As a consequence of the Autumn Budget, businesses are going to face a number of increased costs. Businesses will, naturally, be looking to make efficiencies. A place where efficiencies are likely to be sought is by rationalising supply chain costs and negotiating contracts with suppliers.
Although contracts should be comprehensive, we often see that contracts are “over-engineered” meaning that customers end up paying for things that go beyond their requirements. The purpose of this note is to highlight some points where efficiencies may be found when negotiating contracts with suppliers.
Specification
This specification will set out the technical details of whatever is being supplied. It should be comprehensive, but it should also not go further than needed. For example, a customer should:
- Ensure its requirements are not over specified. If it includes higher standards than are needed or non-essential “add-ons”, these are likely to bring an unnecessary cost.
- Ensure it is clear. Where specifications are ambiguous, suppliers may increase their price to accommodate any uncertainty.
Control
A customer’s ability to make, or veto, changes to a contract can impact on its profitability for a supplier, and accordingly may influence pricing. It is worth identifying what changes may be needed over the course of a contract and ensuring that the level of autonomy exercised by a customer is appropriate. It may be that for different types of change, differing approaches are needed. Some options to consider may include:
- The need for both parties to consent to the change;
- That certain changes can be made (or vetoed) by one party unilaterally; and
- That if the parties cannot agree a change, the contract is either ended, or a dispute resolution procedure is enacted.
Risk
Apportionment of risk is a key factor when assessing the likely profitability of a contract. Matters that parties may wish to look at carefully include:
- A party’s liability for getting something wrong. This should be proportionate, in the light of the likely harm to the customer – and the available options for mitigating loss. It might include an appropriate financial cap, use of service credits, or more practical solutions – such as an ability to follow a remedial course of action prior to being financially liable.
- How parties will deal with wider economic or commercial changes, or factors outside of their control. Consider if the supplier should be obliged to perform the contract, regardless of the circumstances or whether the customer may accept a lesser obligation – for example to use “reasonable endeavours”.
Price
A key reason for setting price at the outset is to give price certainty. However, this does often push risk of the unknown onto a supplier, and they may accordingly look to impose a higher price at the outset. Price adjustment clauses are becoming a key focus for many businesses, looking at indexation, changes in law, currency fluctuation and / or supply chain costs. Some options for sharing some of this price risk include:
- Agreeing if pricing is consistent through the term, linked to a metric, or subject to an event driven or periodic review;
- Agreeing if there should be any ability to terminate the contract early;
- Agreeing the nature of any discretionary price adjustments.
In the course of contract renewal obligations, a pragmatic approach to the areas listed above can contribute to ensuring that value for money is obtained.
If you would like to ensure that your commercial contracts meet your needs we can help you to review the allocation of risk and cost within your key business arrangements. Please contact the Stephens Scown Corporate team on 01872 265100 or corporate@stephens-scown.co.uk.