Wednesday, February 9, 2011
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.
Vendor managed inventory or VMI programs are where the Supplier stocks product at certain agreed locations for the Buyer to pull the products when needed for their use.
Standard Buyer purchase templates usually need to be modified to implement VMI programs:
- Instead of ordering, the Buyer Provides forecasts.
- Instead of having delivery at the Supplier’s dock, delivery occurs when the product is pulled from the Hub.
- Instead of the inventory needed for production being held by the Buyer, it’s held by the Supplier.
- The Supplier’s ability to get paid is based not when it left its dock, but when it was actually pulled.
- The warranty period for the product that traditionally would be measured from when the Supplier ships it, needs to be measured differently based on when it was pulled or the lag time it will spend in transit and in the Hub needs to be built into the warranty.
- Because the Supplier is responsible to get it to the Hub, all shipping costs and risk of loss transfer to the Supplier so the Suppliers costs are impacted.
- If a third party manages the Hub, additional issues of insurance and risk of loss at the Hub come into play.
Since the Buyer isn’t actually purchasing the product until the pull, Suppliers also are concerned with
- Liability for custom product in the event of a termination of the program
- Obsolescence of a product
- The impact major reductions in volumes of consumption may have on the inventory levels
- The accuracy of Buyer’s forecasts and the cost of holding inventory that isn't consumed.
- Their ability and costs to do re-balancing of inventory for standard products (re-deploy it for other customer use).
- Buyer’s liability when pulls simply do not happen as forecasted.
Most VMI negotiations will focus on these issues and the extent and nature of the product profile (Items held, quantity).
In negotiating warranty redemption provisions, just as Buyer’s are concerned about the Supplier’s quality checks prior to shipping parts, Suppliers are concerned that Buyers have a similar quality process in managing returns to screen out items that aren’t defective items. Since many Suppliers are concerned about this they may want samples of the defects to be provided so they can verify the defect prior to issuing a return material authorization to return a larger quantity. Supplier’s may also want to negotiate in no-defect found or no-problem found charges for those situations where the Buyer returns good Product to cover their costs of checking inspecting and testing those returns. Suppliers may also want for the parties to split the cost of the returns with the Buyer paying for the return to the Supplier and the Supplier paying for the return back to the Buyer.
For the Buyer, the primary concern in negotiating warranty redemption is the speed in which the repair or replacement will be performed. The speed in providing a repair or replacing an item will impact how long you may not have the product or service available for use. If you maintain an inventory of items, the time it takes to get a repaired or replaced item impacts the inventory levels that you may need to carry.
Issues like No-Problem found requests can easily be dealt with by offering the Supplier to agree to pay that, if they pay you for all your costs every time they send you a defective product, which is a proposition I’ve never had a Supplier accept.
Supplier requests, such as wanting samples sent where they can verify the defect, create a serial approach where you need to be concerned about the cumulative period. First they want a time to verify the defect, then they want a time to issue an RMA, then they want time to provide a replacement of perform the repair. The total impact can be of substantial. It adds time to the period during which you or your customer may be down, not able to use the product or service. If you maintain spare items, it drives your investment in inventories up. The higher the value of the product, the greater the investment in inventory and the more quickly you need to have the repair or replacement of the product turned around and can’t wait for a serial process to occur.
To reduce the amount of time I’ve seen “advance swap” programs be implemented where when the Buyer has what they believe a defective item, they contact the Supplier and the Supplier ships out a new or repaired item in parallel with the Buyer returning the item under warranty. If the product was bad the Supplier repairs or replaces it, if the product was good it goes into their inventory for the next advance swap. While many Suppliers may be reluctant to agreeing to an advance swap program because it adds to their inventory costs, you may want to consider it as a remedy that they are required to implement if you have an excessive number of defects.
Any time the Supplier wants to include a step prior to your return you need to be careful.
For example if they want to verify the defect, that’s equivalent to the having them agree. If they fail to agree you don’t get warranty redemption. If you need to have a situation where you provide the Supplier with a sample before they issue and RMA, I would require that 1) they agree to act in good faith in performing the verification, and 2) establish the maximum period they have for their verification. What the requirement of good faith does is prevent against them acting in an arbitrary manner. What the firm time period does is to prevent against unreasonable delays on their part in performing the verification.
I would also review the warranty redemption section to determine whether the standard remedies for breach of warranty redemption are going to be effective in terms of driving the Supplier’s behavior. A common remedy is if the Supplier fails to perform the Buyer would have the right to procure it elsewhere and charge the Supplier the difference. That may not be practical as other Suppliers may not be able to repair or replace it.
As to the cost of the shipping as part of warranty redemption, my position has always been that we paid for the Supplier to provide a high quality, high reliability product. We also paid to have that product shipped to us. Since we paid once, we shouldn’t have to pay again. Paying to return defective products adds to you life cycle cost and it’s a cost you have no control over. If you must agree to it, consider adding a requirement that if the quantity of defective products exceeds a certain amount, the Supplier assume the costs both ways.