Suppliers and Supply Agreements

Nearly every business needs suppliers. If you manufacture products, you need raw materials and components. If you run a restaurant, you need food and beverages. If you own a retail store, you need inventory of the goods you sell. And the success or failure of your business could turn on your relationship with your suppliers and their ability to deliver the quantity of goods you need at the quality you desire, on time, and at a predictable price.

For that reason, it is always a good idea to have alternative sources of supply for everything that is critical to your business; otherwise the success of your business will depend entirely on the success of your supplier’s business, which you have no control over. Even if you own a small manufacturing business you may want to have more than one source of raw materials. Otherwise, if for any reason your supplier is unable to deliver on time, it will mean the cancellation of orders and the loss of customers. This could damage your business reputation in an irreversible way.

Whether to put in place a long-term supply agreement or retain the flexibility of an order-by-order arrangement is a question that depends on the product being supplied and its importance to your business. With a long term deal, you can get the supplier to guarantee a certain quantity of goods every week, month, quarter, etc. You may even be able to get a supplier to dedicate a certain percentage of its production capacity to fulfilling your orders. In exchange, however, you will probably have to guarantee a minimum number of orders as well. For everything other than one-off purchases, it is a good idea to have a Supply Agreement in place to increase efficiency, ensure a stable working relationship with your supplier and guarantee as much as possible that you receive the products you desire on time and at agreed prices.

The Supply Agreement should clearly describe your business arrangement with the supplier, as well as identify the terms and conditions applicable to your particular situation. It’s almost never a good idea to build in ambiguities and take the “we’ll cross that bridge when we come to it” approach with suppliers, because the bridge may be on fire and your business at risk when that moment arrives. For this same reason, you should not accept the supplier’s “standard” terms and conditions if you think they don’t apply to your business in hopes that the supplier will not strictly enforce them when the time comes.

All supply agreements should have the following components, written clearly, without ambiguity, and in sufficient detail:

• Goods (or services) to be provided by the supplier, including detailed specifications
• Procedure for placing orders
• Price terms, including methods of adjustment (if appropriate)
• Expiration of the agreement and renewal provisions
• Minimum and maximum order amounts (if appropriate)
• Delivery timeframe
• Quality control and procedures for rejection of defective goods
• Payment terms and schedule
• Responsibility for shipping and handling
• Risk and ownership (who is responsible for losses and when title passes)
• Liability and penalties for late delivery and delivery of defective products
• Dispute resolution
• Ownership and use of intellectual property
• Confidentiality of both trade secrets and order and price information
• Approval required for assignment or subcontracting
• Termination procedures

As you can see, once the primary business terms relating to goods to be delivered, price, and timetable are established, the bulk of the Supply Agreement deals with risk allocation, i.e. who is responsible if the goods are not delivered, are late or are defective for any reason.

Suppliers will want to build in many “outs” that absolve them from responsibility for non-performance due to many factors, ranging from a fire in their factory to a worker strike to their own suppliers being unable to deliver. They will also want to cap their liability at the lowest possible level.

From your standpoint as a purchaser, however, none of this matters if the goods are not supplied on time and as specified. Your business will be harmed nonetheless. So you will want to attempt to limit the supplier’s ability to be excused for the failure to deliver for any reason, as well as maximize the supplier’s liability for damages to your business if it does not perform as promised.

Of course in business, it is always better to negotiate an acceptable solution if one party breaches an agreement rather than litigate over a contract. But if you begin with a disadvantageous or ambiguous agreement, you will go into those negotiations with one arm tied behind your back, and your company may get battered and bruised as a result.

On the flipside, it is likely that your business will require you to be a supplier as well. For example, if you enter into arrangements with outside distributers, you may find yourself on the opposite side of the table we just discussed.

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