Contracting is one of the most important parts of the sourcing process – this is one of the final steps in the process before (or in parallel with) implementation and it documents all terms and conditions agreed to by both parties throughout the sourcing engagement. While it is one of the most important steps in a sourcing engagement, it can also be one of the most painful with numerous rounds of revisions and reviewing legalese that can extend out a project timeline substantially at times. As a Sourcing professional, I ‘ve reviewed my share of contracts ranging from one page agreements to lengthy contracts with multiple attachments and exhibits. Each contracting experience is different, some have gone smoothly and are wrapped up in a few days ‘ time, while others took months to come to agreement on the final language. I will highlight a few recent experiences with contracting and some of the lessons learned that can be applied to others in similar situations.
Don ‘t skip the contract just because of a low spend figure.
On a recent project, my team was brought in to negotiate with a local hardware store that was used regularly for as needed supplies at a local manufacturing plant. Upon further investigation, we learned that the client had already negotiated a discount structure with this supplier earlier in the year, but there was no formal documentation because the annual spend with the supplier was below the threshold when contracts are required.
Rather than considering the project complete, after noticing a recent, unanticipated spike in spend, we decided to review recent purchases to ensure that the agreed upon pricing structure was being applied. Through our audit we found that the negotiated rates were not being applied consistently. As such, we decided to put a formal contract in place with the supplier to ensure that the pricing structure would be applied to all orders moving forward. During the contract negotiations, the supplier changed the language around the pricing structure to be intentionally vague, using terms like most items would receive discounts. This was further evidence that a contract was needed to ensure that both parties were aligned on when the pricing structure would be applied to avoid any potential confusion in the future.
This is an example that we come across quite frequently, pricing is negotiated but then never formally documented which opens the door for potential issues in the future if there are ever questions about why something was done a certain way. This is not to say that every supplier needs a contract, but you should not let a spend figure stop you from considering a contract.
Volume commitments are not always a bad thing.
There have been many times during a negotiation when a supplier has indicated that they would give X benefit if the client would be willing to commit a certain amount of volume in a contract. More often than not, our clients veer away from volume commitment agreements, no one wants to get stuck in a situation where they are obligated to a certain spend or volume threshold with a supplier in case something were to change.
This situation came up recently on a project where I was helping to close out a contract negotiation with a long-standing supplier. The supplier had been providing services for a number of years, the client was happy with their services, and there were few alternate providers in the local market that could compete with the supplier. Given their commitments to other clients, the supplier proposed a volume-based agreement in order to ensure that services would be provided to the client in a timely manner. At first the client did not agree to move forward with a volume-based agreement; however, upon further commitment they saw the value in reducing the risk of supply disruption for a critical service to their business. By agreeing to the volume-commitment, the supplier was able to grant pricing stability for the term of the contract resulting in a cost avoidance given the volatility of the market for the services.
Risk mitigation is a common reason for why a company should consider a volume-based agreement. By committing that volume to the supplier, they are also committing to providing that service/product, which reduces the risk of potential delays or disruptions. Another benefit of volume commitments is that suppliers have a guarantee of your business and as a result are able to provide further discounts and incentives. Before signing a volume-based agreement, you should be sure to evaluate the potential risks and benefits of committing that business to a single supplier.
Beware of autorenewals.
I was recently involved in sourcing a category which is known for having tight contracts with limited to no ability to terminate early. We were aware that the existing contract included an autorenewal clause which had since passed, but the client told us the agreement did not renew because they were midway through negotiating a new contract with the supplier. Based on that information we continued our process of reviewing the spend and developing a go-to-market strategy to realize cost savings. As we were preparing to release the RFQ, the supplier informed us they would not participate in the event because their contract had only just started a few months ago. This was news to the client and had a significant impact on our ability to impact that category. We were able to still impact the category by executing the contract that was already under review; however, the renewed contractual obligations did limit our leverage during the negotiations process.
Autorenewals do allow for fewer contract reviews with suppliers where there is little chance of a supplier transition; however, they also open the door for situations where the contract could renew without your knowledge or before you have the opportunity to make a change. If your contract does include an autorenewal clause, it is important to make sure that there are other opportunities to terminate the agreement during the term if desired. Without a termination for convenience clause, it becomes essential that you monitor the renewal timing so that the agreement does not renew before you have a chance to review the agreement.
The contracting process is one of the most important parts of a sourcing process – you need to make sure that all of the work and results of your sourcing initiative are reflected in the final documentation with the awarded supplier. When dealing with contracts, it is easy to get caught up in the complex terminology and back-and-forth legal reviews often associated with contracting which can cause you to lose sight of the end goal of the sourcing engagement. Therefore, it is essential that you pay close attention to the details of the contract so that you don ‘t get caught in a situation where your results are not fully realized or implemented because of a minor oversight in the T&Cs.