Supply contracting is common in a number of industries, particularly in the construction, information and communications technology, manufacturing, government and professional services sectors.
We asked Lisa Legena, manager of our Advisory Services team, to share her top tips on the factors to consider before you agree to a supply contract.
Consider your capacity to deliver before you enter a contract
“Always consider whether you have the capacity – both in terms of your organisation and finances – to deliver the goods and services required before entering into any supply contracts,” says Lisa.
“If you’re a supplier, it’s important to make sure you can meet the requirements of this agreement and consider the risks to your business in the event you cannot comply. Likewise, if you’re looking to engage a supplier under a supply contract, you need to first make sure you fully understand the terms of the contract.”
Look closely at the pricing structure
Lisa notes that while supply contracts can vary, in most cases the pricing can be determined on a fixed price, time and materials, or cost-plus basis.
A total fixed price to deliver the goods and services is locked in at the time of signing the contract.
“A buyer may like this option as they know exactly what it will cost them,” says Lisa.
“There is a risk to the supplier if the cost of goods increases over the lifetime of the contract, as they will need to bear these costs. Likewise, if the supplier can obtain goods at a discounted price through trade discounts or bulk-buying, they might then build more profit margin into the price.”
Time and materials
This pricing structure includes the cost of the materials used on the project plus the time associated with delivering the project.
“This pricing model is common with information and communications technology (ICT) projects – but without a clearly defined scope of works and parameters in place, this can lead to blow outs in costs for buyers.”
This pricing structure allows the supplier to invoice the buyer for the costs of the work, plus a fixed percentage on top of these costs.
“In this case, the supplier would charge the buyers the actual cost of any materials, equipment, labour, and overheads involved in the project. Profit is factored into the fixed percentage increase.”
Weigh up the risks of fixed vs flexible pricing
Each of these pricing structures has varying elements of risk attached. Lisa recommends that the supplier consider the potential environmental, political and economic impacts which could have an impact over the course of the contract to determine which pricing structure is best for them.
“For example, if a supplier needs flexibility in the pricing structure, they will need to ensure they weigh up the risks and choose a structure that allows for this.”
“If they do select a fixed price method, it’s important to factor in the potential for price increases over the term of the contract when determining the final price for consideration by the buyer.”
Lisa has seen some supply contracting issues arise when business owners don’t consider the lifetime of a contract when setting prices.
“Many suppliers price based on information at the time of tendering or quoting, however, there may be a time lag before they actually start to supply and do not build in enough buffer to cover price fluctuations,” she says.
“For example, a landscape construction business may set a fixed price to construct a playground at a new school which is under construction. However, the project is not due to commence for eight months, allowing time for the school build to be completed. During this time, the cost of steel increases but the supplier has not planned for this eventuality and has to cover the additional costs of this material to deliver the project.”
Watch out for supply contract ‘red flags’
Lisa notes that all supply contracts should be considered carefully – and it’s worth seeking legal advice before signing anything. According to Lisa, it’s important to beware of these potential warning signs:
- Poorly written contracts or agreements – “Make sure you understand every aspect and there are no vague or unfavourable contractual terms.”
- Poorly defined scope of works – “Supply contracts need a clearly defined scope as to what is expected in terms of the supply of goods and services. This way, all parties are aware of the desired outcome and can reduce disputes over the lifetime of the contract.”
- Lack of dispute resolution clauses in the contract – “Having a clearly defined dispute resolution process outlined in the contract can really help if a dispute arises. The SBDC dispute resolution service could be incorporated as part of this process if a dispute escalates.”
“Most contracts or agreements will outline what is expected to be supplied, timeframes to deliver, and pricing and payment schedules. They will also outline the responsibilities of the supplier in relation to matters such as warranties, insurances and indemnities, guarantees, variations and dispute resolution.”
If you’re considering entering a supply contract, make sure everything is in writing and you clearly understand what you are agreeing to before you commit.
- Discover how to avoid underquoting or learn more about understanding contracts and agreements, including the general terms and structure and essential elements of a contract.
- If you are in the construction industry, learn more about the Security of Payment Act that came into effect for contracts signed after 1 August 2022.
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