Monday, April 11, 2011

Negotiating Cancellation And Rescheduling

Products and Equipment

How do most Suppliers approach cancellation and rescheduling? In most negotiations you are dealing with sales people who are goaled, measured and rewarded on sales. Since their focus on getting sales, they will have terms that force you to buy the product whether you need it or not. They will try to force you to take the product within the sales period so they get sales credit within the period. If they offer the ability to cancel or reschedule orders, they may make the charges high enough so that it doesn't make sense to cancel or reschedule. Their goal is to make the sale!

What happens if you are forced to take product when you don't need it? The first thing is it transfers the inventory carrying cost to you. The inventory carrying cost to the Buyer is much higher as the value is for the finished product or service and not the value of any work in process (WIP). For standard products, it also eliminates the possibility of mitigating the cost if another customer could buy and use the product, so it adds to the cost of the relationship.

In negotiating cancellation or rescheduling of Products the first thing to consider is whether the Product is standard or custom. If it is standard, and the Supplier can sell it to another customer, the primary expense to them would be the cost of holding it in inventory until it can be sold. For custom products the thing to understand is the point or step in the process at which the product becomes custom.  Not all products start out in production as custom and many only become custom in later stages of production. If it doesn’t become custom until later stages, and you are able to notify the Supplier of your change in demand before it becomes custom, the rationale is they should be able to use that to fulfill other customer needs.

For custom products, if the reschedule is done before the product becomes custom, the impact is the same as a standard product (as they can use the work in process to fulfill other customer orders. If the reschedule is done after the product becomes custom, the impact is that the Supplier has to wait under your demand can consume it which creates possibly longer inventory carrying costs. If the cancellation is done after it becomes custom, the WIP at that point becomes scrap, as there would be no other customers so the cost to cancel may be high.

In negotiations, the goal is to establish an equitable sharing of the risk that is generated by changing end customer demand. For cancellations, the approach should be to make them whole for the investment they have made in the work up to the date of the cancellation. They lose what they would have made if completed. You lose by having to pay the cost of the cancellation. The risk of the changes in demand is shared. For reschedules, the approach should be to cover their costs of holding the inventory. They get compensated for their extra cost in holding the inventory. You get the savings by having the inventory held at a lower level until you can consume it or they can mitigate the cost by selling it to meet other customer demand. The risk of the reschedules is shared.

How do you sell a sharing of the risk? In manufacturing Buyer's are really functioning as re-sellers of the Supplier's products. Buyers are their sales arm. You provide them with substantial volumes of sales. As a seller, they know that the market is subject to changes in demand. If they were selling it directly they would be taking all of the risk. In selling it though you, you are reducing the risk to them, because you are sharing part of the risk. To force unneeded purchases on the Buyer is a win-lose. It forces the Buyer to purchase and pay for unneeded materials and adds to the total cost of doing business with the Supplier making them less competitive.

How do you negotiate the cancellation charges? Break the product down into tasks or phases. Negotiate a percentage of the total cost assignable to that task or phase. Agree to pay the cancellation charges based on the point at which the cancellation occurred within the tasks.

An example
For an ASIC chip there will be 3 major segments: Production, Bond Assembly, and Test and characterization. Production may consist of 25 mask layers, all of approximately the same cost. If you cancel in production, you should pay based on the layer you are at and the fee would be (x /25 of the production cost. The more you can refine it, the better you will be.

Suppliers may try to negotiate for payment for work not performed, as they can’t backfill other production to offset your changes. While this may clearly be a cost for them, you should try to avoid any agreement to pay for such costs. If you as the Buyer were to pay for all those costs, it wouldn’t represent a sharing of the risk of demand. You also won’t know enough about their operation and process to know that they really aren’t able to backfill with work.

If you are purchasing products for internal use, the argument about sharing the risk for change in customer demand doesn’t work. Since you are the sole Customer, you should be able to manage and control your demand and if you have changes, the Supplier will expect that if there is a cost associated with the change, you should bear the cost and they will want to make cancellations painful and costly to make sure you don’t jerk them around. If you do a substantial amount of business with the Supplier, you should use that as leverage to get reasonable treatment on any cancellation costs.

The lead-time for every product should be the sum of all the tasks involved in producing the product. These tasks involve the queuing for production, the actual production tasks, the time for quality checks, any follow on production tasks such as packaging; the final test of the product, and packing the product for shipment.

For example:
A semiconductor may require:
            7 -10 days for order / production queue.
          26 - 30 days for production (1 day per layer for 26 layers of production)
            5 days for in-transit to the bond assembly and test facility
            3 days for production queue.
            3 days for bond assembly
           14 days for characterization and test.
             2 days for packing,
In negotiating lead-time, the best approach is to break the lead-time down into individual tasks that make up the lead-time.
Ÿ  Negotiate the reasonableness of each task and
Ÿ  How the Supplier may be able to improve upon each time.

In negotiating rescheduling or cancellation, the key determining factors are:
Ÿ  Is the product a custom product?
Ÿ  If it is custom, at what point during the process does the product become custom to you.

For Supplier products that are “standard”, the impact of a reschedule or cancellation is minimal. If you cancel the order and don’t buy the product, someone else will, so the only real impact to the Supplier is the lost sale and the cost of carrying inventory for some limited period until another customer purchases it or until you purchase it.

For products that are custom, the most important factor is at what point in the process does the product become custom. Sometimes what makes a product “Custom” could be something as simple as the requirement that it contain a label denoting it as the Buyer’s product. For that, the product is really a standard product up until the point at which the label has been applied.

The important thing to remember is that in negotiating with a Supplier, the individuals that you are negotiating with are sales people. Since sales people are measured and rewarded based on sales, their goal in structuring their terms is make sure that the sale occurs. They can do that by making orders non-cancelable or make the cost of cancellation so high that it effectively forces you to force make the purchase. It’s fairly common to see proposed rescheduling terms from Suppliers that will allow you to reschedule, but in the end they force you to take product within a limited period of time. The more blatant ones require the product be delivered before the end of a quarter. This is simply so that salesperson gets credit for those sales and the company gets the revenue at the Buyer’s expense by forcing them to either take product they don’t need or forcing the Buyer to take product well before it’s needed based upon demand.

As a Buyer, your goal is to get as much flexibility as possible to respond to the ever-changing demand. From a strict competitiveness perspective, it’s always less expensive for the Supplier to be carrying the product in an unfinished state than for the Buyer to be carrying finished goods inventory. The inventory carrying cost is probably the same between the Supplier and the Buyer, but the difference is that the Supplier is paying for it on raw material or sub-assembly level, whereas the Buyer would be paying for it at the completed product level with all manufacturing value added, overhead and profit built in.

Negotiation Cancellation or Rescheduling of Services

It’s best to prepare for potential cancellation in your agreement where the formula or methodology for cancellation would be established. To do that, break the service down into individual tasks or phases. Then negotiate a percentage of the price assignable to each task or phase. For cancellations that occur during a phase, agree to pay a pro-rata amount of the value of the work for that task or phase that has been completed. The cancellation would then pay the Supplier for the value of all work completed based on what was agreed for those tasks or phases and the pro-rata amount for uncompleted within the current task or phase. 

Suppliers biggest concern with the cancellation of services will be primarily their fixed costs and how long it will take them to back fill the work with other work. Most services have a high labor content as part of their cost, so whether this is a real concern or not would be dependent upon whether they are employees or contractors performing the work.  For contractors you may need to pay actual costs to cancel their contracts. For employees, most of the time Suppliers can redeploy them within a matter of weeks especially if they operate with a mix of contractors and employees, as they can reassign employees to work those contractors performed and terminate the contractors.

The rescheduling deliver of services really depends upon the type of service being performed. Some services could be rescheduled with minor impact if the labor being used can be transferred to other activities. The real potential impact can be to the quality and
Performance after the service is resumed.  There is a significant difference between simply pushing something out a week or two versus suspending the work and wanting the right to have it resumed at a later date.  In suspending the work, personnel that were key to an activity could be assigned to other activities or simply not available.  If you have new personnel assigned to complete the work, there will always be a learning curve that will occur.  Changes in the schedule also impact the potential cost. For example, if you had work being done by a Contractor or Supplier that is unionized, a change in schedule could mean work is being done under a different labor contract with different rates and benefits.  If you want the right to suspend the work, as a minimum you would want it to be done with equitable adjustments to the schedule and with actual and reasonable adjustments to the price based upon actual changes in the underlying costs.

Suppliers don’t like cancellations, reschedules or suspension of the work, but things change and it’s the nature of business to try to respond to those changes in what is the most cost effective manner.  Trying to force you to buy something you don’t need or may not use, or finish something you don’t need because circumstances have changed may be good for their short term profit, but it won’t help build a long term relationship or help win future business.

1 comment:

  1. Hey i found the article very relevant.
    Being a student in supply chain i worked on the project of rescheduling and cancellation of supplies.
    The company that i did project in, has lot of custom supplies. The points made by u totally fit the scenario here as well.i made a reporting format & structure which would specify the inventory value under different reasons identified by me, for which cancellation action is difficult or could not be taken. this value is based on erp oracle output.The out come would be the first step towards root cause analysis of cancellation, customizing erp as per our needs i.e. defining cancellation policy for parts so that system doesn't throw cancel messages for the same, and acting upon other 8-10 reasons.
    ultimately optimizing raw mat inventory.
    Welcome your views on the same.
    Thanks for sharing this article. Indeed very useful.