Disclaimer: I am not an attorney and cannot give legal advice. This series is from a supply chain practitioner’s perspective on negotiating contracts and is simply offering my perspective on common contract clauses. Seek professional legal advice for your own contracts.
Last week we started a deep dive series on contract clauses from a supply chain perspective, so let’s continue this week with pricing and quality clauses! These can show up anywhere in a contract, but in my basic materials template they happen to be up next. The example contract clauses and discussions of them below are separated by horizontal dividers to help you switch between them.
Pricing Clauses
3. PURCHASE AND SALE OF PRODUCTS; PRICE
3.1 Products Generally. Subject to the terms and conditions of this Agreement, Seller will sell and Buyer will purchase those certain products to be used in Buyer’s production of Buyer’s Equipment (“Production Products”) set forth in Exhibit A and those certain products and parts to be used for services and/or aftermarket usage (i.e. parts, assemblies and/or subassemblies and related services) as set forth in Exhibit B (“Service Products” and collectively with Production Products, “Products”).
It’s common (and clear) to start off with a definition of the products, as well as a reference to the pricing schedule. It’s unusual to include the pricing in the the contract itself, as it’s easier to include that part as an exhibit so it can be “swapped out” later when pricing changes without making a mess out of the core contract. In this case, the products are also needed for repairs later, so there is a note creating “Service products” to mean those components that are serving the aftermarket and aren’t going into new equipment.
3.2 Service Products. Seller will provide to Buyer’s Parts Sales Division any Service Product that is supplied to Buyer for production of Buyer’s Equipment. Seller shall also make available any subparts that may be required for service of Buyer’s Equipment. The sum of the prices for the subparts may not exceed the price of the related Service Product assembly. Seller shall sell Service Products solely through Buyer’s Parts Sales Division for Buyer’s dealers and/or business customers. Seller shall continue to supply Service Products at “in-production” pricing, for a period of fifteen (15) years after Buyer ceases production usage of Production Products or Service Products. Seller shall maintain its capability of manufacturing all custom and/or unique Service Products for a period of fifteen (15) years after the applicable Service Product goes out of production or is otherwise discontinued. Seller shall use its knowledge of the applicable Products and industry expertise to assess the best method of preparing for after-production support for such discontinued Products. For up to two (2) years after purchase of Service Product from Seller, Buyer reserves the right to return any non-custom inventory of Service Product, not purchased as part of a last time buy, referenced in Exhibit B or its subsequent amendments. All inventories of Service Product shall be new and not refurbished and in its original packaging. Buyer agrees to pay for all freight to return such Service Product and Seller agrees to issue payment to Buyer for the full purchase price found in Exhibit B or its subsequent amendments within thirty (30) days of receipt of non-custom inventory returns.
Continuing our comment about service products, this clause essentially says the Seller will continue to sell products to the Buyer long after that product is obsolete. Suppliers will often balk at this clause as it is a pain to create high-volume parts at low volumes for years. If a supplier does not allow a clause like this one and your company needs to continue supporting products for your customers, insert some sort of “last buy” clause. This is a clause that allows a company to make a one-time purchase up to six months or so after the product is discontinued and stock up on parts to support their customer. While not ideal, that is the alternative to this continued support. If negotiating a clause like this one, ensure pricing is held for service products, whether they are a last buy or are being purchased over time. Alternatively, index-link the raw material costs only to prevent price gouging on service parts.
3.3 Prices for Products. The prices Buyer will pay to Seller for Production Products and the applicable price reductions for Production Products are set forth in Exhibit A. The prices Buyer will pay to Seller for Service Products are set forth in Exhibit B. Prices are firm for the term of this Agreement unless otherwise indicated in this Agreement. Seller shall continue to improve the Products and services it provides to Buyer and acknowledges that its continuing business with Buyer is based upon its performance. A baseline price for each market-driven commodity will be established on October 1 of each calendar year, and a proportional price adjustment shall be made if costs increase or decrease by more than eight percent (8%). Seller shall provide Buyer all requested information, data, and documentation related to and supporting any price change requests. The prices for the Products shall include all federal, state, county and local sales, use, excise, privilege, payroll, occupational and any other taxes and import and export duties applicable to the sale of Products to Buyer hereunder. Seller will indemnify Buyer against any liability and expense by reason of Seller’s failure to remit the same to the proper taxing authority. Seller’s Product prices are inclusive of insurance, all required and necessary packing and packaging to deliver Products to Buyer in a safe and undamaged condition. Seller warrants prices shown in Exhibits A and B are all-inclusive, and that no additional charges of any type and no increases in the price will be effective, whether due to increased material, labor or transportation costs or otherwise, without Buyer’s express written consent. All pricing, invoicing and payment shall be in United States dollars.
This clause governs how and when prices can change. Sometimes this clause is found in the pricing schedule exhibit, but it is better to have it in the core contract. Note that this example is in the Buyer’s template, so it is heavily in the Buyer’s favor. Whichever template starts the negotiation likely will govern how heavily the pricing rests in the Buyer’s favor vs. the Seller’s favor. This example references “market-driven commodity” pricing, also known as index-linked pricing. It also creates a “buffer zone” of 8% where the price will not change if changes in commodity indices do not cause the price to increase or decrease by less than 8%. It is rare for suppliers to agree to an 8% buffer, although 3-5% is often achievable. The argument to not changing price is the administrative burden on both businesses. Changing system pricing sometimes is made easier through automation and AI, but is time-consuming and done by high level labor, such as Commodity/Category Managers. A 1% change in price is seldom worth the administrative costs required to make that change in the system except for very high volume components.
This clause also clearly labels that pricing is all-inclusive. This prevents last-minute surcharges, such as fuel, logistics, or administrative costs. While logistics costs should be covered with the standard Incoterms clause, they can also sneak in without clear language preventing surcharges.
3.4 Most Favored Nation. Notwithstanding anything in this Agreement to the contrary, the prices of Products sold to Buyer will not exceed the lowest price at which Seller is then selling substantially similar Products and quantities to any other customer of Seller, whether Original Equipment Manufacturer (OEM), Service Products or aftermarket or otherwise. If Seller reduces its prices to others for the same or similar Product, during the term of this Agreement, Seller will reduce the prices to Buyer for such Products accordingly.
I have very mixed feelings about “Most Favored Nation” clauses. This clause basically says that a supplier will not offer a better deal to another customer than the one in this contract. Here are a couple of the issues I have with this:
- It’s extremely difficult to enforce. Contracts are confidential, and should be. So how does the buyer know if the supplier is offering a better deal elsewhere?
- There is more to the value of an agreement or purchase than pricing. Just because pricing is higher or lower does not mean it is better or worse. Perhaps the other customers of the supplier are getting a lower price and a lower level of service.
Despite these issues I see this clause frequently in a company’s template. It is up to the negotiators and legal team what to allow, but I often view this as a clause I will agree to strike in exchange for keeping some other clause I care more about.
3.5 Directed Suppliers. Buyer may designate a third party that Buyer requires Seller to use as a supplier to Seller of parts or services to be used in the manufacture or provision of the Product (such third party shall be referred to as a “Directed Supplier”). Seller agrees to supply materials that meet the required performance and other requirements based on Buyer’s instructions and specifications, using Directed Suppliers if so directed by Company and at the lowest available cost for such parts or services. Such designation does not relieve Seller of any of its obligations under this Agreement. The execution of the agreement between the Seller and Directed Supplier and any disputes arising therefrom will be the responsibility of the parties thereto.
Directed suppliers are not common in many industries, but this is where the clause falls in my template. This means the buyer can have this contract apply to an additional relationship, often a warehouse or distribution site. That third party can purchase goods or services using the same terms as this contract, effectively transferring the contract without legally reassigning it. One example is if the buyer is running a bonded warehouse or foreign trade zone through a third party, who is doing the actual purchasing of the goods flowing into the warehouse before moving them to company sites. Similarly, a 3PL or 4PL might actually do the purchasing for the buyer in order to better manage inventory flow.
Quality Clauses
4. QUALITY CRITERIA
4.1 Buyer’s Quality Standards. Seller must maintain quality standards that are consistent with Buyer’s Product specification(s). At Buyer’s request, Seller shall furnish Buyer with test samples of Product, as may be reasonably required, to determine Seller’s compliance.
4.2 Quality Management Systems. Seller shall be compliant with the applicable quality management systems commonly used for its industry. If Seller is certified according to ISO9001:2008 or ISO/TS16949:2009 or equivalent, Seller shall maintain such certification in full force and effect during the term of this Agreement.
Quality management clauses vary widely by industry and product or service. ISO:9001 is fairly common in manufacturing, while IEEE standards or IEC standards are common in electronics or electric utilities. Note that IEEE and IEC are almost more of a specification than a quality standard, but do have some quality aspects to their requirements. Sometimes companies will have their own quality manuals and requirements, especially large or well-established companies. The important thing here is that any changes to these clauses need full buy-in from the relevant quality department, or that department needs to accept the risk of changes in writing for accountability.
4.3 Record Keeping. Seller shall maintain clear, clean, true, complete and accurate records for seven (7) years of results of acceptance activities for each Product delivered to Buyer and permanent records for any safety critical Product(s). Seller shall maintain such other records for such periods of time as Buyer may reasonably request from time to time. These records shall include the test/inspection criteria, revision level of documents/equipment/software used, activities performed (planning, routing), dates of test/inspection, results, and identification of the individual(s) conducting the activities. Where applicable, the records should include a list of the equipment used for test and/or inspection. Seller shall retain required records for each Product until Buyer notifies the Seller that the applicable Product life has ended and/or Buyer requests the records in which event Seller shall promptly deliver at its cost and expense the requested records to Buyer. Buyer may audit Seller’s quality system at Buyer’s expense at such periodic intervals determined in its sole discretion upon reasonable prior written notification to Seller. Buyer shall not be liable for any lost productivity costs during an audit.
Sometimes the record keeping clauses appear in an audit section elsewhere in the contract. In this case, the primary record keeping is for test reports as part of the ISO:9001 requirements. Sometimes regulatory bodies have particular requirements on record keeping, so ensure you know what those requirements are before changing this clause. Note also that with non-US suppliers, some record-keeping responsibility may fall on the buyer due to differences in laws and regulations.
4.4 Inspection. Upon written request, Buyer and its representatives, may, during normal business hours and following reasonable notice and subject to Seller’s normal security measures (including non-disclosure agreements), witness and inspect Products and any or all stages of Product production or testing. Buyer may review and audit Seller’s quality control procedures as reasonably necessary to confirm Seller’s compliance with its obligations under this Agreement and to assess Product quality. Buyer may also request a meeting with Seller at either Party’s facility on an “as-needed” basis to discuss Product quality and reliability. Seller shall promptly make its representatives available for such meetings.
The inspection clause is one that almost never goes well when exercised. A supplier who needs to be inspected is already down a shaky path with the buyer, and these inspections are often at least slightly hostile. I usually fight to keep these clauses in contracts to keep suppliers on the “straight and narrow,” but will sometimes add “at Buyer’s sole expense” to make it clear the supplier does not have to pay for a buyer-required inspection. This clause is a necessary contingency, but a good supplier relationship and partnership goes much further toward excellent products than an inspection.
Next week we’ll talk about the compliance with laws and purchase order sections as we continue through the contract template. If you’d like to talk to me about your company’s contract clauses, schedule a time to chat.
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