Onerous Contract Terms

In the NCMA LinkedIN group someone asked it there was any training on spotting and dealing with onerous contract terms. That sounded like a good topic for my 601st blog post.

When reading a contract for potential high or excessive risks, it’s just as important to be looking for the things that the agreement doesn’t say as much as what it does say. For example a document could have a limitation of liability section that only addresses limits on the supplier’s liability but not the buyer’s liability or the contractor’s liability and not the sub-contractor’s liability. In that situation they have limited their liability to you, but have left your liability to them for both the amount and the types of damages wide open. While having the same limitation of liability may not make sense, it’s important to limit your potential liability and the types of damages that may be claimed to manage your risk. Other terms that are absent from the contract could easily be the most onerous thing you are agreeing to. One thing that I always recommend is if you need to work off the other party’s agreement, always read that agreement along with your standard agreement to compare the two. That helps identify terms that are either missing and are needed or differences between their terms and your terms that will increase your risk.

A second comment that I would make is just like beauty is in the eye of the beholder, what may seem onerous to you may be considered perfectly justifiable by the other party and vice-versa. It’s important to think of the language in the context of the overall deal. Once you have identified language that you consider onerous, take the time to understand what their problem is and why they included that language. What was the risk they were trying to protect against? Demand that they to take the time to listen to your issues and the concerns that you have with the language. Many times that opens up a discussion where you can change the terms to something that meets the concerns of both parties and isn’t as onerous as first stated.

Many people look upon a term such as liquidated damages to be onerous. Before you refuse to agree to a liquidated damages provision consider the alternative. Do you want the amount of damages that may be claimed to be unlimited? Do you want the claim for the breach of on-time delivery to be potentially what has been agreed as the entire financial cap on liability? While liquidated damages will establish a fixed amount that has to be paid, it also limits recovery for that breach to only that amount. It caps you liability and one of the best ways to manage against onerous terms is to both cap the liability and the types of damages that can result from a breach of that term.

Many suppliers or subcontractors view a termination without cause provision as onerous. For the buyer or contractor it’s a necessary tool. Things change and the last thing they need is to have work continue to be performed when there is no longer a need for it. If you don’t want to have the buyer or contractor abuse the use of it, negotiate a termination for convenience that makes it costly to use it in specific situations. That will eliminate the most of the times the buyer might consider switching suppliers because they can buy something slightly cheaper.

Many suppliers consider indemnifications as onerous. There are multiple types of indemnifications and the only indemnification that I consider onerous is what’s called a broad form indemnification. A broad form indemnification requires the supplier to indemnify the buyer even if the buyer was negligent or the buyer’s actions cause an infringement of an intellectual property. For other types of indemnifications, I’ve never thought it was onerous to have the supplier be responsible for their own negligence or have the supplier be responsible for the infringement they caused. If the injured party sued them directly wouldn’t they be liable?

Always take both time and volume into consideration when considering whether something is as to onerous. Things like financial caps can be structured a number of ways and how they are structured is important. Let me give you several examples. There is a five-year contract. There are $300,000 of purchases planned for each year.

In one approach the buyer includes a one million dollar cap on liability.
In a second approach the buyer caps the liability at the value of the purchases.
In the third approach the buyer established $500,000 liability, which resets each year.

When you consider time and volume:

While the first approach had the highest initial amount, the potential liability per unit is
1,000,000 ÷ (300,000 x 5) or $.66 per unit.

The second approach has the liability grow as the volume grows and the potential liability per unit is $300,000 x 5 = $1,500,000 or $1.50 per unit.

The third approach could potentially create $2,500,000 liability but for that to occur there would need to be at least $500,000 in claims each year to reach that level. If it did, the per unit liability would be $2.50 per unit.

For many other terms that are different from your standard think of the terms from a total cost or total life cycle cost perspective and put a price tag on each. If they want 60 day payment terms versus thirty, tell them the impact that will have on the unit price to get that. For things that simply aren’t acceptable don’t be afraid to say no.

Privity - retaining privity in complex supply chains and outsourced relationships.

Today’s world of complex supply chains and outsourcing has created a number of situations where you either are having third parties purchase products or services for you or you need to purchase from third parties. When this happens, several questions you should be asking are:
1.What will be the impact on contract protections?
2.Will the third party that you are now buying from be able to stand behind key contract protections? For example, can a third party cure and I.P. Infringement?
If you had significant leverage in negotiating the contract with the supplier you probably don’t want to risk losing those by no longer having privity of contract with the supplier on those purchases.

Having faced these situations I thought I would share my thoughts on approaches to these.

Example 1. Purchasing of contract services like contract manufacturing.
The Buyer has a contract with a Supplier. The Buyer hires a contract manufacturer (CM) to manufacture the Buyer’s product and will buy the completed product from the CM. Your options are:

1. To maintain privity with the supplier you could purchase and consign the goods. That is complex and costly. If you fail to provide them on-time the CM can make claims for the delays.

2. You could ask the supplier to allow the CM can purchase off the Buyer’s contract with the Supplier and the Buyer is a third party beneficiary to those purchases. One of the problems with that is the Buyer could be liable for the CM’s actions and the supplier could potentially cause a breach and termination of the agreement.

3. You could ask the supplier to enter into a separate agreement with the CM and provide the same terms and have the buyer be a third party beneficiary to that agreement. The problem with this approach is many suppliers simply do not want to extend any Buyer’s special terms to the CM. The main reason is the CM would want to use those terms with all their customers and that impacts the Supplier’s profit and risk structure.

4. You could be to have the CM buy directly from the Supplier under whatever terms they could negotiate. Those may be less that what the Buyer had. If the Buyer doesn’t want to lose the special protections they negotiated directly with the Supplier you could:
a)Have the Supplier and CM to establish whatever agreement makes business sense between them.
b)Have the Supplier either extend the contract price to the CM or agree to provide the Buyer with a rebate for any price difference.
c)You want agreement with the Supplier that the Buyer is a third party beneficiary to those CM purchases.
d)You want the Supplier’s agreement that that the Buyer can enforce either the terms of the CM’s agreement with the Supplier or the Buyer’s agreement with the Supplier on those purchases.
e)The supplier will want to make sure that since they will be liable to both the CM and the Buyer, that their cumulative liability is no more than what they would have been liable for under their agreement with the Buyer.
f)I want that separate agreement between the CM and the Supplier so the Buyer does not assume any liability under that agreement and to make sure that a breach of that agreement it does not impact the Buyer-Supplier Agreement that the Buyer may need for other business.
g)In the Agreement between the Buyer and the CM, I want several things included:
1. I want the products ordered by the same part number so I can verify consumption and make sure that purchases are not being made for other use.
2. I want the CM to agree that they will only use those parts in the manufacture or repair of
my company’s products. This is important for dealing with allocations of supply.

Example 2. Purchasing of products through distribution.

The Buyer wants to buy Supplier’s product for resale as part of solutions it sells its customers. The Supplier either doesn’t want to sell directly to the Buyer because of the impact that would have on its sales channels, or the Buyer wants to acquire the products through a distributor because of advantages the distributor can provide such as stocking with quick delivery. The Buyer is concerned with the contract protection it will get if purchases are from the distributor with no privity of contract with the supplier. Key concerns are usually warranties and the indemnifications. While the distributor can pass thru what the supplier agrees they can pass thru, for any protection above that the Distributor cannot provide the necessary protections on their own.

As all of the business will be conducted through distribution, you need an agreement with the distributor for those purchases. Then to get privity with the supplier you could then create a simple one-page agreement with the supplier to create privity on purchases through their authorized distributors. For example the preamble of such an agreement to create privity could be:

“Buyer and Supplier agree that all Supplier products (hereafter “Products”) that Buyer may acquire directly or by Buyer Authorized Third Parties from any authorized distributor of Supplier offering those Products for resale, shall be subject to the terms of this Agreement. Supplier agrees to honor the following terms with respect to all such Products acquired by Buyer or Buyers Authorized Third Parties and Buyer may enforce these terms directly on Supplier.”

I’d be interested in hearing how others have addressed this.

Should you put limitations on the Suppliers right to cure a breach?

If you were negotiating contracts for on-going product or service delivery one of the worst things that can happen to you is to have a supplier that is constantly breaching on-time delivery obligations and curing that breach within the allowable cure period. In a production setting that type of unpredictable delivery performance forces you to either have stock-outs or carry additional inventory at a significant cost.

While a supplier may have a valid reason for not shipping on time such as a production problem, many times the reason for a late shipment may not be valid. For example, the volumes intended for you get sold to another customer that is willing to pay more. For example, a major customer of the supplier hasn’t planned their demand and the supplier uses the product intended for you to meet that other customer’s need. These aren’t remote events, they can and do happen frequently.

One way to protect against continuing breach-cure, breach-cure is to put limitations on the number of times the supplier can cure. For example just like in baseball where it’s three strikes and you are out, you can limit the number of times a supplier can “cure” a breach. You do that to trigger an additional requirement, such as having the supplier stock and maintain inventory at your location at their cost. Alternatively you could use it to provide you the right to terminate the agreement.

The key in writing and negotiating a limit on the right of the supplier to cure breaches to on-time delivery requirements is to determine what constitutes a “strike”. For example with late delivery breaches you have several variables to consider:
1. The quantity involved.
2. How late the deliveries were.
3. The frequency of the late deliveries.
4. The total volume involved.
5. The number of strikes allowed.
An order of one unit that is one day late hardly warrants being considered a strike. If you have daily or weekly deliveries the potential to miss a delivery significantly increases. My preference is to always look at performance as a snapshot over a specific period of time such as any thirty-day period and use that to measure performance.

For example if more than half the volume ordered within that thirty-day period is delivered more than 10 days late, that’s a strike. Any individual order of more than X quantity that’s thirty or more days late is a strike. These are just examples as you need to identify the performance levels that will cause you significant pain, and have those constitute a strike.

In determining the number of strikes that trigger your rights, the key is to consider the impact the measurement period will have. For example if you selected three strikes within a 12 month period, you could have two months in a row with terrible performance and not have any rights until that third strike occurred. My preference is to have multiple measurements that can trigger rights. For example, 2 strikes within any ninety-day period or 4 strikes within any 12 months. These combined measurements allow the supplier no more than 1 strike in each 90 day period.

Why would you go through this process? First, as long as the supplier cures within the allowable cure period there is no breach for which you can collect damages unless you specifically included Liquidated damages for late delivery. If they feel no pain, they won’t correct the problem and you will continue to have the problem.

What does “Time is of the Essence” mean and when would you use it?

In contracts you can have minor or major breaches. A minor breach provides only money damages. A major or material breach provides additional remedies and may include the right to terminate the agreement for cause. When you say that "time is of the essence", you are saying that delivery by a specific date goes to the heart of the agreement. For example there is a festival being held on May 15, 2014. You are purchasing goods for sale at that are unique for that festival. You order them and specify that they must be delivered on May 12, 2014. As part of the delivery language you include language that says that time of delivery is “of the essence” of this agreement. You do that to notify them that on-time delivery is critical. Collecting damages or liquidated damages is not adequate because if they are delivered late, you cannot sell them at the Festival and they have little of no value to you.

In drafting time of the essence language you want to make it clear. For example:

Supplier shall delivery the Product to X Location on or before May 12, 2014 ("On-Time Delivery"). On-Time Delivery is of the essence of this contract. Failure to make On-Time Deliver is not subject to cure under Section 12. Buyer shall have the right to reject delivery of and shall not me obligated to pay for any Product attempted to be delivered after the On-Time Delivery period. Supplier’s failure to meet the On-Time Delivery date shall be a major breach of this Agreement and in addition to Buyer’s rights specified in this section Buyer may terminate this agreement for cause."

In that:
•The use of the defined term Product identifies specifically the product that must be delivered.
•You have provided the acceptable window for delivery where On-Time Delivery has been established.
•You have established that On-Time Delivery is of the essence of the agreement.
•You have eliminated the right to cure the breach of the requirement for On-Time Delivery.
•You have made it clear that if On-Time Delivery is not made:
oYou can reject delivery of the goods
oYou do not have the obligation to pay for those goods.
•The failure to meet the On-Time Delivery requirement provides you cause where you may terminate the agreement and claim damages.

You have the right, not the obligation to terminate. If they were delivered to late to sell them, you could refuse to accept delivery of the goods and not pay for those goods because of the breach. If they delivered after the specified date but before the festival you may waive your right to terminate and still accept and sell them. If you decide to terminate, depending upon what your limitation of liability says, you could potentially claim other damages for the breach of that required delivery date. In most agreements the damages you could claim for breach would be limited to direct damages. Direct damage includes the excess cost of re-procurement (the cost of “cover”) if you were able to procure what you need from an alternative source.

Where damages or liquidated damages for delays are adequate you would never use time is of the essence. You use time is of the essence when those damages or liquidated damages are totally inadequate.

Insurance Certificates

Most contracts between buyers and sellers require the seller to carry certain types and minimum amounts of insurance coverage. The question is having the insurance requirement in the contract good enough, or should you also request, keep and maintain certificates of insurance?

If all you do is require insurance coverage, if the supplier failed to maintain those coverage amounts, they would have breached the agreement and you could sue them for damages. The main reason why you require insurance is to have additional financial protection against losses and claims that is over and above what the supplier has for assets. If they don’t carry the required insurance you can only look to their assets. If the supplier went bankrupt, you would be in the same position as any unsecured creditor of the supplier and might not be able to collect anything.
You would be assuming the total loss.

An insurance certificate from a supplier’s insurance company will tell you what insurances the supplier has, the coverage amounts, and the term of coverage. Term of coverage is usually one-year increments. Requiring that you be a named or additional insured means that if there are any changes to the underlying policy that you will get notices of the changes. For multi-year contracts or projects that last more than a year you should require insurance certificates for any renewals with the existing insurer or policies with new insurers. When you get a new certificate you should continue to keep all the prior certificates. The reason for that is insurance provides protection for injuries or damages that occurs within the coverage period. An injured party has a legal period of time in which they must make a claim or they will be prevented from making a claim. That period of time is referred to as the statute of limitations. Each jurisdiction may establish their own statute of limitations and the usually vary by the type of claim. For example in New York, the statute of limitations are:
Fraud: 6 years; Libel / Slander / Defamation: 1 year; Injury to Personal Property: 3 years; Product Liability: 3 years; Contracts: 6 years; Personal Injury: 3 years; Wrongful Death: 2 years. For wrongful death claims the limitations run from the date of the death. For injury claims, the limitation runs from the date of the injury.
For contracts, the parties may agree to a shorter period of at least one year and the statute of limitations runs from the date the contract was breached.

What this means is a party filing a claim can file that claim at any time within that allowable period and that may happen well after the contract has expired or been terminated. In the interim period before filing the claim the supplier or contractor may have gone bankrupt. With respect to claims covered by insurance, the insurance company remains responsible for providing insurance on claims where the cause of action occurred during their coverage period. Their responsibility only ends when the applicable statute of limitations has expired.

For example: The insurance certificate for all perils including personal injury due to negligence has a coverage period of January 1, 2013 to December 31, 2013. A party is injured on December 20, 2013. That injured party has 3 years or until December 20, 2016 to make a claim. They make a claim on December 1, 2015. The buyer had a general indemnification in their agreement with the supplier or contractor indemnifying the buyer against injury claims based upon the supplier or contractor’s negligence. As part of the claim the Buyer is sued. If the supplier is still in existence, the Buyer invokes the indemnification. If the Supplier is no longer in existence, the buyer would need to defend against the claim and would notify the Supplier’s insurance company who had the policy during the term in which the injury occurred, of the claim and they would have the right to defend against the claim. The case comes to trial in January 2017 and the injured party is awarded US$100,000. That US$100,000 should be first paid by the insurance company, up to the limits of their policy. Any remaining amount would be paid by the supplier of they exist, any successors and assigns of the supplier if they have been acquired or merged. Lastly the buyer may need to pay if the supplier is no longer in existence in any form.

The best reason for getting and maintaining certificates of insurance is they can help you identify what insurance company was providing coverage at the point in time when the injury arose. Many things change and changes occur in a three-year period. Suppliers may no longer exist or may have been merged or acquired by other companies. Individuals involved in managing the contract may no longer be with the company. The best protection to ensure that you get the full benefits of the required insurance is make sure you have a paper or electronic trail that allows you to determine what insurance was in place at the time of the injury or loss.

Service warranties

This was a discussion on LinkedIN and people of the selling side basically wanted to provide limited warranties and limit the buyer’s remedies to just re-performance of the work. While that’s nice for them, it may not provide the buyer with adequate protection and the amount of protection required under services contracts varies based upon the type of the services being performed.

To select the right warranties to be included in your agreement you always need to consider two basic things. The first is what is the nature of the services that are being performed as that has a clear impact on what you may need. The second is what would be the impact if those services were not performed correctly? Services can range from something simple such as custodial services for an office space to providing highly technical design services to create a product, design a facility or design a manufacturing process. The impact of failing to correctly perform services can be minimal or they may cause significant damage. In the performance of certain services the transaction may also become subject to a variety of laws that apply to the performance of the work. For example services involving certain technology are subject to export control laws. Services that deal with personal data are subject to personal data laws to protect the individual’s rights in that data. Services for certain heavily controlled industries like banking may be subject to a number of laws.

To provide my thoughts I’ll break service warranties into the following categories. General, Authors or Creative Works, Software, Quality warranties, Export, Personal Data.

General Warranties

The party signing the agreement has the right to enter into this Agreement. This means that they are fully authorized by the company to execute agreements on the company’s behalf. If they are not the other company may not be obligated to perform, but the individual that signed the agreement and gave that warranty can be personally liable for the damages caused.

Performance will comply with any law, regulation or ordinance it is subject to. If a service is performed and that service does not comply with applicable laws the buyer may be liable for that non-compliance or may not be able to use what was produced by the services. For example an owner hires a construction contractor to construct an addition, if that contractor failed to follow the local building codes, the owner would need to correct the work or would not get a certificate of occupancy to be able to use the addition.

No claim, lien, or action exists or is threatened against Supplier that would interfere with Buyer’s rights.
You hire a company to perform maintenance services on your air conditioning systems. That supplier subcontracts with another supplier to perform those services in other locations. The supplier does not pay the subcontractor. The subcontractor files a mechanics lien against the property since they have not been paid.
The landlord that owns the property has a clause in their lease that requires your company to have the lien removed. This warranty would allow you to go against the supplier to collect the cost of having the lien removed.

Services do not infringe any privacy, publicity, reputation or intellectual property right of a third party;
Simply stated what you want is for any supplier that you hire not act in a manner where you could be sued by a third party for infringement of their rights. Under the theory of agency the buyer is the principal in the relationship and the supplier is considered an agent of the buyer and principals can be liable for the acts of their agents.

Services Involving Authors or Creative Works

All authors have agreed not to assert their moral rights. In the United States, the term "moral rights" typically refers to the right of an author to prevent revision, alteration, or distortion of her work, regardless of who owns the work. If you have a service performed for you such as having someone take a photograph or create a document, you want the right to make changes to that for future use, updates etc. To ensure you have those rights you want authors to waive their moral rights in the works.


Services Involving Software Code:

Software does not contain harmful code. Harmful code or malware is defined as software that may be used to disrupt computer operation, gather sensitive information, or gain access to private computer systems. As a software user you want any disputes that you may have with the licensor or that the licensor may have with a third party licensor to be resolved contractually and not by the parties accessing code as part of self help where they can disable the use of your use of the code. You also don’t want the to have code that could access your or your customers information or systems.

It has disclosed any third party code that is included in or is provided in connection with the Software. The disclosure of what third party code is used in the software you will license is something that allows you to identify potential risks associated with that third party code. This is especially important when the third party code is open source code. There are two primary risks with open source code. One is the potential claim of infringement of another party’s intellectual property rights. The second is the impact that open source code can have if you were to use the licensed software to create derivative works. Open source software requires that any use of it be licensed under a General Public License (GPL) and you would need to license your derivative work under a GPL and would not have any IP rights in that protected.

Software is in compliance with all licensing agreements applicable to such third party code. If you license software the includes third party code, you want to ensure that they are not in violation of their license agreement with the third party as the third party could prevent you from using the software because your software supplier is in breach of their license agreement with the third party.


Quality of Services Performed

Services will be performed using reasonable care and skill. This is a standard warranty for quality. Depending upon the services being provided and the service provider, you can always raise the standard to a higher level. For example you could have the standard apply to someone experience in providing that service,
An individual that has a minimum number of years of experience providing that service or an expert in providing that service and what is reasonable care and skill will vary based upon the classification.

Deliverables will comply with the specifications and requirements of the Agreement. Most of the time you would use this for what I call break/fix services. In the end you want the item being repaired to meet the same requirements and specifications as the original. One of the problems with this warranty is all requirements of the original specification may not be able to be met. For example in a out of warranty repair service the service performed may be simply to identify a defective part and replace that. The repaired item would never be able to meet the original product’s reliability specification as all the items that weren’t replaced have been subject to wear through use. In that case you may want the deliverables to simply meet certain performance and functionality requirements,


Services Involving Technology that is Subject to Export Controls:

It is knowledgeable with and will remain in full compliance with all applicable export and import laws. A supplier’s compliance with export and import laws is important as the buyer can be subject to substantial fines and other penalties and may have their rights to export be impacted as a result of any violation.

It will not export U.S. content provided by Buyer to any of the countries or to nationals of those countries listed in U.S. Export Administration Regulations. For contracts involving U.S. Buyers, especially those involved with high technology, there are strict export controls over providing information to individuals or companies from locations that have access restricted by the U.S.. The buyer can be subject to substantial fines and other penalties and may have their rights to export be impacted as a result of any violation.


Services Involving Personal Data

It will not use, disclose, or transfer across borders any information that is processed for Buyer that may identify an individual (Personal Data), except to the extent necessary to perform under this Agreement. This type of a warranty takes into account the fact that different countries provide significantly different legal protection to personal data. As such the Buyer who is responsible for that personal data and who could be liable for its wrongful use wants to make sure the data is only held within one location and is not used, disclosed or transferred to any location where it will receive different protection under the law. This is also a significant issue with Cloud contracting as protection for not just personal data but also confidential business data and Intellectual property may vary significantly based upon the location where it is being stored.

It will comply with all applicable data privacy laws and regulations. While this may be redundant to the general warranty of complying with laws, it may be inserted simply to remind the supplier that personal data is involved and there are different laws that they need to comply with.


Liability and Remedies.

Many times a supplier may want the sole remedy for the breach of a service warranty to be the obligation to re-perform the service. In deciding what is appropriate you need to consider the impact that a breach will have. Let me give you a few examples just to get you thinking about what’s appropriate in different situations:

You contract with custodial services provider for daily cleaning of a location. They fail to provide the service on one day. That day has passed and you don’t need to have the service performed twice the next day to make up for the failure. The appropriate remedy for that is not to re-perform the service, it’s a deduction of the value of that service from their next payment.

You have a contract with a heavy equipment repair shop to repair a huge diesel engine for a bulldozer. The supplier performs the repair and fails to replace several parts. You turn the engine on and it destroys the engine.
Re-performing the repair isn’t going to fix the destroyed engine. What should be the liability and remedy?

You contract to have a supplier provide “cloud services” where personal data will be stored. The security of the cloud system is breached. That data is accessed by third parties who wrongfully use that data. What should be the liability and remedy?

You hire a contractor to perform a highly technical design service. You provide them with critical technology designs, and they fail to manage that data and it winds up being disclosed to a third party operative of an export restricted company. What should be the liability and remedy?

You hire a contractor to perform debit card processing services where shutdowns of any kind are costly because of either loss of business, or the fraud or collection problems they can create. What should be the liability and remedy?

You hire a designer or design build contractor to build a power plant that will produce a specific output. That output is never reached. What should be the liability and remedy?

There is no set formula for structuring liability and remedies. I once negotiated a Debit Card Processing agreement for a Bank. Their major concern was they wanted the suppliers system to be as stable as possible during peak shopping periods. We wanted to make sure that there were no system changes during peak processing times and shutdowns for maintenance needed to be done in the middle of the night to have the least impact on our customers and the least financial impact on the Bank. General service level measurements, which are averages, didn't work because they didn't take into account the impact. I structured liquidated damages based upon three factors. The length outage, the severity of the outage, and when the outage occurred. If they were down in the middle of the night it cost them nothing because our losses would be minimal. If they were down right in the middle of a peak shopping day where the number of transactions was in the millions it became very expensive. The longer they were down the more it cost. I believe liabilities and remedies should be used to drive the behavior you want.

Channels (updated)

The term "Channels" is used frequently in reference to sales and marketing, but what does it have to do with Purchasing? The answer is simple. Every Company has their Sales Channels or the methods by which selling occurs on behalf of the company. For example the following is a list of some examples a supplier may have:

• Original Equipment Manufacturer, Product will become part of the OEM's product
• Value Added Reseller. Product will be added to reseller's product to create solution
• Direct. Sold to customers by sales force.
• Subsidiary. Sold through subsidiary that may be wholly or partially owned.
• Internet sales by Supplier.
• Distributor. Sales to distributors who will resell to either retailers or customers
• Manufacturers Representative, Broker or Agent. Sales to locations without subsidiaries
• Value added Distributor. Sales to distributors who provide value such as training, installation

Most companies have a variety of different sales “channels” involving both direct and third party sales of their products. The Supplier or its Subsidiaries make direct sales to the customer. For example, a company may have customer accounts where there are teams focused on selling Products on an OEM basis. Direct sales by Supplier are usually made to large Original Equipment Manufacturers (OEM’s), large Value Added Resellers (VARS) and may be made direct to major customers. More recently direct sales are also being made through cost effective models such as Internet sales. In locations where the Supplier didn’t have sufficient business to warrant direct sales staff on their own, they may conduct a form of direct sales through manufacturer’s representatives who will sell on their behalf for a commission. If you are buying and a manufacturer’s rep is involved, they are adding cost to your purchases so if possible, its always better to deal direct. For any sales that the Supplier doesn’t want to focus it selling resources directly on they will use Third Party Sales Channels such as Distributors or Value Added Resellers.

Independent third parties who will sell to target markets are also called Channels. With the advent of outsourcing, some Suppliers may not sell any product direct and have all sales be managed through distributors who function as their logistics and order fulfillment arms. When a Supplier sells through channels, the Supplier effectively controls what the Channel does and what you will get

Channels are important to the Buyer as they have an impact on the terms you can negotiate and the price you pay. For example if you purchase from a Supplier subsidiary two things happen. Their price needs to include the amount of overhead and profit they need to make for the subsidiary. The transfer price (how much they paid the Supplier to buy the product), will also control the price they can sell to you at. This limits how much they can discount. The second impact is your agreement is with the subsidiary, not the Supplier. There is no privity of contract with Supplier so the promises are being made by the Subsidiary who is solely responsible.

For purchases from other channels, as they are getting a price or discount from the Supplier which they are locked into, they can only pass on a part of what they get to you. If a distributor gets a 30% discount from the Manufacturer, the lowest price they will sell it to you for is that, less their contribution to their profit and overhead. The same restriction applies to terms such as acceptance or warranty. They can pass on the supplier's standard terms or warranties, but anything more than would require specific agreement by the supplier or you would need to look to the channel's resources and assets to stand behind the commitment.

Suppliers will look at your business volumes and importance to them as a Customer and will determine what channel is appropriate for sales to you. If they are willing to sell direct they will also determine what sales tier they will place you in. For example if you are a tier 1 OEM customer, you will normally get their best pricing and terms. The tier the place you in based on your value to the impacts both the price you will pay and terms they will offer. If they will only deal with you through Internet sales, the price is the price and their sales terms apply. If they refer you to distribution, that impacts the price you pay, the terms you can get and who is making the commitments to you.