By negotiating the best contract terms with your supplier for a long-term contract, you may be increasing your company’s costs. But how can that be?
The Buyer Wants the Best Price
All things being equal, a buyer will optimize the price being paid for goods and services. To their credit, buyers can get incredibly creative when negotiating with suppliers to lower costs. By conceding to supplier goals in negotiation (shorter payment terms, financing preferences, payment methods, etc.), a buyer can usually lower the unit price by a few additional basis points. And, unless you have company guidelines in place, deal terms and conditions can get very interesting as a result. Over the years, as I’ve worked with clients on scaling up their procurement solutions, I’ve seen everything from volume-based scale pricing to pricing based on tons of finished goods produced to pricing based on the day of the week of purchase. But, if that’s what yields the best prices for the business, what’s the problem?
Your System May Not Be Able to Handle Your Contract Terms
Getting the supplier’s best price doesn’t consider the costs to input and automate the pricing scheme in your transactional system. By creating more complex pricing schemes, you are potentially creating work for IT and/or operational procurement and accounts payable. How so?
When you consider your ERP and/or Source to Pay system’s pricing capabilities, you may not be able to capture and automatically apply the pricing terms to purchases (for example, I’ve never seen a system that allows you to input different pricing based on the day of the week). If this is the case, IT would have to develop or configure new system functionality (not to mention support it once deployed) to meet the requirement created by the new contract. Depending on departmental priorities, IT might not be able to deliver that functionality quickly either. So, your contract may be halfway over before you can automate pricing. On top of that, the cost to develop this solution might be more expensive than the savings that were initially negotiated.
This Leads to Collateral Impacts on the Business
When the price of developing functionality is more expensive than supporting the process manually, your operational buyer and business users are left holding the hot potato. You’ve unintentionally given birth to a slew of excel files; perhaps even an access database or two. Your complex pricing has to be manually calculated and input manually into the system. Then, invariably, prices on purchase orders sent out from the system are incorrect as getting pricing right is just another priority to manage. Then, your accounts payable team gets invoices that don’t match the purchase orders as the supplier is correcting the price based on the agreement on his end. Or, even worse, the vendor-corrected invoices are not caught by accounts payable and go straight through to payment meaning that any attempt to use purchasing reporting later on yields “bad data”, eroding your users’ trust in the system.
My example is a bit extreme… However, my point is that most organizations are trying to lower operational procurement costs by simplifying and automating purchasing. By negotiating “impossible to operationalize” terms, your organization’s ability to become more efficient is hampered. This is true regardless of which system you are running.
That’s not to say you should never negotiate creative contract terms. The business case might reveal it is a worthwhile trade off. However, it should be a conscious decision instead of a reaction to a contract that has already been signed.
Proactively Managing Contract Terms & Conditions
To avoid being caught in such a situation, you can take two simple actions:
- Pre-Approved Pricing Guidelines. In collaboration with IT, put in place buyer guidelines for pre-approved pricing schemes which are already supported by your ERP / Source to Pay system without modification.
- Collaborate with IT on Exceptions. Whenever it might be worthwhile to negotiate pricing terms and conditions that deviate from the established guidelines, meet with your IT Analyst to see if they could be supported with your system As-Is. If so, document this new variation in your guidelines for the future. If not, determine the ballpark cost to support the new pricing scheme. Then, determine if there is a valid business case for configuration/development to support this new scheme.
This tactic is very similar to using pre-approved contract clauses from your legal department in boilerplate contracts. The spirit here is very much the same. Remove bottlenecks (IT and/or Legal intervention) from your procurement process by sitting down with them before you need them. This will save you lots of pain later on.
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Have you ever come across contract pricing that could simply not be operationalized? How did you handle the situation? What safeguards did you put in place to prevent a similar situation from occuring again? Let me know in the comments
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Last Updated on January 7, 2021 by Joël Collin-Demers