OSCM CH13,14
feras81
chapter_14_contract_management.pptxContract Management
Chapter 14
OSCM 3660:002 Strategic Sourcing
Spring 2016
Sandeep Jagani
PURCHASING & SUPPLY CHAIN MANAGEMENT, 5e
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
1
Chapter Overview
Elements of a contract
How to negotiate and write a contract
Types of contracts
Long-term contracts in alliances and partnerships
Nontraditional contracting
Settling contractual disputes
Purchasing & Supply Chain Management, 5e
2
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Managing Contractual Relationships with Suppliers
Impossible to predict every single possibility at beginning of a contractual relationship
Importance of moving beyond legal contractual guidelines to improve long-term suppliers and those that supply critical and strategic goods and services
Purchasing & Supply Chain Management, 5e
3
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Pitfalls in Global Commerce
Signing contracts without reading and understanding them
Making risky assumptions
Making or accepting unreasonable demands
Purchasing & Supply Chain Management, 5e
4
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Pitfalls in Global Commerce
Assuming terms in one market are same as in another
Not recognizing cultural or legal landmines
Failing to utilize sufficient resources in contract negotiations
Ongoing commitment and relationship often supersede written contracts
Purchasing & Supply Chain Management, 5e
5
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Preventive Contracting
Spending time in initial stages to …
More fully understand stakeholder requirements and expectations of contractual elements
Flexibility in contract terms and clauses
Usually costs less to avoid getting into trouble than to pay for getting out of trouble
Purchasing & Supply Chain Management, 5e
6
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
What Does a Purchase Contract Do?
Establishes terms and conditions by which parties agree to conduct business
Defines type of relationship
Provides way for parties to obtain mutual benefits
Represents the understanding of parties
Purchasing & Supply Chain Management, 5e
7
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Basic Parts of a Contract
Introduction
Identifies parties
Clauses
Describe different sets of conditions that parties agree to follow
Schedules and appendices
Provides specific details behind clauses
Purchasing & Supply Chain Management, 5e
8
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Sample Beginning of a Contract
THIS AGREEMENT IS MADE this ___________
day of ___________ 2011 BETWEEN
ABC COMPANY LIMITED, a company registered in England and having registered offices at 44 Downing Street, London, U.K. (the “Buyer”) and
XYZ, INC., a corporation duly organized under the laws of the State of Illinois and having its principal place of business at 123 Ridge Road, Chicago, Illinois 60014, U.S.A. (the “Supplier”).
Purchasing & Supply Chain Management, 5e
9
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Elements of a Purchase Contract
Introduction
Definitions
Scope of agreement
Purchase orders
Supply and delivery
Specifications, quality, and health, safety, and environment
Purchasing & Supply Chain Management, 5e
10
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Elements of a Purchase Contract
Payment
Liability
Force majeure
Effective date and termination
Intellectual property
Assignment and contracting
Technology improvements
Purchasing & Supply Chain Management, 5e
11
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Elements of a Purchase Contract
Most favored customer
Confidentiality
Statistics
Key performance indicators and compensation
Notices
Severability
Purchasing & Supply Chain Management, 5e
12
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Elements of a Purchase Contract
Third-party rights
Free trade areas
Minority- or women-owned business enterprises
General
Governing law
Signatures
Appendices (schedules)
Purchasing & Supply Chain Management, 5e
13
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Typical Contract Schedules
Product/process/service specifications, statement of work, or scope of work
Prices and price adjustment mechanisms
Health, safety, and environmental guidelines and requirements
Packaging materials
Purchasing & Supply Chain Management, 5e
14
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Typical Contract Schedules
Approved method of manufacture, delivery, or service deployment
Delivery targets and lead times
Supplier’s hours of operation
Storage and inventory control
Quality assurance manual
Loss allowance calculations and throughput allowances
Purchasing & Supply Chain Management, 5e
15
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
How to Negotiate and Write a Contract
Often modified from earlier agreements without material changes
Minimizes administrative effort
Assumes that previous contracts are appropriate in current agreement
Start with general form and/or sample contracts
Get advice from corporate counsel
Purchasing & Supply Chain Management, 5e
16
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Information in Purchase Contracts
What is being bought and cost
How purchased item is to be shipped and delivered
How items are to be installed (if appropriate)
How and when buyer will accept products
Acceptance clause
Purchasing & Supply Chain Management, 5e
17
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Information in Purchase Contracts
Appropriate warranties
Remedies
Including liquidated damages
Clauses specifying consequences for late performance
Boilerplate
Standard terms and conditions
Dispute resolution mechanisms
Purchasing & Supply Chain Management, 5e
18
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Key Details in International Contracts
Forum selection in the event of dispute
Choice of applicable law
Payment currency
Language
Force majeure
Excuses contract performance under non-controllable circumstances
Purchasing & Supply Chain Management, 5e
19
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Types of Contracts
Fixed-price contracts
Firm fixed price
Fixed-price contract with escalation
Fixed-price contract with redetermination
Fixed-price contract with incentives
Purchasing & Supply Chain Management, 5e
20
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Types of Contracts
Cost-based contracts
Cost plus incentive fee
Cost-sharing contract
Time and materials contract
Cost plus fixed-fee contract
Purchasing & Supply Chain Management, 5e
21
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Firm Fixed Price
Most basic contractual mechanism
Price stated does not change
Regardless of environmental changes
Can be obtained using
Price quotation
Supplier response to RFP
Negotiation
Simplest and easiest contract
Purchasing & Supply Chain Management, 5e
22
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Firm Fixed Price
Supplier bears financial risk in rising market
Buyer assumes financial risk in declining market
Supplier may add contingency fee if uncertainty is high
Important for buyer to understand underlying market conditions
Purchasing & Supply Chain Management, 5e
23
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Fixed-Price with Escalation
Used for longer-term contracts
Where costs are likely to increase over time
Escalation clauses allow either price increase or decrease of base price
Should be tied to independent, well-established published third-party index
Purchasing & Supply Chain Management, 5e
24
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Fixed-Price with Redetermination
Used when parties cannot accurately predict labor or material costs and quantities required upfront
Target price is determined using “best guess” estimates
At predetermined time, buyer and supplier review actual experience and redetermine fixed price
Purchasing & Supply Chain Management, 5e
25
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Fixed-Price with Incentives
Terms and conditions allow cost-savings sharing with supplier
Predetermined rate of sharing – often 50/50
Similar to fixed-price with redetermination contract
Typically utilized under conditions of high unit cost and relatively long lead times
Purchasing & Supply Chain Management, 5e
26
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cost-Based Contracts
Used when there is high risk of supplier contingency fee that would be included in fixed-price contract
Lower risk of economic loss for supplier
Economic risk is transferred from supplier to buyer
But can result in much lower cost to buyer
Purchasing & Supply Chain Management, 5e
27
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cost-Based Contracts
Need to include terms and conditions that require supplier to carefully monitor and control costs
Parties must agree on allowable costs
Generally applicable when goods and/or services are expensive, complex, or important to buyer and there is high degree of uncertainty
Purchasing & Supply Chain Management, 5e
28
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cost Plus Incentive Fee
Similar to fixed-price plus incentive except incentive is based on changes in allowable costs
May include cost-savings sharing at predetermined rate
Appropriate when parties are confident of initial target cost estimates
Purchasing & Supply Chain Management, 5e
29
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cost-Sharing
Allowable costs are shared between parties on predetermined percentage basis
Key is identification of firm set of operating guidelines, goals, and objectives
Need to spell out expectations clearly
Purchasing & Supply Chain Management, 5e
30
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Time and Materials
Generally used in plant and equipment maintenance agreements
Costs cannot be determined prior to actual repair
Based on agreed upon hourly labor rate plus overhead and profit percentage
Requires “not to exceed” amount
Little buyer control over estimated maximum price
Purchasing & Supply Chain Management, 5e
31
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Cost Plus Fixed-Fee
Supplier receives reimbursement for all allowable costs up to predetermined level plus fixed fee
Fixed fee represents percentage of targeted cost
Supplier is guaranteed minimal level of profit above its costs
Little motivation to control costs
Should include cost productivity
Purchasing & Supply Chain Management, 5e
32
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Types of Contracts
Purchasing & Supply Chain Management, 5e
33
| Type of Contract | Buyer Risk | Supplier Risk |
| Firm-fixed price | Low | High |
| Fixed-price with escalation | ||
| Fixed-price with redetermination | ||
| Fixed-price with incentives | ||
| Cost plus incentive fee | ||
| Cost-sharing | ||
| Time and materials | ||
| Cost plus fixed-fee | High | Low |
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Contract Selection Considerations
Component market uncertainty
Long-term agreements
Degree of trust between parties
Process or technology uncertainty
Supplier’s ability to impact costs
Total dollar value of purchase
Purchasing & Supply Chain Management, 5e
34
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Desirability of Contract Types
| Environmental Condition | Fixed-Price Contract | Incentive Contract | Cost-Based Contract |
| High component market uncertainty | Low | Desirability of Use | High |
| Long-term agreements | Low | High | |
| High degree of trust | Low | High | |
| High process/ technology uncertainty | Low | High | |
| Supplier’s ability to affect costs | Low | High | |
| High $ value | Low | High |
Purchasing & Supply Chain Management, 4e
35
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Contract Length
Spot contracts
Purchases that are made on nonrecurring or limited basis
Short-term contracts
Contract purchases that are routinely made over relatively limited time horizon
Long-term contracts
Made on continuing basis for specified or indefinite period (often >1 year)
Purchasing & Supply Chain Management, 5e
36
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Potential Benefits of Long-Term Contracts
Assurance of supply
Access to supplier technology
Access to cost/price information
Volume leveraging
Supplier receives better information for planning
Purchasing & Supply Chain Management, 5e
37
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Questions in Long-Term Contracts
What is the potential for opportunism?
How likely is supplier to take advantage of buyer? Or vice versa?
Is this right supplier to engage in long-term contract?
Is there fair distribution of risk and gains between parties involved?
Purchasing & Supply Chain Management, 5e
38
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Risks of Long-Term Contracts
Supplier opportunism
Selecting the wrong supplier
Supplier volume uncertainty
Supplier foregoes other business
Buyer is unreasonable
Purchasing & Supply Chain Management, 5e
39
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Contingency Elements of Long Term Contracts
Initial price
Too high inflated future profits
Too low lower supplier motivation
Price-adjustment mechanisms
Choice of index or related product
Supplier performance improvements
Evergreen, penalty, and escape clauses
Purchasing & Supply Chain Management, 5e
40
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Nontraditional Contracting
IT systems contracts
Systems contracting risks
Level of service
Turnkey vs. modular vs. shared
Price
Performance criteria
Procedures
Purchasing & Supply Chain Management, 5e
41
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Other Service Outsourcing Contracts
Facility management services
Research and development
Logistics and distribution
Order entry and customer service operations
Accounting and audit services
Purchasing & Supply Chain Management, 5e
42
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Minority/Women-Owned Business Enterprise Contracts
At least 51% ownership required for federal classification for …
African-American
Hispanic American
Native American
Asian-Pacific American
Women
Physically disabled
Purchasing & Supply Chain Management, 5e
43
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Consulting Contracts
Consultant is agent (or independent contractor), not employee
Buyer vs. supplier
Ownership of intellectual property
Issue of residuals
Copyright ownership
Works made for hire
Need for written contract
Purchasing & Supply Chain Management, 5e
44
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Outside Consultant Goals
Avoidance of misunderstanding
Maintenance of working independence and freedom
Assurance of work
Assurance of payment **
Avoidance of liability
Prevention of litigation
Purchasing & Supply Chain Management, 5e
45
** Most important
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Consultant Contract Terms
Payment on delivery of final report
Late-payment penalties
Negotiable promissory note or collateralized promissory note
Arbitration agreement
Need to develop standard consultant agreement template
Purchasing & Supply Chain Management, 5e
46
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Construction Contracts – Sequence of Events
Determine base of preferred contract bidders
Contact potential bidders for interest
Distribute bid requests
Hold pre-bid meeting to answer questions
Final bid submissions
Award bid
Purchasing & Supply Chain Management, 5e
47
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Construction Contracts
Stated completion period
Realistic timetable
Overhead costs
Safety requirements
Substantiated cost summaries
Contractor claims
Liquidated damages clauses
i.e., penalty clauses
Purchasing & Supply Chain Management, 5e
48
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Other Types of Contracts
Purchasing agreements
Online catalogs and e-commerce contracts
Purchasing & Supply Chain Management, 5e
49
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Types of Purchasing Agreements
Annual contracts
National contracts
Corporate agreements
National buying agreements
Blanket orders
Pricing agreements
Open-ended orders
Purchasing & Supply Chain Management, 5e
50
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Online Catalogs and E-Commerce
Parity between electronic and paper records
Enforceability of shrinkwrap, clickwrap, and boxtop agreements and licenses
Attribution procedures
Digital signatures
Purchasing & Supply Chain Management, 5e
51
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Settling Contractual Disputes
All contracts are subject to dispute and interpretation
The more complex and larger the dollar volume, the more likely dispute will arise
Build in dispute resolution terms and mechanisms
Purchasing & Supply Chain Management, 5e
52
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Alternative Means of Settling Disputes
| Action | Description |
| Legal action | File a lawsuit in federal/state/local court |
| Non-legal actions | |
| Arbitration | Use of impartial third party to resolve contractual dispute |
| Mediation | Intervention by third party to promote settlement, reconciliation, or compromise between parties |
| Minitrial | Exchange of information between managers in each organization, followed by negotiation |
| Rent-a-judge | Neutral party conducts “trial” between parties and is responsible for final judgment |
| Dispute prevention | Progressive schedule of negotiation, mediation, arbitration, and legal proceedings agreed to in contract |
Purchasing & Supply Chain Management, 5e
53
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Legal Action
Traditional dispute resolution mechanism
Grounded in commercial law
Case heard before impartial judge
Issues
Uncertainty
Cost
Length of time
Purchasing & Supply Chain Management, 5e
54
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Arbitration
Fastest growth alternative to legal action
Helps deal with negative emotions
Arbitration clause is often built into contract’s boilerplate language
Source of trained and qualified arbitrators
American Arbitration Association
Purchasing & Supply Chain Management, 5e
55
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Contractual Terms for Arbitration
Spell out location and method of conducting arbitration
Review state statutes to ensure presence of appropriate legal provisions
Word arbitration clauses carefully using applicable laws and American Arbitration Association guidelines
Purchasing & Supply Chain Management, 5e
56
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Dispute Resolution Factors
Relationship between parties
Choice of mechanism
Type of outcome desired by buyer
Setting precedence for future disputes
Need for direct involvement by parties
Level of emotion present
Cost to resolve dispute
Purchasing & Supply Chain Management, 5e
57
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
Dispute Resolution Factors
Time pressures
Information required to reach settlement
Strict rules of evidence
Likelihood of publicity
Credibility of available experts and other witnesses
Purchasing & Supply Chain Management, 5e
58
© 2012 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.
