Not enough demand to meet your volume commitments – what should you do?
When you signed that contract, you were absolutely sure that you could guarantee that spend and the volume commitment felt like a piece of cake… now though the world has changed and that contractual obligation is going to potentially cause irrevocable damage.
What Is A Volume Commitment?
Very simply, a supplier will offer a more competitive price in return for increased revenue and will therefore provide a lower unit, or service consumption price for a higher unit/consumption commitment.
These commitments are often formalised within a contract or other form of purchase order agreement and may be fixed or variable throughout the term. The key is, the supplier expects the buyer to meet the commitment, in order to benefit from the lower pricing.
They can be a good way to obtain greater value and from a competitive standpoint, there is nothing wrong with the methodology - the more a buyer spends, the better the discount they receive. However, the snag comes when the volumes decrease, particularly if the decrease is totally unexpected – the less a buyer spends, the discount reduces and in the worst case, the buyer is in breach of the agreement by not meeting the minimum volume commitment required.
Understanding the issue
Let’s say the buyer has committed to an annual volume of 20,000 units/hours and for anything over this, in increments of 5,000, the supplier provides a further unit/hourly cost reduction of 3%.
Normally this was a safe bet, annual volumes were more in the region of 40,000 and therefore the unit/hourly price was low and there was no danger of breaching the agreement by missing the minimum commitment (20,000).
Now demand has reduced and therefore the buyer is struggling to order the minimum volume but contractually, is obliged to do so – otherwise it could be terminated.
Further, for those units still being purchased, the buyer is having to pay a higher unit/hourly price than they are used to, and this means their margin is being negatively affected.
The impact is felt across the organisation but also across the entire supply-chain; the buyer’s reduction in spend means a supplier’s reduction in revenue and margin. Everyone suffers creating a lose-lose scenario.
Resetting the baseline
Now, more than ever, should a contract negotiation be entered into as a two-way street, and a natural win-win arrangement found. Any misalignment or misunderstanding could be damaging, or even terminal for all parties involved.
It’s critical to re-set the baseline and consider what volume can be truly met and what price increase you can accept to retain and protect your supply chain.
Now is not necessarily the time to be thinking about doing things differently or managing a complex tender for a new provider – looking after your incumbent supplier and attempting to come to a mutually agreeable arrangement will ensure supply chain stability.
During negotiations, it is important to prepare and acknowledge that everyone will push for the maximum they believe they can get. It’s up to you as the buyer to control this urge and ensure that something amicable and realistic is agreed by following the key five steps. If you consider the primary negotiation steps and associated negotiation styles that you can adopt, you should absolutely be aiming to achieve collaboration. This may mean giving up some of the discount in return for a lower volume commitment, or perhaps extending the term of the agreement to still provide the required revenue over a longer-term. The key here is recognising what best fits both your organisation and the supplier to reach a win-win.
Put another way relationships simply do not work when either party over leverages negotiation, they may function for a while but issues will creep in overtime, or even worse the relationship can become toxic.
Strong supplier relationships are key – especially now – and it’s better to foster a long-term supplier partnership where both parties can support and protect one-another during this economic uncertainty.