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Tips on Negotiating Better Purchase Agreements

We all have observed the recent volatility in the energy and other commodity markets, some driven by the hurricanes, some the result of business expansion. As year-end approaches, many companies and Purchasing departments will be preparing to negotiate contracts for calendar year ’06. This newsletter includes some suggestions that you can use when negotiating purchase contracts or blanket orders on the buying side of your business. When I presented these ideas recently to a group of CEO’s it was interesting to hear that these same ideas can also be applied to the “customer side “ of your business as well. Here they are:

1. Contract timing

Many companies establish agreements based on the calendar or fiscal year for convenience or from habit. This may result in your negotiations being held at the worst possible time. (i.e. – I would hope that none of you were contracting for gasoline or heating oil during the last 30 days). It is more effective to consider the specifics of the market or commodity that you are dealing with:

  • Is the end of the year a time when suppliers are generally very busy? Is it a time when other major players are requesting proposals?
  • Is the commodity seasonal? Are you requesting proposals or negotiating agreements at the busiest time of the year?
  • What events have occurred recently? If you know your supplier has lost a significant piece of business, this might be a good time to negotiate a new contract or and extension.

After considering what specific timing may provide an advantage, think through how to approach current and potential suppliers. Perhaps a 3 or 6 month extension makes sense in a tight market. Even if you have to accept some price adjustment to gain the extension, that may be better that signing up for another full term. If you cannot get an extension, maybe buying month-to-month is an acceptable approach. The specifics of your situation may be different; the point is to try and control the timing to your advantage.

2. Length of agreements

Here again, people tend to think about 6 month or one year deals. A different approach is to go for as long a term as possible if you think there is an outstanding offer on the table. There is nothing wrong with asking the supplier if they will sign a longer term contract than what was proposed. If they will commit to 3 years, maybe you should do it. Two years would be better than one, etc. Conversely, if the current proposal looks unattractive, don’t sign up for the long term unless you have no choice.

3. Escalation/De-escalation

Volatile commodity prices usually lead sellers to add escalation clauses to contracts and individual order acknowledgements. If you are negotiating relatively long term agreements, this is a sure thing, in fact if the proposal does not include some price re-opener, I would question whether or not you are looking at a fair deal.

Any escalation clause or wording should refer to de-escalation as well. The amount and timing should be the same going up or down, but if you do not explicitly include the de-escalation piece, it may not happen as quickly as it should. The contract language should specify the base price and the specific terms and timing for price adjustments. I.e. – “The base price of oil is $65.00/ barrel on October 1. Your price for “X” will be adjusted by $1.00 for every $5.00 change in the price of oil as published in the Wall Street Journal. Pricing will be adjusted monthly on the first of the month based on the published price on that day.” If the basis for adjustment is a published price in a trade journal or newspaper, you should review the history of that published price versus actual market experience before agreeing to use it in your contract. Not all published prices reflect reality, especially those not tied to a commodity that is traded on a major exchange. In general, I would suggest doing some homework before accepting the proposed clause.

Each situation may not lend itself to using all of these contracting tactics. But if you do keep them in mind, they can represent significant cost savings or cost avoidances right now for your business.

I have helped many clients review their contract language and they have saved money in the process. If you have any questions regarding these ideas, please let me know.

Thank you for reading this newsletter. If you know of someone in your company or in another company that would find it of interest, please forward it to them. For more information regarding inventory management and purchasing, please visit my web site www.hshieldsconsulting.com. If you do not want to receive future newsletters, you may reply and indicate that.

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