Contract negotiations between a vendor and an Original Equipment Manufacturer (OEM) need not be a one-sided affair. In many instances, vendors may feel somewhat overmatched between their need for the manufacturer's business and that customer's demands. However, it’s important to note that while an OEM may have a significant portion of business to offer, they are first and foremost interested in working with a valued resource. Equipment manufacturers need quality vendors who can deliver time-critical, high quality products and who have the ability to manage their supply requirements.
Pursuing Supply Contracts with Equipment Manufacturers
If your company has the opportunity to pursue an agreement with a manufacturer, then you must be aware of the critical points to success. This is not about how to win the negotiation. It is about protecting your interests as it pertains to your inventory and supply chain. You must take into consideration any revisions or design changes instigated by the equipment manufacturer and how these requests impact your existing finished goods, semi-finished goods and work-in-process inventory.
In my post “Supply Chain Management: Running a Better Supply Agreement”, I outlined how to manage a supply agreement that includes boxed quantities ready to ship, semi-finished inventory that is waiting to replenish the boxed quantities, and the work-in-process inventory. The agreement would look something like the outline below.
The agreement is predicated on ensuring that the vendor has parts that are boxed waiting for a release from the customer. The semi-finished and work-in-process inventory is waiting for the customer’s release, before moving on to the next stage.
- Finished Product: These are products that are shipped and waiting for customer releases.
- Semi-Finished Product: These are assembly parts that are near completion and take minimal time to become finished goods.
- Work-in-Process: These are parts in various stages of production that are waiting for the next customer release.
The above video outlines how to choose between a Kan-Ban and a blanket order agreement. You can access a sample Kan-Ban agreement here and a sample blanket order here.
1. Ensure All Finished, Semi-Finished and Work-in-Process Inventory is Protected by Revision Requests
In order for the contractual agreement to work, you must have parts that are in various stages as described above. Those finished goods that are boxed should not fall under any revision requests. Your contract must allow for a prevision that establishes the liabilities that are incurred by a change in revision to all three inventory classes.
Finished Goods Inventory: In my experience, most revisions on design changes can be delayed. They are most often not time sensitive. Therefore, with respect to the finished inventory, the equipment manufacturer must be willing to either accept the finished inventory as-is, or sign an engineering change notice (ECN) so that the revision only affects future release quantities. Make sure your agreement protects your finished inventory and establishes the customer’s liability.
Semi Finished and Work-in-Process Inventory: If a revision request is made, and the semi-finished and work-in-process amounts can be reworked, then ensure the contractual agreement stipulates that the manufacturer must sign off on the rework costs and accept the lead time on repairs. In most cases, when faced with the costs associated with reworking semi-finished and work-in-process inventory, the equipment manufacturer will decide to avoid the repairs. If it is absolutely necessary, then the manufacturer must be willing to pay for the rework. Here is an example of what the stipulation might look like.
“In the event of a revision change request instigated by the customer, the customer will immediately advise vendor. Vendor will assess revision request’s impact on all inventory classes at vendor’s facility. Vendor will first assess costs pertaining to 1) finished goods inventory 2) semi-finished inventory & 3) work-in-process inventory. Vendor will provide rework costs for each inventory class and agree with customer on a mutually agreed upon time for rework. If rework is not possible on finished goods inventory counts, then customer will be solely responsible for full value of that inventory. Semi-finished and work-in-process inventory costs of repair will be borne by the customer. In the event that these design changes increase vendor’s costs, vendor reserves the right to adjust future prices on all subsequent releases.”
2. Establish Set Lead Times for All Three Inventory Classes: While pursuing the contract negotiation with the OEM, make sure the agreement establishes lead times for all three inventory classes. The finished goods inventory should be ready to ship at a moment’s notice. The semi-finished inventory must have a minimum lead time to become finished. In this case, the finished inventory lead time should be no more than 1 business day (if needed) and the semi-finished should be less than a week. Therefore, in our example above, the customer has the ability to release 15 finished products within a day and take another 15 (from the semi-finished inventory) within a week. This should be more than enough to compensate for any spikes in demand.
The Benefits of Selling to Original Equipment Manufacturers (OEM)
3. Establish Contract Termination Liabilities
It’s essential that you include liabilities for the OEM should they decide to terminate the contract. Of course, issues of product quality, or theinability to maintain the delivery requirements on your end, should be exempt from any customer liability. However, baring any quality issues, if the equipment manufacturer decides to cancel the contract, they must understand their liabilities as they pertain to the work your company has completed.
“Should the customer decide to terminate the agreement, the vendor’s claim shall not exceed the value of 1) finished goods inventory, 2) Semi-finished inventory and 3) work-in-process. The value of these three inventory classes are defined below:
- Customer’s Finished Goods Liability of 15 units: $5,000.00 U.S.
- Customer’s Semi-Finished Inventory Liability of 15 units: $3,500.00 U.S.
- Customer’s Work-in-Process Liability shall include all raw material costs and labor costs at time of termination: (estimated liability: $1,500.00 U.S.)
The customer can terminate the contract,, or any extension thereof, provided a ninety (90) day notice is given to the Vendor. Vendor will then ship the finished goods inventory, and complete any semi-finished inventory to complete the last release within the agreement. The customer then has the option to request the final work-in-process quantities become the contract’s final release, or assume the liability as defined above."
Finally, when pursuing contract negotiation with an original equipment manufacturer, insist on having signatures. I know this may sound somewhat redundant, but a number of companies enter into agreements without stipulating any liability whatsoever. They tend to believe in a “gentleman’s agreements”. A signed contract is a contract that stipulates everyone’s liabilities and responsibilities and allows all to be cognizant of what's involved. Make sure it's signed in order to avoid any ambiguities.
Dell's Push-Pull allows it to deliver custom-made finished goods by allowing its customers to determine requirements at the point of sale. It is a unique supply chain strategy that allows it to prepare sem-finished goods prior to receiving orders. To read more, please go to: Dell Push-Pull: An Order Fulfillment and Supply Chain Strategy
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