Radical Thought: Outsourcing agreements are nothing but a bureaucratic exercise and a waste of time.
The statement above may be true if you are fortunate enough to operate in an environment where: forecasts are accurate, inventory liabilities are clear, products do not fail, price changes match expectations, and roles and responsibilities are well understood in the relationship.
A recent Aberdeen survey of Fortune 500 Executives would suggest that few companies are that lucky. In this survey, 79% of Executives considered outsourcing agreements to be either "Important" or "Very Important". It is surprising then to see how often companies fail to complete a comprehensive agreement. We see problems frequently in our practice and agreements tend to fall in three categories: (1) abandoned midstream while still in draft form; (2) hastily negotiated under time pressure to meet a deadline; or (3) too general to accurately document the specific business - not legal - challenges of outsourcing.
Outsourcing agreements are at the heart of your manufacturing relationship and should become the document that defines how business is conducted. There are a few key points to consider when creating and negotiating outsourcing or supply agreements:
1. Negotiate before you over-commit yourself to the relationship. This is important regardless of whether you are an OEM, an EMS provider, or a component supplier. Once you have pulled the trigger and are locked in, you lose your negotiation leverage. Also, you cannot assume that you will have more time later to "work out the details." Operational urgencies have a way of forcing you to concede on terms and accelerate the process of finalizing the contract. In order to maintain your leverage and your objectivity, negotiate your agreements and bring them to closure before you engage in business.
2. Map out and discuss critical business terms upfront. The process of contract negotiation normally starts with one party sending its boilerplate contract to the other so that it can be "marked up". This is the wrong approach towards developing comprehensive win-win agreements. Before you begin exchanging drafts, you need to understand what you want from this agreement and from this relationship. Also take some time to understand what is important to your manufacturing partner. Too often in the heat of negotiations, you can get stuck on the minor issues and lose sight of the factors that have the most impact on your success. Before you begin negotiating, be clear on your musts and wants for critical items such as: inventory liability (especially important for Sarbanes-Oxley), pricing, supply flexibility, warranty, services, and protection of intellectual property.
3. Allocate the right resources to negotiate these agreements. Negotiating robust agreements takes time. When you consider advanced preparation, the various rounds of negotiations, and the inevitable problems and escalations, it is easy to see how a contract of even modest complexity can take weeks. Experience has shown that the better prepared you are, and the more time you spend looking for non-price value, the better the results you get. According to one study, non-price terms account for an average of 17% of an agreement's value. If you are pressed for time, you are less likely to look for and capitalize on those opportunities. A swing of just 5% in value on a $1 million contract is worth $50K.
4. Get Closure. The process of contract negotiation starts at a relatively fast pace and slows down considerably as you filter through to the tough issues. You do not get the value from the agreement until you finish it. The last stretch may only involve a handful of issues but it may take as much as 80% of the time. Stay focused, engage decision makers on both sides, and get creative in finding acceptable solutions to seemingly intractable issues. The key is to keep from getting derailed. Once momentum wanes on an agreement, you increase the risk that it will never be completed or it will be rushed together later to meet a deadline. Both scenarios have negative consequences.
Bureaucratic - perhaps, but well negotiated contracts have saved the day for many companies in today's complex, outsourced supply chain. Additionally, the requirements dictated by Sarbanes-Oxley now make it even more important to pay close attention to the details, particularly when it comes to how liabilities are incurred and reported. Maybe the most compelling reason for doing it right is the opportunity to use agreements to bring clarity to a relationship and create a framework for value beyond the price you pay for an item.
Creating and
negotiating outsourcing agreements is an area where Symphony offers years
of expertise and best practices. Please contact us if we can add value to
your initiatives in this area. You may also visit the following website link
for a workshop on this subject: http://www.symphonyconsult.com/workshops/workshop_eoa.php