That said, “Strategic Partnering” has become a common theme with manufacturers/distributors and their vendors. Often, these strategies develop and enhance relationships where the parties eventually become mutually dependent on one another, contracts are signed and typically an assortment of covenants and provisions governing the relationship are condensed to a supply agreement. We often see a “Most Favored Nations” (MFN) clause embedded in these contracts, which is typically reserved for the policy wonks at the State Department, but is an important feature to a number of companies. To understand the underlying implications and consequences of this term, consider the following:
Each month, Coyote Manufacturing commits to purchase 5,000 metric tons of an ingredient from Road Runner Supply (BEEP BEEP – yes I am a Baby Boomer). The raw material is essential to the production of a component that is Coyote’s “Cash Cow”, so the continuity and quality of the supply chain is critical. Road Runner is joined at the hip too, since the relationship represents 75% of their production capacity and top line. Mutual dependency is front and center and there are economic rewards and penalties embedded in the contract when sales volumes exceed minimum tiers or Coyote fails to purchase (or Road Runner fails to deliver).
In return for Coyote’s commitment and guaranty of purchases, the parties agree to a “Most Favored Nations” clause, stipulating that the pricing afforded to Coyote for this raw material will be the absolute lowest price that is offered to all other Road Runner customers operating in a defined industry and/or a geographic region (e.g. the Eurozone, Latin America or North America).
While this pricing guarantee seems pretty straight forward and Coyote’s negotiated price is a bright line threshold, we have seen a multitude of mistakes and missteps in monitoring compliance with these terms. If there’s a penny difference on each pound of material sold in this example, this issue becomes a $1.3 million annual problem.
Suppliers, like Road Runner, often fall victim to:
The contract has been in place for years and Coyote has never raised a concern or question. On the other side, the financial staff of Road Runner isn’t aware of the MFN clause in measuring liabilities and/or closing their books. Amendments to the contract are often not distributed to the appropriate level of management or ignored.
Road Runner’s sales force is charged with bringing in new business and, in an effort to grow the top line, unknowingly offers other companies a price lower than that negotiated with Coyote.
Rather than assessing compliance with the definitions espoused and stipulated in the contract, suppliers have been known to follow the “spirit” of the contract in their monitoring activities. They will ultimately discover that the written contract trumps the spirit of the agreement.
Rather than reading the contract, people often rely on third-party interpretations of the terms or discussions as to what sales should be included in measuring compliance. An officer of Road Runner was quoted as saying…. “I’ve been told that the contract has no geographic limitations on who we can sell to and these other sales are exempt from the MFN guaranty.” Well, guess what, the contract says just the opposite!
Knowing that sales to a third party are subject to the MFN clause, schemes can range from the simple…
To the complex…
Since the contract’s inception, all of the personnel who negotiated the contact have retired or moved on to other careers. Continuing management has no sense of what the negotiated issues were then or how to address them now. Finally, analyses prepared in previous periods with computational mistakes are carried forward year after year.
Whichever side you’re on (vendor or customer) companies need to be aware of these items and consider the following:
These strategic alliances make a lot of economic sense, so continue developing and enhancing these relationships in a true “win-win” mindset; however, due to the concentration that’s created on both sides, be careful in assessing the inherent risks. As in any business relationship, look ahead and envision how to resolve any future discrepancies with your strategic partner.
Make the most of your strategic partnership by contacting a trusted Withum advisor to ensure that all parties are compliant under the terms of your supply agreement.