When two companies enter in to a relationship for the manufacture and supply of goods, both sides often have legitimate concerns about the volume of future orders and production.
The customer seeks assurance that all of its orders will be filled, so it won’t be left in the lurch in times of high demand. The supplier seeks assurance that purchasing volume will remain steady, or increase, so its initial investment will be recaptured, profit margin will be realized and it won’t be stuck with a warehouse full of costly, unwanted inventory.
Those legitimate concerns on both sides may largely be alleviated through the artful drafting of several possible contract provisions. The variations are endless, but here are a few basics.
Rolling Forecast Provision
The primary approach to resolving such concerns is through a forecast provision, but if the customer has superior bargaining power (or lawyering skills) the clause will end up fairly ineffective such as this:
“By the tenth day of each month, Customer shall provide Supplier with a non-binding rolling forecast of Customer’s estimated purchasing requirements for the next twelve (12) months.”
Such a provision has limited value, because the forecasts are non-binding and no remedy is stated for failure to conform to the forecasts. The Supplier might prefer something like this:
“The first month of the forecast shall impose a binding commitment for Customer to place purchase orders for the stated quantity of Product; the remainder of the forecast shall be non-binding.”
A more elegant variation might state:
“The forecast shall impose a binding commitment for Supplier to supply and Customer to purchase the following quantities of Product: 100% of the amount stated in the 1st quarter of the forecast, +/- 20% of the amount stated in the 2d quarter of the forecast, +/-50% of the amount stated in the 3d quarter of the forecast, and the 4th quarter of the forecast shall be a non-binding, good-faith estimate.”
Ensuring Customer Conforms to the Forecast
To protect the Supplier, the agreement might include language like this:
“In the event Customer purchases less than the amount stated in the binding portion of a forecast, Customer shall be liable for all resulting damages, including without limitation finished Products, unfinished Products and raw materials. Supplier shall use reasonable efforts to reschedule those materials for production and delivery in subsequent months.”
Ensuring Supplier Conforms to the Forecast
To protect the Customer, the agreement might include provisions like these:
“Supplier shall maintain an inventory of raw materials and components necessary to manufacture Products in accordance with the forecasts and shall provide Customer with quarterly updates on the extent of such inventory.”
“If Supplier becomes aware that it may encounter difficulty meeting any forecast quantity of Products, it shall immediately notify Customer in writing, providing details of the expected shortfall, causes of the shortfall and proposed solution. The Parties will discuss all appropriate means of resolving the problem, including establishing an alternate source of supply, a back-up manufacturing facility, or other measures.”
Firm Volume Commitments
In some cases, the Supplier may demand a certain purchasing volume to compensate for initial start-up costs and ensure that pricing and margins remain consistent with preliminary assumptions. The following example imposes annual and quarterly obligations:
“Supplier agrees to sell and Customer agrees to buy at least the annual quantities of Product specified on Schedule 1, as may be adjusted from time to time by mutual written consent. Each quarter, Customer shall place Orders for Products in a minimum quantity of __% and a maximum quantity of __% of Customer’s annual commitment for that year. The sole and exclusive remedies for failure to fulfill any obligations set forth in this section are stated at Schedule 1.”
In the (likely) event that a customer rejects such commitments, it may be possible to satisfy Supplier’s concerns through other options such as (a) use of a tiered pricing structure, with Supplier’s prices decreasing based on volume, (b) Customer pays a portion of Supplier’s start-up costs, or (c) Customer proposes also working with Supplier on other projects.
There’s no question, most customers and suppliers entering into an arrangement for the manufacture and supply of goods will have legitimate concerns with respect to future volume of orders and production. Like any business relationship, a certain amount of faith is required. However, carefully lawyering can often add a valuable layer of contractual protection to the deal.
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