A brief guide to contractual relations with the supplier

In the delivery of High-Tech, it is usually difficult to apply the logistical procedures commonly used in the buyer organization to purchase “conventional” goods. Therefore it is not appropriate to consider only fixed-price contracts, otherwise the most common ones. The following overview should give You some ideas to select the most appropriate type of contract depending on the specifics of the purchased goods or services.

There is always a triangle that shows the performance requirements of the supplier. The corners of the triangle are

  • objectively measurable output,
  • budget and
  • time.

Pressing on one of the triangle corners “overflows” the problems to the other two. Therefore, all three corners of the triangle should be well specified, with the apparent emphasis on only some of them.

Another critical factor is that there is a risk associated with each contract. Reduction of this risk is never free for the buyer; if the supplier has to bear the risk (e.g., in a fixed price contract), then the buyer must pay an “insurance premium” to insure the risk. And, contrary to popular belief, it is valid even if this bonus is not quantified in the contract.

According to this theory, we can create several contractual alternatives. Some of them are here:

  1. FTFP – the fixed price contract always includes an insurance premium for the supplier. In this case, the focus is on the triangle corner with the price. It is necessary to have precisely defined the other two corners, therefore. This type of contact is helpful if the supplier knows better than You the details of the gadget delivered. Why? Because his “insurance premium” may be meager. On the contrary, if You know better what to deliver, this type of contract is not an advantage because “insurance premium” is relatively high and out of Your control.
  2. T&M – payment for time and material. In this alternative, the buyer pays no “insurance premium” because he bears the risks. So he can get to the lowest price. From the triangle point of view, this is the case with an emphasis on the first corner (output), and it is necessary to treat the other two corners (e.g., by setting time and financial limits).
  3. FTAC – the bonus included to fix price contract places considerable emphasis (usually) on time. It has all the advantages and disadvantages of an FTFP contract with one exception: it gives You an instrument to manage the most critical aspect for You.

Of course, combining these extremes creates other types.

There are four aspects to consider when explicitly considering the appropriate type of supplier contract. The point is,

  1. how critical is the precise achievement of the desired outcome in general (item 1),
  2. the specificity of the target product and its comparability to something else (item 2),
  3. the market position of the supplier in terms of competition (item 3),
  4. the manager’s contact time in the purchasing organization (item 4).

The following table shows the options and recommended forms of contracts:

item 1item 2item 3item 4contract type
highclearly definedbuyer marketgoodwith premium / penalty
middleproduct that needs to be customizedmoderate competitiononly for important mattersfixed price or delivery date
lowunclear, will arise from the developmentsupplier marketbadtime and material