If you fully identify what you want to purchase in your specification or statement of work prior to your negotiations, you have the maximum leverage to get the most competitive price. If your specification or statement of work is not complete or does not represent exactly what is needed, it usually requires that you to negotiate a change. There are two types of changes. One type is changes that require the mutual agreement. The other type is when the contract provides one party the right to unilaterally order a change where the parties have agreed in advance the types or changes that may be ordered and establish how the cost or schedule will be impacted by those ordered changes (“change orders”). Most changes and change orders occur after you have issued the purchase order or signed the contract, which means that you may no longer have the same negotiation leverage.
The amount of leverage you have to negotiate changes will depend upon a number of factors including:
•What your contract or purchase order says regarding how changes will be managed and how the cost of the change will be determined.
•The stage of performance at which the need for the change occurs.
•The degree of simplicity in which the work may be stopped and given to another supplier.
•The potential costs of making the change to another supplier.
•The impact a change in suppliers will have on the schedule.
The worst case situation you can have is when you didn’t address how changes would be managed and how the cost would be determined in your contract and at the point you want to make the change it would be difficult or costly to change suppliers or changing suppliers would have a negative impact on a program that would be far more costly than paying the supplier’s price. In that situation the supplier has significant leverage.
There are a number of potential costs in changing a supplier midway through the performance of the work.
•There may be termination costs with the current supplier.
•There will clearly be a cost associated with having a new supplier come up the learning curve to understand what has been done and what is needed.
•There may be costs associated with some work needing to be re-done so that it is compatible with the new supplier’s systems, tools, etc.
•There may also be a cost associated with any delays that occur as a result of changing suppliers.
The greater the potential cost impact of the change, the more leverage the supplier will have in negotiating the change and the more you need to build in protection
The best way to protect yourself and retain needed leverage in negotiating changes is to ensure that you use the maximum leverage you have before you reach agreement with the Supplier to negotiate two things into your agreement:
1.The right to terminate the purchase order or agreement without cause.
2.A changes provision that establishes both a methodology and a formula for determining the cost of the change.
In addition, if portions of the work could be done by other suppliers, you may also want to have the right to deduct portions of the scope of the work.
The right to terminate the agreement without cause provides you the leverage to bring on another supplier if that is feasible and necessary because you are unable to reach agreement with the supplier on equitable terms for the change. The changes provision provides you with some leverage to negotiate changes based on those terms when there is no other reasonable option than just staying with the existing supplier. Being able to deduct portions of work from the scope could provide additional leverage to ensure an equitable cost for the change.
What are the types of things that should be included in a changes provision? That depends upon what type of product or service you are buying. Here’s an example of some of the different issues you could address:
1.The supplier should be required to provide detailed estimates of the cost of the change.
2.The language should state that if you can’t mutually agree on the cost of the change on a lump sum basis, that you can require the Supplier to perform the work on a time and materials basis.
3.It should establish the rates that you will pay for all the different categories of labor, or processes, if work must be performed on a time and materials basis.
4.The basis for direct cost for any materials required as part of the change (what can be included in direct cost and what must be provided for in their overhead rate).
5.The allowable percentages for contributions to the Supplier’s overhead and profit.
6.The allowable mark-up on work performed by subcontractors both for the subcontractor and the main contractor.
6.Other cost elements if necessary, such as acquisition rates, allowable levels of scrap from a specific process.
7.Documentation substantiating the costs charged (e.g. copies of invoices for materials, labor time sheets)
8.Rights to review or inspect the work in process to verify any time and materials charges.
9.Rights to audit all documentation not required to be submitted.
10.Last but not least, while the formula should address how deductions in the Scope of Work will be managed. (Otherwise the Supplier may want full price on additions, but want to give you pennies on the dollar for deductions).
The leverage in negotiating changes will vary the same as all the other factors that influence leverage. If you did business with a supplier on a repetitive basis and they know that treating you fairly is a pre-condition of getting future business you may need less protection than if you are dealing with a Supplier where the agreement may be their only dealing with you. To me it’s always better to play it safe and build in protection irrespective of the relationship. You never know what can occur during the course of an agreement that could change both the dynamics of the relationship and the supplier’s behavior.
One approach to simplify contract management’s negotiation of changes is to establish that the cost of a change or change order can be either
1.A cost that is mutually agreed between the parties, or if there is no agreement
2.It will be established using the formula for establishing the cost.
In doing that the supplier knows that if their quote doesn’t appear to be fair or reasonable, the buyer can require the supplier to provide proof of their actual cost based upon the requirements listed in the changes section.
Changes or change orders need to be documented. You can then do periodic amendments to add those to the agreement by an amendment that incorporates them by reference.