Today’s guest post is from Jennifer Engel, a Senior Supply Chain Project Analyst at Source One Management Services, responsible for executing strategic sourcing and process improvement initiatives.
Despite the convenience of boilerplate language and pre-approved templates to expedite execution, contracting is never a one-size-fits-all process within any silo of a business. Contracts for professional services tend to require a focus on performance expectations, and rarely have a need for protection against pricing volatility, lead time requirements, and fuel costs. Diametrically, contracts for the tactical purchase of goods focus not on service levels, but on maintaining pricing, ensuring product availability, and outlining delivery terms.
A trait often unique to the Maintenance, Repair, and Operation (MRO) space within a business is that many suppliers are providing a combination of both goods and services that support overall operations. As a result, contracts within this space are difficult to mold to a single template, and constructing agreements without taking into account the business needs to cover each area can be detrimental to the overall relationship goals. When undergoing contracting with a new or existing supplier, there are a few key principals to keep in mind that will benefit both parties as well as drive best value in pricing and service levels.
#1) Fully assess the risks associated with the goods and services separately
When negotiating terms, it is important to prioritize the areas that could most drastically impact the business should a change occur. If the pricing of a good is tied to a volatile commodity index or may be subject to interruptions due to raw material availability, protecting exposure to these factors should be at the forefront of the agreement. If the service associated is more critical than the actual good, for example a specific sanitation chemical being less critical than the completion of the actual sanitization process, then the level of service needed to ensure the business can continue to operate at or above standards should take priority. This primarily holds true to categories for which product substitutes are widely available, however the end result of the service is critical to business continuity.
#2) Adjust the terms of the agreement to form a mutually beneficial relationship that does not expose either party to significant risk.
Explicit service levels and pricing escalators and de-escalators inherently protect the business from any supplier shortcomings or market changes. As long as commodity increases are tied to a verifiable index, are accommodated by a manufacturer’s letter and advanced notice, and de-escalate at an equal rate should pricing decrease, the supplier is protected from becoming insolvent and the customer is protected from realizing an increase not driven by market conditions. For goods not driven by an identifiable index, pricing increases should be capped at a reasonable rate and subject to review and mutual agreement of the involved parties.
#3) Leverage rigorous service levels as another tool to drive negotiations and ultimately satisfy both parties.
As long as supplier expectations are detailed, measurable, and tied to a condition of termination with cause, there is less business risk to include contract language that may be viewed as more favorable to a supplier than the customer. A common point of disagreement in most MRO contracts is term length. Businesses are hesitant to engage in two or more year agreements with fear of dissatisfaction in a supplier’s performance. From a supplier standpoint, these lengthier terms allow them to invest more heavily in a specific customer without risk of being replaced in the near term. As a result, suppliers are often more likely to give more favorable pricing and terms under these extended agreements. Another point of leverage that incentivizes suppliers to offer more competitive terms is exclusivity clauses or volume commitments. Both can be high risk for a business to include, however are easily protected under strict service levels and quality expectations outlined in the agreement.
When putting together such agreements, stakeholder involvement should go beyond the legal department and relationship owner (department manager and/or procurement). End users, and those more closely aligned with the day to day operations should be consulted to outline critical functions of the supplier and bring to light any historical or future potential issues that will impact the integrity of the relationship or daily operations. Contracting should be viewed as opportunity to maintain and strengthen the relationship from both parties, and not seen as a necessary evil of back and forth on general language until legal departments reach consensus. Dedicating the extra resources necessary to construct a detailed and forward thinking agreement will prove beneficial in the long term, as company standards will be maintained without sacrificing cost competitiveness.