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.
In our continuing series on contract clauses from a supply chain perspective, last week we talked about governing law and force majeure (ah, COVID, our favorite force majeure ever…). This week we wrap up our series talking about exhibits to the contract.
Contract exhibits are a little different, because they vary so widely. In the example template we’ve been using, Exhibit A is about pricing and pricing improvement efforts such as Value Add/Value Engineering (VA/VE), Exhibit B is about service products and index-linked pricing, and Exhibit C is about the buyer-owned property such as tooling. I have also commonly seen Exhibit A include the scope of work as published in the RFP and Exhibit B focus on pricing schedules and the index-linked pricing. Other things I have seen in exhibits include service level agreements (SLAs), supplier manuals, additional insurance requirements, codes of conduct, background check requirements, cybersecurity requirements, and a host of other items. Essentially, the exhibits are where you can put anything that needs to be contractually agreed between the parties but doesn’t have a clear “home” in the base terms. I like to try to keep my base terms more uniform to avoid confusion when I’m managing hundreds of supplier contracts.
The example contract clauses and discussions of them below are separated by horizontal dividers to help you switch between them.
Exhibit A – Production products, prices, and productivity
1. PRODUCTION PRODUCTS / PRICING / LEAD TIME
The following price list is effective upon execution of this Agreement and shall apply to deliveries made during the term of this Agreement.
| Seller Part Number | Buyer Part Number | Revision Level | Product Description | Lead Time (weeks) | Minimum Order Qty | Unit of Measure (UOM) | Unit Price Each (US$) |
EXHIBIT A-1
PRODUCTIVITY
1. COST SAVINGS/REBATE OPPORTUNITIES
1.1 PIECE PRICE IMPROVEMENT
a) Seller agrees to an annual 3% Product piece price savings (“Savings Target”) over the term of the Agreement, with a minimum of 3% savings each year. Savings will be calculated by using the previous year’s Product sales volume and must be mutually agreed between the Parties. Should Seller not reach the 3% Product piece price Savings Target during the Agreement term, Seller will issue Buyer a cash disbursement for the portion of the Savings Target not achieved during the last quarter of the Agreement term. Buyer may issue a new Purchase Order reflecting the updated Prices after application of these reductions, and Seller shall accept such updated Purchase Order, but Seller shall provide such price reductions even if a new Purchase Order is not issued.
1.2 VALUE ADDED VALUE ENGINEERING (“VAVE”) SAVINGS
Seller agrees to 3% in VAVE reductions, defined by the Parties agreeing to a pipeline of qualified VAVE savings opportunities, pre-approved by Buyer, (hereinafter “VAVE Savings Goal”) for each fiscal year during the term of this Agreement. Reductions tied to VAVE include, but are not limited to redesign, material substitution, freight/logistics, working capital improvements, labor savings at Buyer, Product listed in Exhibit A, and shared savings based on volume buy from shared supplier efforts via purchasing. Savings will be agreed upon by both Parties and approved in writing. For VAVE projects initiated by Buyer, Seller’s engineering hours will be credited towards the VAVE Savings regardless of whether the said project is implemented or initiated by Buyer. All engineering hours must be approved by Buyer’s Purchasing Category Manager prior to Seller engaging in the said project. Seller’s engineering rate is set at $____/hr. Should a VAVE savings initiative be approved by Buyer, but not implemented, Seller will receive credit for the savings towards the VAVE Savings Goal. Any implemented VAVE reductions that in total exceed the VAVE Savings Goal over the Agreement term will be shared by Buyer and Seller on a 50/50 basis. If Seller fails to find or achieve the VAVE Savings Goal for any fiscal year during the term of this Agreement, Seller shall issue a cash disbursement to Buyer for the difference between the identified reductions and the VAVE Savings Goal within sixty (60) calendar days from the end of Buyer’s fiscal year, i.e. September 30th.
For clarification purposes, the following are the time periods for the above calculation and payments of VAVE Savings:
1) Oct 1, 20XX through Sep 30, 20XX
2) Oct 1, 20XX through Sep 30, 20XX
3) Oct 1, 20XX through Sep 30, 20XX
4) Oct 1, 20XX through Sep 30, 20XX
1.3 VOLUME INCENTIVE
In the event Buyer’s Product purchases exceeds ______% percent of total purchased Product volume in a given Agreement year starting from the Effective Date, Seller shall provide a ______% percent rebate on total Product purchases to Buyer within thirty (30) days from the end of that respective Agreement year in the form of a cash disbursement to Buyer.
| EXAMPLE: | |
| Annual Product Purchases: | Rebate: |
| $0 – $1,249,999. | 0% |
| $1,250,000 & above | 1.0% on all purchases |
1.4 PURCHASE ORDER/RELEASE LIABILITY
a) Discrete POs. Subject to Buyer’s obligations in this section, Buyer may at any time cancel all or any part of a Discrete PO. Upon any such cancellation, Seller will, to the extent and at the times specified by Buyer, stop all work pertaining to the cancelled portion of the Discrete PO, incur no further costs, and protect all property in which Buyer has or may acquire an interest. Buyer will not be responsible for any costs in connection with a cancelled Discrete PO except for payment of: (i) the portion of the Goods delivered and/or Services performed prior to notice of the cancellation provided that such Goods and/or Services meet all of the Specifications and requirements of the Contract; (ii) raw materials and components (if any) that were purchased by Seller in order to meet the requirements of the Discrete PO and that: (A) met all of the relevant Specifications under the Contract; (B) were ordered no earlier than applicable Lead Times of the materials and components in order to meet the delivery dates specified in the Discrete PO; and (C) could not be returned for a refund or credit or used for or sold to any of Seller’s other customers.
b) Production and Service Purchases; Releases. An Authorized Purchaser may reschedule or cancel all or any portion of any Release issued by such Authorized Purchaser upon written notice, at any time. An Authorized Purchaser also may require that Products requested in a Release be delivered in partial shipments. Such written notice may occur in any manner, including hand delivery, mail, courier, facsimile, email or an electronic data interface system. The Authorized Purchaser’s only liability for rescheduling or cancelling or changing any Purchase Order or Release shall be to pay (as provided for herein) for the lesser of either (i) the Products that are to be delivered under the Release within the first four (4) weeks covered by such Release or (ii) the Products whose production had begun prior to the notice of the cancellation.
c) Purchase Order Disclaimer. Buyer makes no warranties regarding the volume or quantity of Products that Buyer or any other Authorized Purchasers will order, if any. Volume or quantities referenced in a Purchase Order or Release or in discussions or other documents are non-binding on Buyer, except to the extent provided in Section 1.5. Buyer has no obligation to issue any Purchase Orders to Seller.
This exhibit is structured to lay out the pricing between buyer and seller, as well as provide a cross-reference between buyer and seller part numbers. Note the first part does not have any estimated volumes in it; when possible I try to avoid putting any kind of volume or annual/monthly quantity in the contract. Even if there is a clear disclaimer that volumes are for estimates only, the supplier can argue that the buyer is obligated to buy that volume. This can pose a major problem if there is a large change or drop off in company sales. The second part of this exhibit focuses on the supplier continuously improving their product and production, and passing those savings onto the buyer. This contract template was written for a high-volume manufacturer, but something like this may still be applicable for other material purchases.
The first section asks for a flat 3% price reduction annually from the supplier, based on the idea that they will find efficiencies in making the part year over year. Suppliers almost always redline this section or strike it entirely, to no one’s surprise. However, suppliers who run a Lean or Six Sigma program do expect this kind of efficiency gain internally, so I recommend pushing back if a supplier has that kind of manufacturing program. It is best to get a quote before sending this clause to a supplier, if possible, because otherwise they will simply price that 3% annual reduction into their initial costs so they can lower it later.
The second section is about value engineering, which is essentially redesigning a component to make it less expensive to manufacture. This is mostly applicable to custom parts designed by or for the buyer, not off-the-shelf commodities. This clause also only applies if the buyer has a technical team willing and able to review improvements, because they would need to approve any changes. Examples of VA/VE would be making all fasteners in an assembly common, changing weldments into castings, reducing the thickness of sheet components, making it more difficult to assemble a subassembly incorrectly, moving components to standard sizes, and similar changes.
The section on volume incentives is probably the most applicable to all buyer organizations. I do recommend a clause like this one in contracts, especially if the buyer knows there is a chance volumes could increase over the course of the contract. A relationship between procurement and the business unit is critical, because that business unit knows if they have a new project or design coming up that might increase volumes, and hopefully they have an estimate on how much those volumes might increase. Whether you use a rebate or some other mechanism is up to you, I have some thoughts on supply chain rebates here.
The last section in this example is about how “Discrete POs” function, which would also be called a blanket release. The intent of this contract was to establish a blanket purchase order that outlined needed volumes for approximately a year, and then issue discrete POs against that blanket to authorize shipments when needed. This section also outlines, in detail, what happens if a discrete PO is cancelled.
Exhibit B – Service Materials and Market-Driven Materials
1. SERVICE PRODUCTS / PRICING / LEAD TIME
The following price list is effective upon execution of this Agreement and shall include all Products listed in Exhibit A and below in this Exhibit B and apply to deliveries made during the term of this Agreement.
| Seller Part Number | Buyer Part Number | Revision Level | Product Description | Lead Time (weeks) | Minimum Order Qty | Unit of Measure (UOM) | Unit Price Each (US$) |
2. MARKET-DRIVEN MATERIALS
The following price list is effective upon execution of this Agreement and shall include all Products listed in Exhibit A and below in this Exhibit B and apply to deliveries made during the term of this Agreement. The price of the base material included in each Product (“Total Material Cost”) is identified below and shall be reviewed and may be subject to change once every calendar year during the twelve (12) months commencing on the “Date: Base Set” below (“Review Period”), otherwise the Total Material Cost is firm and fixed. During each Review Period, if the Total Material Cost is within the below agreed to threshold range (“Threshold”), then the Total Material Cost shall not result in any Price changes for the Product. In the event that the Total Material Cost differs from the current Price by more than the Threshold, the Total Material Cost for the Product shall be adjusted by the amount, which the Total Material Cost difference is greater or less than the Threshold. Any fluctuation within the Threshold shall be absorbed by Seller and shall not result in any Price changes for the Product.
Total Material Cost:
| Seller Part Number | Buyer Part Number | Rev Level | Product Description | Lead Time (weeks) | Material Type | Material Weight (lbs) | Index Cost ($/lb) | Total Material Cost ($) | Date: Base Set | Index | Threshold for changes |
This exhibit is for purchasing materials for service/repair parts, and also includes market-driven (index-linked) materials. The first section of this exhibit looks similar to the one in Exhibit A, but is intended to be for components of the parts purchased. For example, if the buyer is purchasing a gear shift subassembly, the service components might be the knob on the top of the gear shift, the decal, the gear shift shaft, and the base. This allows the buyer to service their own customer and not require their customer purchase the entire subassembly to make repairs to broken components.
The second part of this exhibit is for index-linked pricing when the cost of a material can be tied to third-party indices. When index-linked pricing is used, this is seldom the actual table I end up with. Every supplier has their own Excel sheet to calculate pricing based on indices, and so I often end up simply copying and pasting that table here. The “threshold for changes” part is important, however, because it has the opportunity to reduce the administrative burden of index-linked pricing. I hate making price changes of 1% to components because the indices only moved a little bit. I also hate making price changes too often. It costs labor time and headaches to be constantly changing pricing in a system, and category managers have more important things to do. When I can, I try to make the threshold for a change 5%, either up or down, meaning only if the price index causes the price to change by more than 5% does the price change calculation kick in.
Exhibit C – Buyer-Owned Property
BUYER OWNED PROPERTY
(Note: if applicable, please list property here by p/n, location, qty and value)
I should probably take this exhibit out of my template, as it’s only applicable in corner cases. This is a very manufacturing-centric clause and is really only applicable if the buyer is purchasing tooling to be held and used by the supplier. I’m leaving it here today as a placeholder for “all the other stuff” you might want in an exhibit. Anything that is applicable to a specific supplier or specific purchase goes here, or that otherwise is not desired to change the core terms and conditions. I might argue that if you have an exhibit with the same template for every supplier (such as cybersecurity requirements), you might look at incorporating that language into your base terms.
That wraps up our deep dive into contracts! Here’s links to the whole series, in case you’re looking for something specific!
Pricing Control and Quality Clauses
Law Compliance and Purchase Orders
Nonconformance, Inspection, and Payment Terms
Product Changes and Buyer’s Property
Indemnification and Termination
Governing Law and Force Majeure
Next week I’ll go back to more individual topic articles until I start whatever series is next. If you’d like to talk to me about your company’s contract clauses, let’s chat.