Effective contracting is the backbone of a smooth-running operation. From raw materials to
finished products, the supply chain is a complex network of interdependent
parties that must work closely together to meet demand. In this blog, we will take a closer look at contracting in the supply chain. We'll look below at the different types of contracts used and discuss best practices for optimizing contracts for maximum efficiency and value.
Whether you are a supply chain professional, or just interested in the path products take from manufacturer to end user, this blog provides valuable insights into the reinforcing effect of contracts on the links that keep the supply chain going.
Why is contracting in the supply chain so important?
Imagine this: the sales manager, the account manager or the sales department has secured a nice new large customer after much effort. In fact, with this project, the company is well beyond its revenue goals for the current fiscal year. There is one "but": it is a very large order. So the CFO or boss is called in because this contract could use some extra attention. Perhaps a lawyer or attorney is also called in, because surely all of this has to be written down properly. After all, you don't want to run any unnecessary risks with an order like this; the contracts have to be conclusive.
What unfortunately gets overlooked: consultation with the buyer or purchasing department. Because while everyone takes great care to discuss sales contracts with topics such as warranties and warranty terms, delivery dates, and other important issues, it is often forgotten that those contracts are also purchased for. If that purchasing doesn't match, then you have a problem. It turns out that in your contracts, for example, you give a 2-year warranty on your products, while the components that sometimes break down - and which make repairs expensive - are supplied under a 12-month warranty. That means that as a manufacturer you fall between a rock and a hard place.
What about a limitation of liability in your supplier's general terms and conditions, which prevents you from pursuing your entire customer claim against that supplier? Or delivery delays, where your supplier has stipulated in the fine print or general terms and conditions that no binding commitments are ever made, while you yourself have made a binding delivery agreement with your customer, for whom this is very important?
Purchasing and sales run in parallel
In the recent period, when after corona there were incredible delivery delays in the materials market, many a manufacturing and trading company went bankrupt due to a customer canceling a contract because of late delivery of goods, while the supplier delivered the components with months of delay and demanded payment under its agreement.
So the agreements between the various parties in the supply chain of which you are a part should preferably be coordinated. It pays, especially with larger contracts, to have the negotiations on purchasing and sales run in parallel or coordinated. If the conditions for purchasing are already fixed, e.g. because you work with long-term contracts or have fixed agreements with your supplier, then you will have to be careful when you negotiate your sales contracts to make agreements that are in line with those with your supplier when it comes to warranty periods, requirements for complaints, delivery deadlines, liability limitations, etc.
Conversely, with (new) suppliers, you should preferably make agreements in your contracts that are in line with your own sales contracts when it comes to delivery deadlines, guarantees, liabilities, etc. In the event of a particularly large order, with a customer that has special requirements, you will have to sit down with your supplier again to see if you can negotiate special conditions for this one order. If this does not work, you and the customer will have to see how you can close the 'gap' in your contracts in a fair way. Sometimes you can also solve the problem by taking out extra insurance for a project. In that case you have to agree on the extra premium costs or include them in the total sales or contract price.
The importance of general terms and conditions
Another thing we often see go wrong is the incorrect use of general purchase and sales conditions in contracts. Often people think they are 'covered' by their own terms and conditions, but afterwards they turn out not to be applicable to a contract or order.
Negotiation and relationship management
In contracts, contract negotiations also contribute greatly to building and maintaining strong relationships with suppliers, buyers and other partners in the supply chain. Therefore, a contract is more than just capturing all the risks and issues; it is also pre-eminently an opportunity to strengthen and build relationships with the parties in your chain.
A customer who is offered a permanent contract indirectly gets the message that he is important enough to get a contract instead of working with separate orders. This contributes to customer loyalty. A supplier who is allowed to sign a framework agreement that assures him a minimum turnover will try harder, than one who gets the occasional single order with a tight deadline. The annual progress meetings within the framework of these agreements are by definition relationship management meetings where you express your appreciation for each other and strengthen the relationship. At the same time, you can adjust your collaboration during those evaluations so that both parties remain satisfied.
Types of contracts
Procurement side
As a manufacturer, you come into contact with various contracts. On the purchasing side, in addition to individual purchase orders, you sometimes have framework agreements with regular suppliers. In these framework agreements you make fixed agreements about the conditions under which you purchase from that supplier. These framework agreements are often for a longer term, or even indefinite, and notice periods apply. In some cases there are also exclusivity agreements, agreements on minimum purchase quantities or minimum turnover per year, or agreements on the use of intellectual property rights.
These procurement contracts are critical to your company's agility. When it comes to important raw materials, components or materials, you want to have certainty, so that you do not have an interruption in your supply chain. On the other hand, you also want to be able to switch if your own regular supplier cannot deliver on time or if there are, for example, quality problems, or delays in further developments, etc.
Sales side
On the sales side, you also have different types of contracts. As with the purchase side, you can work with individual purchase orders, which are actually also, and especially if there are more frequent purchases, a contract. Or you work with framework agreements. You want to do that especially if it's large quantities per year, you have to buy specifically for that customer, or if it's a customer that comes back regularly. Then you don't have to think and negotiate things like price, terms, delivery dates, etc. every time.
It may be that you work with resellers, wholesalers, distributors or traders, who resell your products back to the end customer. In that case, whether this is put on paper or not, there will often be what is known as a distribution agreement.
Making appointments
With your reseller, wholesaler, distributor or dealer, you often want to agree in contracts, such as:
- In what area are they allowed to sell? Who are they allowed to sell to? Do they have area exclusivity?
- Are they allowed to offer competing products in addition to your products?
- What prices or discounts apply? Is there a minimum purchase quantity?
- Should or should they advertise your brand?
- Should their store or the presentation of your products (in a point of sale, store, or online) meet certain requirements?
- What is the warranty on the products? Does the distributor, reseller or wholesaler provide after-sales support, technical support, etc.? ?
Intellectual property rights, engineering
In some cases, you may be creating custom products for your client, with or without that client's input. In that case, you also make agreements in contracts about those developments (design, engineering), the ownership of those designs and engineering, and the use of intellectual property rights.
It may also be that you manufacture the products by order of the customer and on the basis of his drawings, for example because you are an OEM manufacturer or contractor. In that case you must also make agreements about intellectual property rights, but also, for example, about responsibility and liability if something turns out to be wrong with the design (design faults), the possible advisory obligation of you as manufacturer and expert in that field, etc.
Contractual elements
Many entrepreneurs think that everything is in the general terms and conditions and that they therefore no longer need to make certain agreements explicitly in contracts. This may be correct in principle, but it often goes wrong when the general terms and conditions are declared applicable. For example, because not only you, but also your customer or supplier refers to his conditions, and therefore it is not clear whose conditions actually apply. Many legal proceedings, instead of being about a party's claim, are mainly about whether or not those general terms and conditions apply. As a result, sometimes you don't even get to the actual question of liability and damages.
Therefore, it is a good idea to also write down the most important agreements in your Purchase Order (PO), purchase contract, sales contract or Order Confirmation.
It is not just about price and numbers but also about:
- Delivery deadline, and how binding is it (indicative, fixed, what happens if the deadline is exceeded).
- Quality (what can the customer expect).
- Delivery terms: Incoterms are often referred to here. Have you agreed on the correct Incoterm?
- Claims period, warranty period, warranty exclusions (think wear parts, improper use, unauthorized repairs, etc).
- Payment terms: when must or may be paid and what happens if payment is not made on time.
Especially for deliveries to customers in countries outside the EU, it is a good idea for contracts to check whether the insurance covers possible claims by foreign parties (abroad in a foreign court) and whether attorney's fees (abroad in a foreign court) are also reimbursed. Sometimes certain countries, such as the U.S. or China, and recently also Russia, are completely excluded, or in case of damage not everything is reimbursed that would be paid in the Netherlands. Often you can take out additional insurance, although this can be quite expensive.
There may also be claims in the customer's or supplier's contracts or general terms and conditions that are not covered under insurance.
In all cases of contracts, it is important to check under which legal system you are contracting with the client. Even if you do not make agreements with each other, you cannot automatically assume that if you have an international customer or supplier, it will be under Dutch law and that you can seek redress in a Dutch court. Moreover, outside the EU, dispute resolution is not equally effective everywhere, so you need to look carefully at how you get your money or belongings if things go wrong with your business partner.
Some standard payment conditions that work and make sense within the Netherlands or the EU can be better replaced by good payment agreements in which you work with letters of credit or bank guarantees, so that there is a simultaneous exchange of (approved) goods and money. But even then, in case of complaints, you may get a raw deal with the supplier. Or that you run the risk of high damage claims or sky-high legal fees if you have delivered defective products, as is often the case in the US.
Because you don't always have control over what happens around you (think Covid-19, Suez Canal, Ukraine war) you will also have to check contracts carefully for sufficient 'escapes' . These are also called 'force majeure clauses'. This refers to circumstances that prevent you from fulfilling your part of the agreement, but for which you yourself are not 'to blame'. Force majeure is not a fully defined term, so you would do well to describe what constitutes a force majeure situation in your particular case. For example, consider the lockdowns during Covid-19, that in itself was not a force majeure situation. It would have been different if you had defined, for example, "obstruction of the free movement of goods or persons" as a force majeure situation.
Legal aspects
You have to comply with all kinds of laws and regulations, especially if the products contain electronics. In a contractual sense, there is then always the question of who is responsible for compliance with local legislation. While you can get by with a CE mark in the EU, this does not apply to other countries such as the UK since the Brexit. If no agreements are made about this, the question is whether your supplier has to supply a UK-proof product. You will have to agree that separately.
Subsequent discussions sometimes arise as to whether or not a product meets a CE standard, a DIN standard, or another international, national, or industry standard. Often a customer claims that a product is defective because it does not meet a certain standard. For this, you usually have to have expressly agreed that a product will meet that standard. Otherwise, unless it is required by law to meet certain conditions, it is not part of the contract.
Sustainability and ethics
Nowadays, even in contracts, there is an increasing focus on so-called ESG (Environment - Social - Governance) compliance. In short, this means that you manufacture your products in a way that has as little impact on the environment as possible, that you do not exploit people and that you organize your company and make decisions in a fair and careful manner.
Many multinationals have extensive separate contract provisions or even page-long appendices to their contracts in addition to conditions in this area in the general terms and conditions or fine print. Thus, you often see provisions on anti-terrorism, prohibition of bribes, outsourcing to low-wage countries and working conditions, etc. As an SME entrepreneur, those provisions often seem rather American or hysterical. But for those companies, it is serious business. It is often related to the fact that they themselves have substantial audit obligations. These, in turn, they impose on their suppliers. If you don't comply, you risk having your contract terminated. If you are a supplier of a supplier of such a multinational, you may also have to deal with these - imposed - provisions, and this is happening more and more often.
Technology and digitization
New technologies such as contract management software and blockchain can improve the process of contracting in the supply chain, make it more efficient and increase transparency. Tracking and properly managing contracts is something that becomes a hefty chore fairly quickly. Even if your company is still relatively small. Especially also when it comes to the familiar question: "which version is the most current one now?", knowing what notice periods there are, or when the price lists need to be renewed. Often everyone stores stuff in their own folder/by their own department, so that if Kees from purchasing is sick, Jan from sales or Pete the CFO doesn't remember.
You can of course buy an expensive contract management system, which is especially interesting for large companies, but even as a small company you can already do a lot to keep everything under control:
- Determine a central place on your server where all signed contracts come in and everything that goes with them (renewal letter, current price list, minutes of progress meetings).
- Make sure everyone, from purchasing to sales, stores everything there.
- Create a fact sheet for each client that includes what kind of contract there is, what the term is, who the contacts are, etc.
Best practices
Of course, we'll give you tips on how to contract effectively in the supply chain:
- Match buying and selling.
- Make sure you have a good understanding of how to use general terms and conditions.
- Pay attention to risk management: the larger the contract (volume/turnover), the more carefully it should be looked at.
- Create standard processes and standard documents (e.g., all orders over amount x must pass the finance director or all orders with volume y must be handled with purchasing/sales according to 4-eye principle).
- Ensure that key customers/suppliers have firm contracts with clear agreements on term, warranty, liability(s limitation), termination, quality, etc.
Learn more
Do you still have questions after reading this blog? Would you like more information or could you use some advice? Feel free to contact us, our specialists are waiting for you.