Steel prices have plummeted, and there have been numerous articles, blogs, and discussions about how this could impact various different industries, markets and the economy overall. I, however, want to remind businesses to beware of blanket purchase orders and requirements contracts.
Here’s an example - Company XYZ sells an auto competent to an original equipment manufacturer (OEM) and one of the main raw materials in that component is steel. If XYX is negotiating a long-term supply agreement with the OEM, XYZ likely (or hopefully) has a mechanism for price adjustments tied to fluctuations in the cost of steel, and potentially other costs. This would mean that if XYZ’s cost of steel rises by x percent, the price of the part to OEM would rise accordingly. If XYZ is entering into a discreet, short-term purchase order, even if no price mechanism is negotiated, it likely can forecast short-term costs so it won’t be impacted by any increase (or at least any significant increase) in the cost of steel.
Often however, XYZ (and its competitors) enter into blanket purchase orders or requirements contracts. In each case, the supplier is required to sell to the OEM whatever amount of parts the OEM orders, and the supplier has little to no ability to reject any future orders or to modify its prices. That purchase order often has a short line item incorporating the OEM’s terms and conditions of purchase – and those terms and conditions are often 20-50 pages long, laying out the draconian rules governing XYZ’s relationship with the OEM. Moreover, these purchase orders can be very long term (e.g., 10 years). Keep in mind, this arrangement is not memorialized by a negotiated long-term supply contract, but instead is all laid out on a one or two-page “simple” purchase order that states something to the effect of “blanket purchase order” or “supplier shall supply all of customer’s requirements.”
Too often, companies like XYZ do not conduct a legal review of these documents because “it’s just a PO.” However, before you see dollar signs and simply accept a purchase order – beware.
First, while you are required to sell products on the extract terms laid out in a purchase order, your customer rarely has any obligation whatsoever to actually purchase products. Most troubling – the price is set in stone on that seemingly “simple” purchase order, often a price that you are tied to for as long as 10 years. And, there is no room to renegotiate the price when steel costs (or taxes, labor costs, import costs, etc.) change in the future. So when steel prices double in two years, you could be stuck with the bill as a result of paying a much higher cost with no room to increase the price you charge the OEM.Before you get wide-eyed over the prospect of supplying an OEM, consider how long your cost structure is likely to be good and whether you should be negotiating room for movement. And make sure your purchasing department receives high-level authorization before entering into a purchase order of more than an agreed-upon amount of time.