03 Oct 7 Secrets to Long Term Agreements
As a bearing suppler, we have seen our share of long-term agreements (LTA). And, we’ve learned a few things about what makes some more successful than others. Below is 20 years of insight on how to best approach the arrangement.
- LTAs are Fair to Both Parties
Fairness is not just for schoolyards and sibling disputes. It plays a huge role in business relationships. Bringing an LTA to the negotiating table that is already vetted by one side shows lack of consideration and respect for the developing partnership.A template that has worked in the past is welcome, but both sides need to play a role in creating the document. Simply having one side update the terms of the other’s version leads to miscommunication and misunderstandings.
- Contain Allowances for Raw Material Increases & Decreases
Imagine if you purchased ice cream cones for a set amount all summer while the shop’s profit margins dwindled due to increased raw material costs. If the shop did not raise prices, it go out of business. The same holds true for bearing manufacturers.When raw materials spike and hold over a specific time period, margins can be fully eliminated to a point where the LTA costs them money to do business with a specific customer. The opposite also holds true. If raw material costs decline significantly, the buyer should benefit from the lower costs.
Have an index that can be reference for raw material price fluctuations and build it into the agreement. This way, a third-party is providing proof of a sustained cost change, not just the manufacturer or buyer.
- Set Minimum Quantities and the Failure to Purchase Clauses
Minimums are usually the foundation of an LTA. What would happen if the buyer had to shut down production due to a regulation issue and they could no longer use the parts? Have a penalty clause within the agreement gives both sides time to react. Carefully spec out what would constitute an agreed timeframe for notifying all parties, acceptable reasons for the change and penalty cost. No one plans to break a partnership, but having a pre-designed agreement in place eases the process.
- Exchange Rate Variations
Similar to raw materials, exchange rates changes throughout the LTA. Have a set amount at which the buyer covers the difference in cost. Many LTAs dictate that exchange rates over 5% are covered by the buyer, but choose a percentage that works for both sides.
LTAs help the manufacturer forecast production schedules and the buyer diminish pricing fluidity with flat cost structures. Having an agreement does not prevent other manufacturers from targeting the buyer with lower prices – or having a buyer shop prices. However, it is not in the best interest of the partnership to have the agreement under constant requoting.It is fair to ask for a requote when proof of a 20% reduction is offered by a competing company with a similar product. The LTA must be very clear when it is acceptable for a buyer to ask for a requote, and may limit the number of times a requote can be requested.
- Warranty Guarantees
Warranties are measured based on usage as it relates to years, hours or mileage. For example, the typical bearing warranty is one year after purchase. However the warranty is structured, it needs to be fair and reasonable for both parties.
- Closer Clause
Not all LTAs last for the entire contract. A “kick out” clause allows both parties a way out in times of dire circumstances. The cost to be released from the contract should be high enough that it gives reason to pause and try to work through any differences of opinion.
The Bottom Line
When companies enter an LTA, it should be for the long haul. Knowing that you have a true partner helps to do what is in the best interest of the partnership when things get rough.