Friday, February 18, 2011

Negotiation - Thoughts on Purchase Orders Issued Under Contracts

Many contracts are structured in a manner where the contracts make no firm commitment to purchases and simply function as a pre-agreed set of terms for if and when purchases actually occur. The actual commitment to purchase under the contract and resulting responsibilities occur when a Purchase Order is issued.

Most purchase order language describes the method by which Purchase Orders may be made, with issues regarding cancellations, rescheduling and flexibility dealt with elsewhere. Orders of precedence may also address the order of precedence given to Purchase Order terms in comparison with the other documents.

In negotiating purchase order provisions Suppliers usually have two concerns.
1.     They do not want to be bound to accepting orders for unlimited volumes and may want to limit purchase order volumes to an agreed forecast. The simple reason for this is they have limited capacity and don’t want to be liable for failing to perform if there isn’t sufficient capacity to deliver.
2.     They are always concerned about additional or differing terms being added to a Purchase Order that could slip past them, so in most cases they will either want to have obligations only for those purchase orders that are accepted in writing by them, or that do not contain additional or differing terms.

Getting written acceptance of a Purchase Order can be an administrative nightmare. Most companies also have standard acceptance forms that may contain different terms that would set off a “battle of the forms” problem where agreement isn’t reached.

If you are dependent upon the Supplier to perform each time you place an order, the last thing you want is for the purchase orders to be subject to their acceptance. If they don’t accept you won’t get delivery and there is nothing you could do about it.

To deal with a Supplier’s concerns about volumes you could propose that you agree upon a volume forecast and as long as the volumes you order are within the agreed forecast they must accept them. You could further agree that for any volumes in excess of the agreed forecast, that they will use reasonable efforts to fulfill them. By using a reasonable efforts standard of commitment they wouldn’t be liable for not delivering them, they would only be liable if they failed to use reasonable efforts to try to fulfill the order.

To deal with the Supplier’s concerns about additional or differing terms, you could define what the parties agree will constitute an additional or differing term and require that those must be accepted in writing.  For example if the Contract had a specific delivery location specified and the delivery term was origin based (with Buyer assuming all costs), should the Buyer need to get approval from the Supplier if they specify a different location?  My opinion is that if the additional or different term doesn’t impact their ability to perform or create an additional cost or potential liability, they shouldn’t need the right to approve them. If the Supplier won’t agree to having changes be made by purchase order one way to deal with it is to include options within the agreement in the individual sections where you may want to specify something different in the PO.  For example, in the Delivery section you could say something to the effect that:
“Buyer may in its Purchase Order specify different ship to locations provided that there is no additional cost to the Supplier”.

When the definition of the Contract includes purchase orders that are placed under the agreement, you have both potential for conflict and you can have additional or differing terms being added.  One way to avoid conflict is to specifically exclude all pre-printed terms on the reverse side of a hard copy purchase order or any standard purchase order terms transmitted with an electronic order. If you have additional or differing terms you want those to have priority and that needs to be addressed in the Order of Precedence by giving the highest priority to the terms on the face of the Purchase Order that do not require acceptance by the Supplier or that have been mutually agreed in writing by the Supplier when their agreement is required.

Negotiation – Thoughts On Out of Warranty Service And Support

If you have on-going support commitments to your customers or you are buying a product that will need to be maintained, serviced, repaired or supported, the best time to negotiate those Supplier obligations is before you agree to make the purchases that will need them.

If all you do is buy maintenance agreements to meet those needs, your primary concerns in the negotiation are cost, the length of the support commitment and the scope of the services (what they will do, when, how, the response times, and how problems will be managed and escalated etc). 

If you do self maintenance or perform service and support for others, as a minimum you need to be able to purchase Field Replaceable Units (FRU’s) and out of warranty repairs.

If you will do lower level support you may need to purchase of spare parts, training, tools, test equipment or programs and possibly back up support. The most important things you negotiate in all of this is the term and the cost.

The term is how long you can count of the Supplier to provide what you need. The cost is important because if you don’t have control over that in the future, the Supplier could price the support items where it is cost prohibitive thereby avoiding all the other commitments. The Supplier can use the fact that you are locked into them to substantially improve their profit at your cost.

Once the costs and term are locked in, the next most important thing is to negotiate response times and escalation processes to assure you get what you need when you need it and that you get the appropriate response when problems arise.

Since out of warranty service and support is a great profit generator for Supplier and provides them with a revenue stream year after year, when you negotiate the cost you need to be aggressive. Back in the 60’s when a car cost $3,000, if you purchased all of the spare parts to make that car it would cost well over $20,000 and I’m sure that the situation hasn’t gotten any better. Spare parts, and FRU’s will cost more than the production piece if for nothing more than the fact that they must be individually tested, inspected and packaged so an old rule of thumb was that there shouldn’t be any more than a 30% price premium.

The other thing that you clearly need to be aware of is that Suppliers will probably have the tendency of trying to charge more for the items that will need replacement more frequently and may try to charge less for those that have substantially less of a probability to fail just to make the overall cost look better. Consumable supplies clearly fall into the category of things you need to closely watch the pricing on to make sure it is competitive.

In negotiation of repair pricing you need to remember that repairs are just another manufacturing process in which tasks are performed and materials are consumed, so the cost you pay for repairs should be based on the competitive cost of those elements plus a reasonable contribution to their overhead and profit consistent with the industry.

Maintenance contracts also need to be looked upon as just another service. There are planned maintenance calls which have certain labor and materials associated with them and there are break-fix maintenance calls in which there is labor and in most cases the swap out of FRU’s that may need to be repaired.  In negotiating maintenance agreements the biggest unknown is the frequency of the amount of break fix activity. If you can estimate what the planned maintenance portion of the cost is, it’s then easy to back into what the Supplier has allotted for break fix as part of their annual fee to determine whether it is better to have an all inclusive maintenance agreement or pay on a per call basis. Since most Suppliers don’t want you to buy maintenance on a per call basis, they will usually overprice the per call rates and they may also use a connection between contract status and service call priority to try to drive you to a maintenance agreement where the odds are great that it will be more profitable for them. As long as you negotiate all of this before you make the initial commitment to purchase the product you have the leverage to negotiate a better deal. If the nature of the business is really structured in a way where the Supplier is dependent on the annuity stream that on-going support provides, always use that to get the best deal you can on support, and use any reluctance you have with them on giving you what you want for support as leverage to drive the initial purchase price down.