How to avoid one-sided vendor contract provisions

We’ve all had this experience:  a vendor surprises you with a rate increase or informs you it’s not responsible for a problem with their product; you – incredulous – look at the contract; and you discover the contract supports their position – leaving you high and dry.

Before the internal finger-pointing starts – between Legal, Procurement, the business owner – it’s important to get in the habit of “mine-sweeping” vendor contracts before you sign on the dotted line.  But it’s never too late to revisit existing deals to know your exposure or, even better, insist on a re-negotiation.

What to look for

As a start, consider the following problematic vendor provisions:  (1) locked in annual price increases, (2) minimum purchase commitments and (3) automatic renewals.

Locked-in annual price increases

They’re incredibly common:  a provision authorizing the vendor to increase the contract price every year of the contract term.  The amount of the increase varies by industry, but typically ranges between 3 and 6%.

Reasonable?  No.  It increases the customer’s cost, reduces the vendor’s incentive to control their expenses and typically results in your paying significantly more than current market price. 

Vendors will argue they need the increase to protect them from inflation.  The provision certainly achieves that goal, but the vendor doesn’t need it to manage inflation:  most of the time, motivated vendors can drive savings to achieve zero increases or even price reductions. 

But, while not partner-like, it is in the vendor’s best interest to lock you into providing them with increasing cash flow.  And with a guaranteed price increase, the vendor has little incentive to pursue productivity improvements. 

My firm, B&W, regularly delivers for its clients a reasonable, risk sharing provision which prohibits price increases during the first two or three years of the contract term and thereafter limits increases to the lesser of 2% or the rate of inflation.  This arrangement controls the customer’s costs while giving the vendor an incentive to control its expenses before it resorts to a price increase.

If your vendor objects and argues inflation risk, remind them that the first line of defense against inflation is firms who are good at managing their expenses as opposed to taking advantage of their customers.

Minimum purchase commitments

Everyone likes to get a product at a discount but getting one in exchange for a minimum commitment is a trap.  Once the customer is obligated to buy a certain volume of goods or services, the vendor’s incentive to ensure quality and timely delivery typically drops off.

Like everyone else, vendors have to juggle competing priorities.  Their most important one is to sell more products and services.  Faced between a choice of addressing an issue with a completed sales order or investing in closing a new deal , vendors almost always chose the latter.  The “minimum commitment” customer suffers.

Refusing minimum commitments does not mean customers have to forego the same deep discounts offered with the minimum commitment deal.  A vendor committed to building strategic relationships with its customers will recognize that it needs to continuously earn its customers’ business, on both price and customer service. 

If a vendor tells you they cannot give you their best price without a minimum commitment, they are really telling you they can’t sell you their product unless they can avoid responsibility for great customer service.  If they claim they’re worried you won’t stay faithful to their product or service, they are really saying you don’t have the common sense to stick with a vendor who delivers great products and services at a great price.  My firm has closed many deals with no guaranteed purchase commitments at discount levels that equal or exceed commitment deals.

Automatic renewals

Many vendor contracts renew automatically, without requiring a customer’s signature.  Some customers see this as a convenience.  But it comes at a price:  vendors worry a lot less about keeping your business.

Far more often than not, customers don’t cancel their contracts before they auto renew.  Even worse, very few customers evaluate their contracts before they auto renew.  Vendors know this and they assume, therefore, they don’t need to make any extra effort to ensure their customers are happy when a contract is coming up for renewal.

When a contract expires without customer action, on the other hand, the customer can be sure the vendor will be focused on ensuring the customer is motivated to renew.  And there’s no down side to the customer:  if the customer forgets that a contract is about to expire, they can be sure the vendor will remind them.  Economists have shown that loyal customers who give their long-term business to vendors almost always pay more and get less than customers who carefully review their contracts on an annual basis.

The foregoing are just three examples of vendor contract “land mines.”  Please return to this blog for more on this topic.