Commodities markets have been put through the ringer since the onset of the pandemic. As demand for inputs plummeted amid shutdowns, production of many commodities also fell. Alongside the reopening of the economy, demand is rebounding for many commodities, such as lumber and steel, more quickly than producers can keep up with. As a result, shortages and price spikes have plagued many buyers. To simplify commodities purchases and help businesses navigate commodity contracts and trends, ProcurementIQ has put together a list of commodity purchasing best practices.
1. Metrics should be carefully defined
It is important to carefully define metrics and use risk-proof language when drafting a contract in order to avoid potential loopholes that could be open to interpretation. Below are things to be aware of when drafting:
- Avoid vague citations of commodity price metrics and ambiguous references to dates and terms.
- Make sure the metrics in the SLA align with the buyer’s stakeholders’ needs and wants.
- Ensure that the commodity price index used for benchmarking is explicit and robust.
- Include provisions for a successor price index should the designated index be dropped.
Contract clause example – Price Escalation: “During the term of this agreement, additional fees shall be subject to price escalation on DATE of each contract year during the Term of this Agreement, in accordance with the increase in the PRICE INDEX as published by PUBLISHER. The price will be determined based on the percentage increase in the INDEX for the twelve (12) month period ending three (3) months prior to January 1st of each contract year during the Term of this Agreement.”
2. Quality is more important than quantity
Covering all of your bases in a contract means you have a clear picture of your business objectives and goals and have identified your company’s risk appetite. This helps set appropriate expectations for both parties. However, while terms should be detailed and thorough, quality is always more important than quantity. In other words, having more metrics is not necessarily better. Too many metrics may result in an overload of information that will take too long to analyze, thereby reducing operational efficiency and the overall value of the service-level agreement (SLA).
3. Choose metrics that are within the supplier’s control
Procurement professionals know how important it is to protect their company when contracting with suppliers. Covering each base and putting your business’ needs first is crucial for ensuring business longevity. However, it is also important to prioritize supplier relationships by working together as a team to create mutually beneficial terms. This means understanding what is in the supplier’s control. For example, if a supplier fails to meet a metric due to circumstances such as a force majeure event or a mistake, a missed deadline, or another oversight on the buyer’s end, the supplier should not be penalized. Additionally, what constitutes force majeure events and failures on the buyer’s end should be clearly defined.
Contract clause example: Force Majeure - “No Party shall be liable for any failure in the fulfillment of any of its obligations under this Agreement (other than the obligation to pay the purchase price of Products sold and delivered) to the extent that such failure is due to any prevention, delay, interruption, loss or damage occasioned by Force Majeure; provided that reasonable steps are taken to mitigate the consequences of such Force Majeure and to bring it to an end as soon as reasonably possible; and provided, further, that such Party has given notice of such Force Majeure to the other Party pursuant to Section 18.2.”
4. Strategize the scope and timing of the contract
Thinking long term and investing in the future are never bad ideas and can often be the difference between a good deal now and a great deal that keeps on giving. Applying these same principles to a contract, buyers can purchase materials in advance or for several projects at once. Buyers can also try to get the owner to pay for the storage of materials in a bonded warehouse, which would eliminate future price escalations. These strategies help to reduce overhead costs in the long run. They also create beneficial terms for the supplier by securing them more business, but not at the buyer’s expense. Rather, it further prioritizes the buyer as a client.
5. Add a meet-or-release clause
A meet-or-release clause requires the seller to meet a lower price if one can be found. The benefits of this addition are obvious; it allows the buyer an open door in case they find a lower price in the market that was previously undiscovered. However, release clauses can potentially run into issues with competition laws because they can prevent competing suppliers from having the opportunity to earn customers’ business.
Contract clause example – Meet or Release: “If at any time during the period of this Agreement Buyer can purchase commodity of like quality at a price which will result in a delivered cost to Buyer that is lower than the delivered cost of the material purchased hereunder, Buyer may notify Seller of such delivered cost and Seller shall have an opportunity of pricing material hereunder, within a reasonable time, but not more than 90 days, on such a basis as to result in the same delivered cost to Buyer. If Seller fails to do so or cannot legally do so, Buyer may purchase from the supplier of the lower delivered cost material, and any purchase made shall be held to apply on this Agreement, and the obligation of Buyer and Seller shall be reduced accordingly.”
6. Ensure supply consistency
Add a stipulation stating that commodity quantity requirements will not drastically change over the course of the contract or that the supplier may not drastically change the quantity supplied. Such inclusions result in long-term commodity contracts that guarantee stable future supply at low prices. They also take the supplier into consideration by ensuring that the buyer will not suddenly adjust expectations and demands.
By: Mara Michael & Ben Kempenich
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