Improving Contractual Flexibility – The Difference Between Success and Failure (Article 2)

Spend Matters welcomes this guest post from POD Procurement, a business consultancy that created the POD model.

Introduction

In our second article we focus on reducing business costs and risks associated with contractual over commitment:

  1. Centralized Procurement (Article 1).
  2. Improve Contractual Flexibility (Article 2). Reduce business requirements post-contract award without contract re‑negotiation, without pre-agreed pricing models and without using a framework.
  3. Encourage and Reward Post-contract Supplier Innovation/Efficiency Gains (Article 3).

On the CIPS Knowledge Site there is a new model called POD, which is an easier way of achieving all three business objectives.

Improved Contractual Flexibility

To achieve the maximum savings, buyers need to commit to procuring the goods/services from the suppliers. Once the contract has been awarded, both parties focus on delivery. If the business requirements reduce post-contract award it can lead to a difficult business decision.

  1. Absorption: If the reduction in business requirements is minimal and does not warrant the risks and costs associated with a contract re-negotiation, the business does not re-negotiate the contract but continues to procure the full quantity and assumes it may be used in the future.The issuez in this approach includes the business has increased excess working capital, reduced the organization’s cash flow and the contract may go over budget from additional costs for storage and disposal of the excess.
  2. Re-negotiate the contract: If the reduction in requirements does warrant a contract re-negotiation, it leads to additional business risks as the outcome is unknown, additional business costs in people and resources to re‑negotiate the contract, potential project delays during re-negotiation and impacts the supplier relationship.

Different organizations have different approaches to addressing this challenge, such as:

  • Use frameworks to provide the flexibility to reduce post-contract commitment, but at the cost of savings.
  • Use a pre-negotiated pricing model, a very complex and time-consuming approach for both buyer and supplier, which can also cause the supplier to interpreting it as risk and increase costs accordingly.
  • Strong-arm the supplier into absorbing a reduction in revenue and profits without re-negotiation. This approach may work short term but can severely impact relationships.

Post-Contract Flexibility using POD

Here are the steps to use POD within your organization in order to achieve increased contractual flexibility:

  1. Negotiate and award the contract as normal based on the commitment to procure the full requirement, maximising the savings available. (Do not use a framework!)
  2. If post-contract award the business requirements reduce, contact supplier and notify of new requirement, without re-negotiating the contract and without using a pre-negotiated pricing model. 

Outcome

If the full commitment was required, it delivered the intended procurement savings. If post-contract award requirements reduce, then reduce commitment and only pay for what is required, returning unused budget back to the business, without contract re-negotiation or a pre-agreed pricing model.

Summary

No waste, no excess working capital, no additional costs for storage and disposal, no additional business risk or costs from contract re-negotiation and achieved with the suppliers full support.

First Voice

  1. Richard:

    This looks like a very narrow approach to a change in quantities required. Depending on the complexity of what is being procured, the upfront costs for the supplier can be considerable, with payback being achieved over a certain number of units / time period. As a supplier I would expect an increase in unit price / period service revenue for the type of reduction described above. This could potentially be offset by signing a longer contract, or taking other goods services in addition to the original agreement.

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