Managing Key Supplier Responsibilities: Part II

Editor’s Note: This is the second of a four-part series written by Thomas Keenan and Geofrey L. Master, Mayer Brown JSM

Product pricing and productivity means the ability of a manufacturer to offer, maintain and improve the best total price over the course of the product life cycle in light of challenges from material, labor and currency markets. Best total price does not mean necessarily the lowest purchase price to the customer from the manufacturer, but the best final net cost to customer through the end of the product life cycle—taking into account the costs of product returns and warranty costs borne by the company to end-consumers.

Best total cost can only be achieved when supported by confidentiality, sharing of best practices and transparency as critical elements of the relationship. Sourcing agreements for manufacture often require that the parties work from a “cost plus” basis using an itemized Bill of Material (BOM) for products. To support accurate, full information-sharing between the parties , sourcing agreements should have bilateral confidentiality provisions.

Manufacturer that only purchase commodity materials from spot markets when they receive an order will always be vulnerable to commodity fluctuations and will have little ability to maintain stable pricing for their customers in volatile markets. One method supporting lower commodity costs by assuring production levels is to include a contractual customer commitment to purchase a carefully defined portion of forecasted volume of products. This commitment allows a supplier to purchase input commodities at troughs in the market throughout the commitment period.

Pricing provisions within manufacturing contracts should require that the manufacturer make transparent to the customer the actual prices paid for input commodities. With such accurate information, the weighted-average price of a product commodity can form the basis of a commodity-management mechanism in the contract. This type of commodity-management mechanism introduces a regular review rhythm to the parties and requires that they share commodity price increases or decreases on a scheduled basis. The advantage of such a mechanism is that it removes the emotion, risk and impact of constant requests for price increases and reduces the threat of the manufacturer stopping product shipment due to financial constraints. Furthermore, such mechanisms can capture decreases in the commodity market and align the interests of both manufacturer and customer.

Productivity improvement means net reduction in standard cost for a product. Ideally this measure is based on year on year reductions. In the face of constantly rising commodity and labor costs, manufacturers should be required to find ways to reduce costs through process improvement (waste elimination exercises such as Kaizen ) and tasked with suggesting ways to improve costs through changes to the product specification. Sourcing contracts should align the interests of both customer and manufacturer through shared savings from provisions that govern such tools at value-added engineering (VAE), use of customer commodity contracts and collaborative Kaizen activities.

Geof Master
As a partner in Mayer Brown JSM’s Business & Technology Sourcing practice, Geof Master has broad experience in sourcing transactions, including the outsourcing and offshoring of information technology and services as well as of business processes. He can be reached at [email protected].

Tom Keenan
Tom Keenan is a Registered Foreign Lawyer (Victoria, Australia) of Mayer Brown JSM. He can be reached at [email protected].

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