Contract Management

Lecture 23 & 24

MUHAMMAD MOAZZAM
Overview
Elements of a contract

Types of contracts

Long-term contracts in alliances and partnerships

Non-traditional contracting

Settling contract disputes

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Pitfalls in Global Commerce

Signing contracts without reading them

Making risky assumptions

Making unreasonable demands

Assuming terms in one market are the same as in another

Not recognizing cultural or legal landmines

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Preventive Contracting

01 02 03
Fully understanding Need for flexibility in It usually costs less to
stakeholder contract terms and avoid getting into
requirements, clauses trouble than to pay
expectations, and for getting out of
communication of trouble
expectations

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 What Does a Purchase Contract Do?

Establishes T&Cs by which the parties agree to conduct business

Defines the type of relationship

Provides a way for the parties to obtain mutual benefits

Represents the understanding of the parties

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Elements of a Purchase
Contract
1. Introduction of the contracting parties
2. Definitions
3. Scope of agreement
4. Purchase orders
5. Supply and delivery
6. Specifications, quality and health, safety,
and environment

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Elements of a Purchase
Contract
7. Payment
8. Liability
9. Force majeure
10. Effective date and termination
11. Intellectual property
12. Assignment and contracting
13. Technology or cost improvements

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Elements of a Purchase
Contract
14.Most favored customer
15.Confidentiality
16.Statistics
17.Key performance indicators and
compensation
18.Notices
19.Severability

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Elements of a Purchase
Contract
20.Third-party rights and liabilities
21.Free trade areas
22.Minority- or women-owned business
enterprises
23.General
24.Governing law
25.Signatures
26.Appendices (schedules)
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Types of Contracts

1. Fixed-price contracts
a) Firm fixed price
b) Fixed-price contract with escalation
c) Fixed-price contract with redetermination
d) Fixed-price contract with incentives

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Types of Contracts

2. Cost-based contracts
a) Cost plus incentive fee
b) Cost-sharing contract
c) Time and materials contract
d) Cost plus fixed-fee contract

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Firm-Fixed Price

• Most basic contractual mechanism

• Price stated does not change
• Can be obtained using
− Price quotation
− Supplier response to RFP
− Negotiation
• Simplest and easiest contract

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Firm-Fixed Price

• Supplier bears financial risk in a rising market

• Buyer assumes financial risk in a declining market
• Supplier may add a contingency fee if uncertainty is high
• Important for buyer to understand underlying market conditions

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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 an independent, published third-party index

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Fixed-Price with Redetermination

• Used when parties cannot accurately predict labor or material costs

and quantities required
• Base price is determined using “best guess” estimates
• At a predetermined future time, buyer and supplier review actual
experience and adjust price

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Fixed-Price with Incentives

• Terms and conditions allow cost-savings sharing with supplier

− At a predetermined rate of sharing
• Similar to fixed-price with redetermination contract
• Typically utilized under conditions of high unit cost and relatively long
lead times

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Cost-Based Contracts
• Used when there is a high risk of a supplier
contingency fee that would be included in any fixed-
price contract
• Lower risk of economic loss for supplier
− Economic risk is transferred from supplier to buyer
• Can result in much lower cost to buyer

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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
a high degree of uncertainty

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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 a predetermined rate
• Appropriate when parties are confident of initial target cost estimates

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Cost-Sharing

• Allowable costs are shared between parties on a predetermined

percentage basis
• Key is identification of a firm set of operating guidelines, goals, and
objectives
• Need to spell out expectations clearly

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Time and Materials

• Generally used in plant and equipment maintenance agreements

− Costs cannot be determined prior to the actual repair
• Based on an agreed upon labor rate
• Requires a “not to exceed” amount
• Little buyer control over the estimated maximum price

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Cost Plus Fixed-Fee

• Supplier receives reimbursement for all allowable costs up to a

predetermined level plus a fixed fee
• Fixed fee represents a percentage of the targeted cost
• Supplier is guaranteed a minimal level of profit above its costs
• Little motivation to control costs

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Types of Contracts

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Desirability of Contract Types
Environmental Fixed-Price Cost-Based
Condition Contract Incentive Contract Contract
Desirability of Use
High component
Low High
market uncertainty

Long-term
Low High
agreements

High degree of trust Low High

High process/
technology Low High
uncertainty

Supplier’s ability to
Low High
affect costs

High $ value Low High

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 Spot contracts – those purchases that
are made on a nonrecurring or limited
basis

Contract Short-term contracts – contract

purchases that are routinely made over
Length a relatively limited time horizon

Long-term contracts – made on a

continuing basis for a specified or
indefinite period (often ≥ 1 year)

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 Assurance of supply

Benefits of Access to supplier technology

Long-Term Access to cost/price information

Contracts Volume leveraging

Supplier receives better information for planning

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 Supplier opportunism

Selecting the wrong supplier

Risks in
Long-Term Supplier volume uncertainty
Contracts
Supplier foregoes other business

Buyer is unreasonable

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 Initial price

Contingenc Price-adjustment mechanisms (i.e.

y Elements linking to an index)
of Long
Term Supplier performance
improvements
Contracts
Evergreen, penalty, and escape
clauses

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 • IT systems contracts (i.e. IT
outsourcing)
• Level of service
− Turnkey vs. modular vs. shared
Nontraditiona
• Price (fixed or variable)
l Contracting
• Performance criteria
• Conversion mechanism from in-
house to outsourcing

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 • Facility management services
Other • Research and development
Service • Logistics and distribution
Outsourcing • Order entry and customer service
operations
Contracts
• Accounting and audit services

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Consulting Contracts

• Consultant is an agent (or independent

contractor), not an employee
• Ownership of intellectual property
• Issue of residuals
• Copyright ownership

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Outside • Avoidance of
misunderstanding
• Assurance of
payment
Consultant • Maintenance of • Avoidance of
Goals working liability
independence and • Prevention of
freedom litigation
• Assurance of work

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Other Types • Purchasing agreements
of Contracts • Online catalogs and e-commerce contracts

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 • Annual contracts
• National contracts
Types of • Corporate agreements
Purchasing • National buying agreements
Agreements • Blanket orders
• Pricing agreements
• Open-ended orders

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Settling Contractual Disputes

• All contracts are subject to dispute and

interpretation
• The more complex and larger the dollar
volume, the more likely a dispute will
arise
• Build in dispute resolution terms and
mechanisms

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Means of Settling Disputes
Action Description
Legal action File a lawsuit in a federal/state/local court
Nonlegal action
Arbitration Use of an impartial third party to resolve a contractual
dispute
Mediation
Intervention by a third party to promote settlement,
reconciliation, or compromise between the parties

Minitrial An exchange of information between managers in each

organization, followed by negotiation
Rent-a-judge A neutral party conducts a “trial” between the parties and is
responsible for the final judgment
Dispute prevention
A progressive schedule of negotiation, mediation,
arbitration, and legal proceedings agreed to in the contract
Interviews with Procurement
Managers (Video Resources)

• Al-Karam (Supplier) – Ikea (Buyer)

− https://www.youtube.com/watch?v=rN_Us12T0KQ
• John Paterson, IBM Chief Procurement Officer
− https://www.youtube.com/watch?v=ZDs1RhL66hE
• The Competitive Edge Supplier Development Management
− https://www.youtube.com/watch?v=Avzq1vPurk4

MUHAMMAD MOAZZAM 37