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When entering supply agreements, buyers and sellers have different interests around the volume of goods to be purchased or supplied. A buyer wants maximum flexibility on the volume of goods it will order, ...
When entering supply agreements, buyers and sellers have
different interests around the volume of goods to be purchased or
supplied. A buyer wants maximum flexibility on the volume of goods
it will order, while seeking favorable pricing and security that
the seller can provide the volumes the buyer needs. A seller, on
the other hand, wants the buyer to commit on the volumes it will
purchase, so the supplier can plan its production, ensure
predictable sales, and align pricing with volumes.
The purpose of this article is to address these different views
on volumes and summarize each party's perspective. The table
below lists key topics of interest for buyers and sellers with
respect to volumes. It shows how each party might address them in a
contract to support their respective interests. Ultimately, what is
drafted in the contract will be the outcome of negotiations between
the buyer and seller on these volume-related issues.
Volume Estimate vs Purchase Commitment
Buyer
Seller
No binding commitment on volumes of goods to be ordered
Can provide volume estimate, but it is not binding [Volume
estimate is estimated requirement for Goods that buyer expects to
purchase from seller over a set period of time (e.g., monthly or
yearly volume estimate).]
Prices valid for set period of time, regardless of volumes
ordered
If volumes are binding, buyer should have ability to change it
for certain circumstances, such as:
o goods supplied don-t comply with
specifications or other contractual requirements
o other factors impact
volume/forecasts (e.g., a change in regulation that impacts demand
for goods, end/customer demand falls significantly, buyer changes
its business plan)
Require binding purchase commitment from buyer
Require minimum quantity of goods or spend per order
If volumes are not binding, then:
o Tie pricing to amount of volumes
ordered
o Seller has right to change pricing
if certain volumes not met (i.e., change pricing if volume
estimate/market share not met)
o Seller has right to extend length
of contract if certain volumes not met during initial term
o Orders can't be cancelled or
buyer must pay non-recoverable costs of order
Market Share
[Market share is a % of buyer's overall net requirement for
goods in a market that is given to seller, e.g., 80% market share
in EU means buyer purchases 80% of its widgets for the EU market
from that seller, and buyer purchases remaining 20% of widgets for
the EU market from other suppliers.]
In calculating the net requirements this would be what buyers
actually purchase and receive
Buyer
Seller
Can provide market share to supplier but should not be
binding
Buyer has ability to change market share for certain
circumstances, such as:
o goods seller provides aren't
complying with specifications or other contractual requirements
o other factors impact
volume/forecasts (e.g., a change in regulation that impacts demand
for goods, change in buyer's business plan)
If market share is binding and buyer converts it into volume
estimate (for supplier's production planning purposes), the
corresponding volume estimate should not be binding
Require market share to be
binding
For production planning purposes, market share should be
converted into a corresponding market estimate, so seller knows the
number of goods this would correspond to
Process/procedure for auditing market share - buyer total
spend/orders in market versus actual orders received by seller
Tolerance Level
(For volume estimate and/or market share)
Buyer
Seller
Include a tolerance level for the market share or any volume
estimate. A tolerance level is an acceptable variation in quantity
ordered versus the estimate (e.g., +/-3%)
A tolerance level is especially important if any volume
estimate/market share is binding. It protects the buyer if it
orders less or more than volume estimate/market share
Have narrow band of tolerance with respect to volumes buyer
will order
Tolerance level needs to be tightly defined and ideally a
worked example provided
Order Modification
Buyer
Seller
Right to modify or cancel order up until delivery without any
liability to seller
Buyer should notify seller of cancellations/modifications to
order within agreed period (should be a limited/short period)
Ideally orders can't be cancelled once placed
If production already started when buyer notifies supplier,
then buyer should be pay for goods already produced, and raw
materials ordered and other non-recoverable costs
Securing Production/Production Planning: Rolling
Forecast
Buyer
Seller
Rolling forecast should not be binding and not be construed as
minimum purchase obligation
Right to review rolling forecast and any volume estimates or
market shares granted to seller:
o on a regular basis ideally
quarterly at least annually
o in event goods seller provides
aren't complying with specifications or other contractual
requirements
o if other factors impact
volume/forecasts (e.g., a change in regulation that impacts demand
for goods or change in buyer's business plan)
Require buyer to submit rolling forecast of volumes to cover an
agreed period (e.g., monthly 6 month rolling forecast)
If amounts buyer orders don't meet rolling forecast for a
specific period of time (e.g., for 3 consecutive months), then
seller can re-adjust prices to reflect amounts ordered
Allow for seasonality effects on production output i.e. may be
certain periods where output is lower due to holidays or summer
period or planned maintenance
Securing Production/Production Planning: Production
Capacity
Buyer
Seller
Require seller to guarantee a minimum annual production of
volumes
Require supplier to warrant it has production capacity to
fulfill all orders up to an annual volume capacity
Require supplier to warrant it has production capacity to meet
a supply contingency above the annual volume capacity (e.g., annual
volume capacity +5%) to account for unanticipated volume
increases
If seller has to make a warranty regarding production capacity,
the warranty should not apply if certain events occur, e.g., if
supplier can't get raw materials
Ensure annual volume capacity is achievable; if agreeing to
supply contingency, it should be a low %
Securing Production: Contingency Plan
Buyer
Seller
Require seller to have contingency plan demonstrating how it
will secure continuous supply of goods to buyer and handle supply
constraints
This may include alternative production sites in different
geographic locations. Alternative productions sites should meet
buyer qualification standards for production facilities
No additional costs to buyer for production from other
sites
Availability of key raw materials, stores in specified
warehouses in different locations
Contingency plan should account for needs of various buyers on
best efforts basis, but seller has full flexibility to determine
who is supplied first or in which sequence
Supplier Inability to Meet Volumes
Buyer
Seller
If seller can't meet volumes in an order or forecasted
volumes, it should give buyer action plan of how it will rectify
this
Seller should give preference to buyer's orders over
production for other customers
If seller can't meet volumes, buyer can purchase substitute
goods from other third parties without liability to seller-any such
purchases should count toward any purchase commitment buyer has
made with seller
If trouble meeting volumes in an order, work with buyer to
agree on alternative dates for delivery
Don't agree to give preferential treatment to buyer's
orders
Safety Stock
Buyer
Seller
Require seller to guarantee having a minimum amount of stock of
goods (or their raw materials) on hand to ensure buyer can get
amount of goods needed in event of higher demands
Seller should keep stock close to factory/warehouse and store
per industry standards
Safety stock kept in different geographic locations
Key materials list subject to regular updating based on
buyer's requirements
Ensure flexibility on where safety stock can be stored (e.g.,
don't have to keep it on -site; can get stock from
affiliates)
Cost of carrying safety stock paid for by buyer
Buyer must purchase safety stock at end of contract or obsolete
safety stock periodically
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.