cost perspective, improving quality will reduce Buyer’s costs that were associated with problems with Supplier’s quality. Cost reductions can occur in the elimination of incoming inspection and its associated costs, reduction in inventory levels associated with quality levels, reduction or elimination of cost of quality which occur because of in failures in process (such as re-work costs) or failures which occur in the field (Spare parts and repairs inventories, field service calls, etc.).           

Early Supplier Involvement: The concept of early supplier involvement is to involve suppliers in the early stages of the design process to use their expertise. The cost goal of Early Supplier Involvement is to use the Supplier to help design a more cost effective product; use more cost effective materials; or help design the product for lower costs of manufacture, service, etc.

Outsourcing; While there are many reasons why a Company may decide to outsource, the reasons most frequently mentioned are: to focus investments on core competencies with higher returns on the investment; to avoid making new technology investment; improved efficiencies; greater flexibility and less risk from a manpower perspective; reduced costs because of the outsourced partner’s buying power; reduced labor costs from using operations in lower labor cost areas, fewer business risks. With the exception of focusing resources on core competencies that is designed to yield a higher return on investments, all the others are focused on reducing cost directly or the potential cost associated with certain risks.   

Vendor Managed Inventory:  Vendor Managed Inventory takes pull replenishment or JIT activities one step closer, with the Supplier actually providing the inventory directly to the Buyer’s site and managing the order / replacement based upon a combination of the Buyer’s forecasts and pulls from the on-site inventory. The cost goal in this is once again to eliminate inventory carrying costs and all costs associated with managing the inventory (space, utilities, insurances, damage, shrinkage, obsolescence, and shelf life obsolescence).

Supply Chain Management: The initial goal of supply chain management was to speed up the supply from suppliers to customer to make companies and their suppliers more responsive to the Customer’s demand. In doing supply chain management, the cost benefits were to reduce the level of inventory held at the different stocking locations, reduce the number of stocking locations, change product level ordering strategy or manufacturing strategies to focus on higher level assemblies to reduce the amount of movement of materials and subassemblies from location to location and their associated transportation costs. It was to select and implement strategies that optimized the supply chain’s speed and cost.  

Supplier Performance Scorecards and Measurements: The simple fact is that unless there is measurement, reviews, goals, and penalties or rewards associated with performance, Suppliers won’t make the efforts to improve, especially if they aren’t the ones bearing the cost. To drive change requires that they feel the same pain the Buyer feels and these types of programs are designed to manage continuous performance improvement to reduce the associated costs.

Total Cost of Ownership:  In Selling Outsourcing Services such as Contract Manufacturing, Suppliers try to sell on what they call the Total Cost of Ownership which usually includes: Quality; Delivery Performance; Access to Competitive Manufacturing Technologies; Support Services; Competitive Pricing; and Flexibility. From a cost perspective TCO only addresses a portion of the real total cost of ownership that would include not just the total cost associated with the purchase, but also the life cycle cost of the product. 

Supplier Qualification: The concept of supplier qualification is for the supplier to technically qualify a product according to pre-agreed parameters. From a cost perspective, Supplier Qualification reduces the amount of investment the Buyer needs to make in such qualifications.

E-Procurement: There are a number of goals of E-Procurement. From a cost perspective, one goal is to reduce the procurement infrastructure required to manage the transaction process which frees up resources from that low value added type of activity (such as order placement) and allows you to eliminate them or focus them on higher value added activities which will reduce cost. Instead of placing the PO’s the resources should be negotiating the contracts and discounts that will be used in E-Procurement. A secondary goal is to take advantages of the electronic marketplaces that have been created to identify new, lower cost sources of supply.

Covenants

A covenant is promise to engage in or refrain from a specified action.

When there is a covenant in a contract the party providing the covenant (covenantor) makes a promise to the party receiving the covenant (covenatee) that they will or won’t take some action in the future.
The most common types of covenants that exist in purchase contracts can be things like a Buyer making a covenant on the use of the purchases or the Supplier making a covenant not to compete. For example, if a Supplier is concerned with a Buyer potentially buying and reselling product directly to third parties without providing additional value added, the Supplier could request a covenant that the Buyer will only use its purchases for its own needs and will not resell the product. For example, if the Buyer make a significant investment in developing a product with the Supplier and wanted to protect that against competition from the Supplier or the Supplier working with a third party that would compete against the Buyer, the Buyer could ask for the Supplier to provide a covenant not to compete.

Any covenant should include specific parameters. For example in a covenant not to compete, it should define the markets, and the period of non-competition.  In situations where a covenant is important, as part of that covenant you need to establish what the appropriate remedy would be for breach. 

If you want the ability to force the Supplier to comply with the agreed covenant, as a remedy you would want to have the right under equity to injunctive relief so you could go to court to have the Court order compliance with the covenant.  If money damages is adequate, you would not need injunctive relief, but you would need to make sure that the damages you could recover are not restricted by the limitation of liability.  For example, if the majority of your damages would be lost sales and profits, you can’t have a limitation of liability that excludes recovery for damages associated with lost sales and lost profits.  

Duplicate Agreements

There are a number of times where it may be necessary to create a duplicate agreement.

For example:

• If you have an agreement with a Supplier and want to contract with a different Supplier legal entity.
• If you want to have a different Buyer entity contract with the Supplier.
• If you have a situation where the Buyer and Supplier have an agreement between the parent companies, but you want to purchases to be made between different Buyer and Supplier entities.
• Where your company wants to assign a portion of its business to a third party, but you still need to retain the existing agreement as you will still need to conduct business.
• Where the Supplier needs to assign a portion of their business to a new company and you need to do business with both the Supplier and the new company.
• Where a Supplier has divested, or spun off a business and you want to quickly put a new agreement in place with the new entity.

Why would you want to create duplicate agreements when you are only dealing with a Subsidiary of a Supplier?  One reason is if you allow that Subsidiary to operate off your agreement, you could be responsible for the actions of that subsidiary and the Subsidiary’s actions could potentially be cause to terminate your agreement. While this may be of lesser concern when you are dealing with wholly owned subsidiaries, many times companies may only have controlling interest in a subsidiary and would not want to be liable for the Subsidiaries actions. Another reason is maintaining the activities separate is good to separate the companies for tax purposes.

Duplicate agreements are simple documents that use incorporation by reference. You can incorporate by reference all the terms of the existing agreement that you want to duplicate and then in the body of that new agreement either add or remove terms from that agreement to make it applicable to the current situation. For example you could make changes to comply with local law or trade practice, and you could include terms that would be limited to only those Products or Services that are required under that new agreement. Once executed, each agreement is independent and would stand on their own and actions on the agreement that was incorporated will not affect the new agreement and vice versa. As it is a point in time incorporation, bringing in only the terms and conditions that were in effect when the duplicate agreement was made, it will not incorporate any changes to the original agreement unless the parties to the duplicate agreement agree to include those future changes.

The biggest risk in duplicating agreements is you may be also duplicating commitments that will stand on their own. For example, if the original agreement committed  a firm volume be purchased, if you didn’t exclude that within the body of the duplicate agreement you would now have the same commitment and because they are separate agreements one doesn’t count against the other.  A Supplier’s biggest concern with duplicating agreements frequently involves their potential liability. For example, if the original agreement had a $US 25,000,000 cap on a specific type of liability, by agreeing to the duplicate agreement they would now have the same cap in both agreements thereby doubling their potential exposure.

Duplicate agreements can be written against any type of agreements, When dealing with Subsidiaries of Suppliers the Supplier entity that you will be dealing with either needs to be financially qualified on their own or you may need a parent or company guarantee. As an independent agreement, it will remain in effect on its own, even if the other agreement is terminated.

Incorporation by reference allows you to incorporate almost any document whether its existing or may have expired, the key is you need to be able to prove the terms of that document so both parties should have copies of any incorporated document.

One additional caution in creating duplicate agreements.

If you will be creating a duplicate of multiple agreements such as a Master Agreement and a separate Statement of Work, you should keep them separate by either creating a duplicate of each individual agreement as a separate agreement, or if you include them into a single document you want that document to establish separate agreements for each document you are creating a duplicate of.  For example if you have an Agreement that is evergreen as to its term and a Statement of Work that had a two year term, if you merge both documents into one agreement without making them separate agreements the resulting agreement will be controlled by the order of precedence in the terms. So in the example, if the Statement of work had precedence over the Agreement, when the SOW that had a two year term  expires, the Agreement would also expire on the same date. That is because you created

one agreement that had conflicting terms, and the precedence was for the terms that were listed in the SOW which made the term of that agreement 2 years.  If you created separate duplicate agreements, the duplicate Agreement would remain in effect for future use. Where this is even more important is if you were also to make a duplicate of a Confidentiality Agreement. You always want that to be separate.  

Damages

There are a number of potential types of damages that may be claimed:

·      Direct damages: Actual losses that are an immediate, natural and foreseeable result of the wrongful act. . An example of a direct damage would be the cost of “cover” which is the excess cost of re-procuring the item from another Supplier.

·      General damages: Includes direct damages and damages for losses whose monetary value would be difficult to assign.

·      Consequential or Special damages: indirect loss or injury.  Losses sustained not as a natural result of the injury but because of the circumstances, e.g. damages relating to the business that are easily calculable in monetary terms.  If the damages were reasonably foreseeable at the time of contract that the injury would probably result if the contract were broken. Consequential damages may include lost profits and other indirect injuries caused by the breach of the contract provided the such damages were foreseeable and can be determined with certainty

·      Special damages are damages that are peculiar to the situation or circumstance. For example under international property law a court may order treble damages as a special damage to prevent future occurrences

·      Incidental damages: Losses incurred in handing and caring for goods, reasonable expenses for cover, all other reasonable damages from the breach that don’t fit any other category. Incidental damages are paid to reimburse the cost of mitigating the damages sustained.

·      Expectation damages: Damages that are designed to put the injured party in the position they would have been in had the contract been completed (such as making certain profits).

·      Liquidated damages: An amount agreed upon by the parties to the contract as adequately compensating for the loss. Liquidated damages will be upheld if they are reasonable.

·      Punitive or Exemplary damages: damages for serious or malicious wrongdoing that are intended to punish or deter the party from doing it again or deter others from behaving similarly.

Limitation of liability provisions will traditionally limit the types of damages that may be claimed. For example the following limitation of liability would limit damages to only direct damages.

Limitation of Liability between Supplier and Buyer

In no event will either party be liable to the other for any lost revenues, lost profits, incidental, indirect, consequential, special or punitive damages.

If there were individual commitments or section of the agreement where direct damages would not provide an adequate remedy, those commitments or sections would need to be carved out of the limitation of liability so other types of damages could be collected.

For example:

This mutual Limitation of Liability does not limit the obligations and liability of Supplier provided in the Section entitled Supplier Liability for Third Party Claims or the Subsection entitled Epidemic Defects.

For a breach of the named clauses, the Indemnifications and Epidemic Defects the limitation to only direct damages would not apply.  There are several reasons why you may want to exclude clauses such as these from the limitation to only direct damages.

First, the indemnifications involve third party claims and are not something that is damage directly between the Buyer and the Supplier. For Intellectual Property infringement, if a court found the infringement to be willful they could award treble (3X) damages as a penalty against that behavior.  A penalty is considered a special damage. For something like epidemic defects the Buyer wants to be able to recover the incidental and consequential costs associated with the defect such as field repair costs, re-work costs. Those cost would be excluded if all you could recover were direct damages,

With the exception of liquidated damages, there is a requirement of certainty with respect to damages. It’s not what you anticipate it’s what you actually sustain. For liquidated damaged there is not a requirement of certainty, the pre-agreed damages are only required to be reasonable.

Dates, Days, Numbers

Dates

In writing dates, the recommended approach is to spell out the date – February 27. 2010 and not use abbreviations such as 2/27/10 or 2.27.10. The reason for this is that different countries have different date numbering conventions. The US numbering convention is month/date/year. Other countries have numbering conventions of day/month/year. So if for example we have 02/07/12, in the US it means February 7, 2012, but in other countries with a different date numbering convention it could mean the 2nd of July 2012..

Defining Days

There is a substantial difference in time between work days and calendar days so in the Agreement you need to define whether the days are work or calendar. Work days generally include Monday through Friday, excluding recognized holidays. Calendar days include all days of the week, including weekends, and possibly recognized holidays. The difference between the two can be substantial.

For example:

90 calendar days is 90 days

90 business days would be 18 weeks or 126 Calendar Days or longer if there were any holidays during the period. 

As “days” will frequently be used in many part of the contract you should create a definition of days.

“Day’ or Days”. Unless expressly stated to the contrary, all references to “Day” or “Days” shall mean calendar days.

If you will use the term “Business Days” you need to define whether the Business days are based upon your business days or the Supplier’s business days as the two may be different especially when dealing internationally.  I can remember GCM’s pulling their hair out because they didn’t make it clear which applied and in dealing with a Japanese Supplier they weren’t getting deliveries because it was “Golden Week” and the plants were shut down.

If you fail to specify what days mean it leaves it open for a Supplier to want to interpret a particular item in their favor by applying business days rather than calendar days (giving them more time to complete the task).  When I’ve encountered that, a tact I’ve taken is to say that since it wasn’t defined we need to manage things consistently. We can choose to operate either as all calendar days or all business days, but it’s not both unless it was specifically specified.  When you offer that the Supplier should realize that if everything measured as Business days the comment to pay them in sixty (60) days would mean at least 84 or more business days.  Faced with that, they’ll most likely have a different interpretation of days.

Dates instead or Words

Words alone can cause confusion. Does bi-weekly mean twice a week or every other week?  When you need something be specific.

“Review meetings shall commence on Tuesday May 10, 2012 and shall be held every fourteen days thereafter. In the event of a holiday occurring on a Tuesday, the review meeting will be held the next Buyer’s business day”.

   

If you need a report each month tell the Supplier when it must be provided. The report shall be provided no later than the 15^th of the following month. That way if the 15^th is a holiday for the Supplier, they need to provide the report before the 15th.

Instead of:

“Each quarterly price reduction will take effect Day 10 of a new quarter of Quarter beginning with the start of the first full quarter

You might use:

“Quarterly price reductions shall commence on July 10, 2007 and shall be applied each January10^th, April 10^th , July 10, and October 10^th of the term.

(The difference is in the first day 10 could be measured as either business or calendar days whereas in the second makes it a specific date.

 

Numbers

When a number is used in the body of the Agreement, it is recommended that you spell out the number both alphabetically and numerically. This is to eliminate any confusion and in the event of a problem the written word will have priority. This is not recommended for price lists that contain prices for many part numbers where just listing the number numerically is used. Written numbers would not be capitalized as they are not a defined term. Except for multiple of ten (twenty, thirty, forty, etc.) for numbers between 21 and 99 you write numbers hyphenated.  E.g. forth-six.

Example:

The non-recurring charges shall be one thousand dollars (US$ 1,000.00).

Supplier shall provide the replacement part within five (5) calendar days.
The Price shall be forty-six dollars (US$46.00).

 

Currency

There is something like twenty-three countries that use the term dollar for their unit of currency. Some are small countries; others can be significant trading partners like the United States, Canada, Hong Kong, Taiwan, and Australia. To avoid confusion on currency, spell out the specific currency you are using (ten thousand U.S. dollars (US$10,000.00) where used or through a clause or definition (e.g. ”Dollars” shall mean U.S. Dollars).

Defined Terms

When terms used in an Agreement have a specific definition/meaning, they are usually defined either in a Definitions section of the Agreement or, they may be defined in the Agreement by adding language that makes it a defined term.

Example:  The XYZ Machine (hereafter referred to as “Product”).  So every time you used the work Product in the agreement it would mean the XYZ Machine.

The first letter of Defined terms is always capitalized.  In drafting, reviewing and negotiating Agreements you need to check each time a defined word is used throughout the Agreement and any associated documents to ensure it is used properly as a defined term.  If it should not be used as a defined term, the first letter must be lower case (“product”).   This is important because many terms may have multiple meanings such as material, and the use of the defined term will determine which meaning applies. In reviewing your Agreement, also ensure that the defined terms are used consistently throughout.

For example:

“Product” may be a defined term used in the Agreement.   The definition of Product could be  “those products listed in the Statement of Work” or those products listed in Attachment A.  Many of your terms may refer to Product. Many warranties apply to Product. If you purchase something that is not listed in document where the applicable products are listed, you would be purchasing a product, not a Product. That is because the term Product only applies to those items listed on the applicable document. To have coverage of the Agreement, the products you buy need to be added to the applicable document, putting them into the category of Products (the defined term).  You can do that by either amending the applicable document to add it or by mutually agree upon an alternative process by which other items may be added to the list of Products.   

Many times in a negotiation the other party may want to make changes to the definition of a specific defined term. To understand whether to accept the proposed change you need to identify the potential impact.  To determine the impact you need to search for all places within all the documents that make up your Agreement to see where the defined term is used and then see whether the proposed change negatively impacts that commitment.  With Word Processing tools it’s easy to search for each time the defined term has been used. For example using Microsoft word under the Edit pull down menu you would select Find and as defined terms must be capitalized you click on “Match Case” and simply type in the Defined term add it will bring you to every time its used.

For example assume that the Supplier made the following proposed changes to the definition of Personnel.

"Personnel” means  agents, employees or subcontractors  engaged or appointed by Buyer or Supplier.

To understand the impact on the the change in the defined terms that deleted “agents” and “Subcontractors” from the definition, you need to search the agreement for the where the defined term “Personnel” was used. You discover that it is used in two places. It’s used in the General Indemnity, and with this change the Supplier would not be required to indemnify the Buyer against negligent or intentional acts of either the Supplier’s agents or Subcontractors leaving the Buyer exposed.  You find that it was also used in the Section on Supplier Personnel, and the impact of the change would be that the Supplier would not be responsible for managing contract requirements for Supplier personnel with their agents of Subcontractors. Since it would substantially change the commitments in both these areas and increases the Buyer’s potential liability you would reject the proposed change.

There are two ways that a Supplier can change a commitment in a Section. The obvious one is when they modify the section itself. The more subtle way is by changes to Defined terms that are used in the Section. To make sure you get what you need you have to manage both. 

Delivery

In negotiating delivery terms the important thing to understand is the cost impact of the specific delivery term. Many Suppliers’ sales terms are FOB or Ex Works their factory. That means you need to pay all the costs to get it to the point where you need it and the sum of the price and those costs is called the landed cost. The landed cost includes as a minimum:

·       The Price of the item.

·       The actual cost of shipping the item from the origin point to the destination.

·       The cost of insurance (as risk of loss passes at their factory on these terms).

·       The cost of any duties, customs brokerage charges and other costs applicable.

·       The cost of money (if payment is made at time of shipment as in letter of credits).

·       It may also include other incidental costs incurred such as additional costs of packing and packaging required to protect the shipment.

In addition there is the risk of loss or damage in transit

Every time goods are moved there are risks in making the shipment, and there are costs associated with the shipments. The risks are:

·       The shipment may be lost (such as a package being lost in the distribution system, or the entire cargo is lost because of a disaster such as a plane crashing or ship sinking),

·       The shipment may be stolen, or

·       The shipment may be damaged (by either physical damage, or by failure to properly package, pack, or be damaged by the environment).

·       The shipment may be prevented from being exported or imported because of failure to get the proper import or export licenses, or improper documentation preventing clearance.

The party that bears the risk of loss, damage, or theft, and the party that is responsible for export and import and all the costs and risks associate with those is determined by two things.

1. The specific delivery term that is agreed
2. The stated delivery point.

For example,  Ex-Works Suppliers Dock in  Hong Kong.  Means the delivery point is Supplier’s dock in Hong Kong and the delivery term is Ex-works.  If you failed to state the delivery point, the Supplier could ship the product from any location and that could impact your landed cost.

A definition of delivery terms can be found in INCOTERMS that is published by the International Chamber of Commerce. Delivery terms range from Delivered, Duty Paid (DDP) where the Supplier is responsible for all risks and costs to the Buyer’s location, to Ex-Works (EXW) where the Buyer is responsible for all risks and costs from Seller’s location.

The most common terms and where the risk of loss transfers are:

Delivery term	Risk of loss point
DDP	When goods are at the disposal of Buyer or designee, at the delivery point, on the method of transport used by Supplier. (e.g. On board Supplier’s carrier at Buyer’s loading dock)
DDU	When goods are at the disposal of Buyer or designee, at the delivery point on the method of transport used by Supplier. (e.g. On Board the Supplier’s carrier at Buyer’s loading dock)
DEQ	When goods are at the disposal of Buyer or designee, at the delivery point on the quay or wharf designated.
DES	When goods are at the disposal of Buyer or designee, at the delivery point on the vessel at the designated delivery point. (e.g. Delivered to Federal Express, Narita Airport, Tokyo)
DAF	When goods are at the disposal of the Buyer at the delivery point at the frontier. (E.g. Delivered to Port of San Francisco, prior to customs clearance)
CIP	When goods are at the disposal of the Buyer at the delivery point, however Supplier is responsible to procure transit insurance (Delivery is as a location usually different from Supplier’s facility)
CPT	When goods are delivered to the Supplier’s selected carrier at the agreed delivery point (which is usually different than Supplier’s facility).
CIF	When goods are delivered on the carrier at port of shipment, however Supplier is responsible to procure insurance and pay for freight. (on-board the vessel or aircraft)
CFR	When goods are delivered to the carrier and have passed the ships rails (on-board the vessel or aircraft)
FOB	When Ggods are delivered on board the carrier designated by Buyer (e.g. Delivered on the carrier at Suppliers loading dock)
FAS	When goods are placed along side the carrier designated by Buyer (e.g. delivered to Federal Express, at Kennedy Airport, New York)
FCA	When goods are delivered to the Buyer or person designated by the Buyer at the place designated by the Buyer (e.g. Delivered to Buyer’s freight forwarder at their location)
EXW	When goods are at the disposal of the Buyer at the delivery point (e.g. At the Suppliers loading dock).

In every purchase you need to establish both the delivery term and deliver point such as:

“DDP, Buyer’s facility located at: 5 Pine Street, Anytown, NY 12555”.  Both the delivery term and the delivery point are negotiable and some of the factors the Buyer should consider in making this decision are:

·       Is there substantial risk of loss or damage in transit?

o   If there is, who could manage it more efficiently and cost effectively?

·       Which party has the most cost effective distribution network?

o   Are there individual activities that the Seller may be able to manage more cost effectively, such as inland transport prior to shipment?

·       Does the Buyer have the presence in the exporting country to effectively manage certain responsibilities?

·       Will there be any financial advantages or impact to the depending on the location of transfer of title?

o   Savings in duties paid because of the difference in paying duties based on seller’s internal transfer price versus Buyer’s purchase price.

o   Tax advantages to the Supplier because where they earn their profits.

The delivery term also defines which party has the responsibility for preparing export documents, exporting, preparing import documents, and importing the goods. A list of responsibilities by delivery term is listed below.

ACTIVITY

DDP

DDU

DEQ

DE S

DAF

CIP

C P T

C I F

C F R

F O B

F A S

F C A

E XW

Load At Seller Premises

S

S

S

S

S

S

S

S

S

S

S

S

B

Domestic Cartage

S

S

S

S

S

S

S

S

S

S

S

B

B

Contract For Carriage & Dispatch

S

S

S

S

S

S

S

S

S

S

S

S

B

Export Documentation

S

S

S

S

S

S

S

S

S

S

B

S

B

Customs Clearance for Export Country

S

S

S

S

S

S

D

S

S

S

B

S

B

Export Charges

S

S

S

S

S

S

D

S

S

S

B

S

B

Loading At Carrier’s Terminal

S

S

S

S

S

S

D

S

S

S

B

B

B

Transport. Equip. & Accessories

S

S

S

S

S

S

D

S

S

B

B

B

B

Insurance (Transit)

S

S

S

S

B

S

B

S

B

B

B

B

B

International Freight

S

S

S

S

B

B

D

S

S

B

B

B

B

Unloading At Terminal Of Import

S

S

S

B

B

B

B

B

S

B

B

B

B

Import Documentation

S

B

S

B

B

B

B

B

B

B

B

B

B

Customs Clearance

S

B

S

B

B

B

B

B

B

B

B

B

B

Duties And Other Import Charges

S

B

S

B

B

B

B

B

B

B

B

B

B

Receiving Country Cartage

S

S

B

B

B

B

B

B

B

B

B

B

B

Unloading At Buyer Premises

B

B

B

B

B

B

B

B

B

B

B

B

B

S = SELLER PAYS

B= BUYER PAYS

D= DEPENDENT UPON NAMED PLACE OF DESTINATION

Assume you want to buy a product from a Supplier in Japan for delivery to your location in New York. If you agreed that the purchase would be ex-works their dock in Japan, you have agreed to assume the following costs:

o   The cost to Load the product on a local carrier at Seller Premises

o   The cost of the domestic carrier

o   The cost of preparing export documentation

o   The cost of customs clearance for export

o   The cost of any export charges

o   The cost of loading the product at the carrier’s terminal

o   The cost of any unique transportation equipment and accessories required for the move

o   The cost transit insurance

o   The cost of the international freight carrier’s charges

o   The cost of unloading at terminal of import

o   The cost of preparing necessary import documentation

o   The cost of managing customs clearance

o   The cost of any duties and other import charges

o   The cost of the carrier at the receiving country

o   The cost of unloading the shipment at Buyer’s premises

o   The cost of any warehousing or demurrage charges incurred in route because of delays in things like clearing customs, or having the carrier pick up the goods as scheduled.

The delivery term also define where the risk of loss also passes. Once the risk of loss passes to the Buyer, the Buyer assumes the cost of any loss or damage, subject to any possible insurance reimbursement provided for in the delivery term. Any term that includes an “I”  (such as CIP or CIF) has the Supplier paying for the cost of insurance to the defined delivery point.

If the delivery term has the Buyer assuming any risk of loss or damage in transit, the Buyer may want to manage this risk by:

·       Including specific packaging and packing requirements as part of the purchase specification. Most companies packaging and packing specifications are designed to reduce the possibility of damage in a cost effective manner.

·       If there are specific environmental risks (such as temperature or humidity), Buyer may include in their specifications that all shipping, and storage be in accordance with specified environment standards.

·       The Buyer will usually want to specify the Carrier to avoid shipping with high-risk carriers.

·       The Buyer may want to specify shipping lanes to be used, to avoid shipment through high-risk ports or other areas where there is a history of substantial damage or pilferage. 

If one of the standard delivery terms doesn’t exactly meet your needs, you can always include the closest term to what you need, and then amend that to meet your requirements.

With all of the standard terms the responsibility to unload the product from the import country’s carrier at the Buyer’s delivery point is Buyer’s responsibility. If you were buying something that you didn’t have the ability to unload or if you wanted the item to be installed in a specific spot such as a large piece of capital equipment, you would need to add those requirements to the delivery term. For example, if you were buying a piece of capital equipment that you wanted to be installed by the Supplier, the delivery term could be “DDP, Buyer’s facility located at: 5 Pine Street, Anytown, NY 12555 and Supplier shall be responsible and bear all costs of unloading the Product from the Carrier at destination and shall manage and pay for all rigging and installation costs to have the product installed in the location defined in the attached drawing”. You could also buy the Product Ex-works and still add responsibilities at destination with a delivery term like: “Ex-Works, Supplier’s facility in Tokyo, Japan, however Supplier shall be responsible to coordinate delivery to Buyer’s facility and shall be responsible and bear all costs associated with unloading, rigging and installation of the Product at the place defined in the attached drawing.”

There are several factors that will impact what delivery terms a Supplier may be willing to agree upon, the biggest of which is taxes. Delivery terms define where the sale is occurring based upon where title to the product transfers. Where it is sold is also where profit from that sale is made and where it would be subject to being taxed. For example, a Supplier that is based in a High Tax location may want to have the sales occur through their local Subsidiary because the tax rate in the Subsidiary’s location is less as party of a tax management strategy. A company may not want to sell a product delivered in a Customer’s country as then that would be a local sale, and to do the local sale the company would need to be registered to do business in that country and would also be subject to local laws and taxes. For example a Supplier may be unwilling to have a vendor managed inventory held at a specific location as that constitutes delivery in the local location and all the same issues arise.

Free trade zones are also something you should understand when dealing with delivery.

Many countries allow free trade zones that are nothing more than a controlled area of warehouses that are located either after customs at the port of export or before customs at the port of import prior to customs clearance. Transactions that occur in free trade zones are considered to be international sales where the Seller does not need to be registered to do business in that country, and is not subject to the laws and taxes of that country. So a Supplier could sell you a product delivered to that free trade zone without a tax impact.  

Another thing to consider when negotiating the delivery term is what impact that has on other clauses that are dependent upon delivery such as payment or warranty. For example, your payment terms may be 30 days after delivery; your acceptance rights may be 30 days from delivery; and your warranty may be 24 months from the date of delivery. If you were purchasing a bulky from a Supplier in Taiwan the most economical mode of shipment is ocean freight. Then assume that it takes 20 days for the shipment to arrive in the West Coast port, 2-3 days in customs, and another 5 days by motor carriers to get it to your site. If you purchase FOB Origin or Ex-works, all those time frames commence when you take deliver at the Supplier’s site. The impact of this will be that you will receive the material approximately 27 days after you took delivery under the ex-works term. This means that from an acceptance or rejection of the goods standpoint you have all of 3 days to inspect or reject the material and if there is any further delay in transit or your inspection, your right of acceptance may have lapsed. If that happens it means your only rights for defective product are under whatever warranties you have. You have 3 days after receiving the material to make payment, and if there is any delay in transit, you could be making payment prior to even receiving the goods at your site. As to warranty, since the warranty period commenced when you took delivery, all the in-transit time has effectively reduced the warranty period and if it took you another 30 days before delivery to the Customer, your effective warranty coverage for only 22 months, not 24. 

If you will be buying products where you take delivery at any place other than your dock, you need to take the expected in-transit time into account when you negotiate other terms that are based off when the Buyer takes delivery. For example if what you really want is a 24 month warranty with the Customer, and you knew the transit and supply chain time before delivery to a customer would never be more than two months, you could try to negotiate a warranty that’s 26 months from the date of delivery.

The last thing to consider in determining the right delivery term is the import duty.  If the Buyer is importing the Product, the Buyer will be paying duty based upon the purchase price. If a Supplier Subsidiary is importing the Product, the Supplier will be paying duty based upon the “transfer price” which is the price at which the Subsidiary purchases the product from the Parent company for resale.  If you were purchasing something for delivery in a location that had a high duty rate it may be better to have the Supplier import it, and pay the duty on the transfer price rather that you import it and pay the duty on the higher Purchase Price. The key is if you will purchase a large volume of product that is moved internationally you need to work with your suppliers to determine the delivery term and delivery point that works best for both parties.