adr international Procurement consultants

The old rules no longer apply

Deals struck before the current economic turmoil may have left your business in a weak position, says Rebecca Howard – so you should take changing circumstances into account when negotiating contracts with suppliers

A company I dealt with recently had entered into a contract with a supplier linked to indices for the price of energy and fuel.

Energy, plastics and transportation were just some of the commodities for which the purchasing goal at the time was simply to secure capacity in a high-pressure market environment rather than achieve the best total cost over a period of years.

But the terms of the contract meant that when it came to renegotiating the deal, these cost elements were at an all-time high and the company lost out big time.

Many purchasing professionals living with such contracts are now trying to renegotiate them for more favourable terms.

The traditional thinking has always been to mitigate the risk of cost variation in volatile categories by linking the contract to indices such as inflation, commodity pricing or a currency exchange rate.

This has seemed like a good idea in the past. But these indices are now very difficult to predict and some organisations have come to think that they may be better off with short-term contracts.

One company I deal with agreed to link pricing to inflation indices in the supplier’s manufacturing country based on the current year’s rate, which was rapidly escalating. However, deflation is now the main concern. Effectively, this company is paying increasing prices for goods and services while costs are reducing for the supplier.

And those US organisations which agreed European deals over the last five years are facing difficult times with the dollar at a significant low against the euro.

What should you do to avoid falling into this trap? First, consider the duration of your contract carefully – the benefits of collaboration through a long-term agreement may not offset the cost variation risks to either party.

Take another look at your contracting strategy. The supply landscape may have been very different when you created your sourcing approach.

Finally, think supply chain, not supplier – understand what the cost drivers are and where they are happening. You may be buying from a UK-based supplier, but their costs of business may be incurred in another country with a very different economic climate.

It is essential that purchasing training is updated to take these factors into account – and we have created new training materials to help purchasing professionals make sense of what to do with their contracts in current conditions.

The training includes, for example, rigorous interrogation of your real-life suppliers’ financial accounts to understand their areas of concern. If a supplier’s annual accounts say they are planning to raise customer prices, as many do, you need to know about it  - and how to forestall it.

Rebecca Howard is Director of ADR Learning

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