When working in the procurement field, a procurement contract is something that is, obviously, unavoidable. A procurement contract (sometimes called a purchase contract) is a document that establishes a legally binding relationship between buyers and sellers. Procurement is an important element of any company, and their overarching corporate strategy. A contract review checklist and subsequent negotiations are inevitable and can be necessary to secure the procurement process. Negotiations are commonly used to agree upon the best price and payment terms; delivery estimates and lead times; quality standards and other factors. Winning procurement negotiations usually involve a tactful balance between vendor and purchasers.
In many industries, the power balance has shifted in favor of the vendors, therefore negotiating procurement contracts requires strategy, skill and strong relationships with vendors.
We have put together a list, focussing on some of the key clauses and potential pitfalls to watch out for during these negotiations; while some may seem simple or obvious, it’s important to remember them and be aware.
1. Commercials
Commercial clauses surround and relate to the buying and selling of goods. It is important that the price is agreeable for both parties, but also that you as the procurer are not overpaying, or being charged more by the vendor than is reasonable. While the vendor is running a business too, they will be anticipating commercial negotiations, and will accordingly start with higher prices. When negotiating price, it is imperative to remain reasonable, but firm. This is also the time to agree payment terms.
Commercials do not only relate to price; minimum order quantities (MOQs) and lead times (more on this later) are other crucial aspects. Make sure you know the MOQ and that it’s acceptable for you. When it comes to lead times, you need to know, accurately, how long it will be from order to delivery.
2. Service Levels
Service levels are basically the service the vendor is providing you with. Lead times (as mentioned above) are a key consideration for all procurement professionals, and is a clause that can often trip you up, especially as it should be one of the most straightforward parts of any procurement contract. Being able to guarantee how long between placing an order and physically receiving the goods at the destination is something that definitely needs to be negotiated; most procurers will have a deadline they are working too. Similarly, there will be a limit to how quickly a vendor would be able to supply certain products. Careful negotiation and acceptance of certain unavoidable, external factors are needed for this. (It is important to note that with most of the world still suffering through the pandemic, lead times are slightly less reliable, due to the unpredictability of supply chains).
With this level of uncertainty, the levels of ‘safety stock’ have never been more crucial, and a vendor’s offer of substantial safety stock is definitely a clause that needs to be carefully examined. Spending time determining safety stock requirements will save money and increase efficiency. (There are a number of specific formulas for working out appropriate levels of safety stock, but most are dependent upon the product and the vendor).
Also, don’t be afraid to negotiate consequences on late or incorrect delivery. It is essential to discuss this and have it in writing what has been agreed upon. Clauses surrounding delivery errors are often not clear cut and can cause issues should it happen. You need to make sure you are covered, and carefully negotiate terms you are happy with.
3. Exclusivity Rights
Exclusivity rights is, simply put, an agreement that grants exclusive distribution rights. Exclusivity causes are not always carefully drafted; determining the scope of certain terms (‘sole’, ‘exclusive’ and ‘preferred’) can be difficult, as they are often dependent on the context to determine their meaning. A contract review and clause negotiation is especially relevant here, in order to expose these risks and make sure both procurer and vendor are on the same page.
When reviewing exclusivity right clauses, negotiations should include
- Scope
Ensure compliance with the exclusivity rights; all parties (procurement professional and vendor) understand what is covered by the rights
- Territory
Prevent a breach in the provision by knowing and agreeing upon a defined territory where exclusivity rights’ obligations apply.
- Carve outs
Exceptions to the exclusivity clause are important to note. (Carve outs can provide a level of flexibility. For instance, if both parties agree, certain products could be sourced by other suppliers, etc.)
- Period
The length of time the exclusivity obligations are active must be clearly understood; start and end dates should be negotiated (where necessary) and agreed upon.
4. Liability & Insurance
When working or dealing with vendors, it is important that those vendors meet the necessary insurance requirements. Service providers should be able to show you, as a procurement specialist utilising their service, evidence of satisfactory insurance coverage.
When it comes to negotiations relating to insurance and liability, it is important to know that for every stage of the process, it is clear who is ‘responsible’. Similarly, both consequential and inconsequential liability must be understood and, where necessary, negotiated. The majority of contracts include clauses surrounding liability of both kinds, and these require careful navigation; if either party suffers losses due to a breach of the contract, clauses often seek to limit the liability of one or all parties.
Misunderstanding between the legal distinction of ‘consequential’ and ‘direct’ or ‘inconsequential’ loss can lead to exclusion clauses that do not achieve their intended conclusion. It is one of the most complex elements of any contract, and it is recommended to always have someone who understands the intricacies of legal liability look over the contract for clauses that set off any alarm bells or raise red flags.
It is equally relevant to make sure that all warranties are acceptable, in place, and will stand up in the case of a contract breach.
5. Compliance
Put simply, compliance is the regulation and maintaining of standards and guidelines. Various industries will have their own guidelines relating to the execution of their individual business processes.
In terms of procurement through the use of vendors, compliance refers to the minimum level of standards the supplier must abide by. When negotiating, it’s important to understand that the suppliers’ level of compliance may be a factor that could depend on how easy or otherwise they are to work with.
Sources:
https://hbr.org/2020/02/how-to-negotiate-with-a-procurement-team
https://kirasystems.com/contract-central/exclusivity-clause/
https://www.wto.org/english/tratop_e/trips_e/intel1_e.htm
https://www.lexology.com/library/detail.aspx?g=e5c5dd4d-e8df-42d0-ada8-3dfe3a14b508
