OESA Legal Corner: Using Contracts to Manage Capacity in this Up-Down World
Dan Sharkey, Brooks Wilkins Sharkey & Turco PLLC

As Yogi Berra said, “Predicting is hard, especially about the future.”  Suppliers would love slow and steady growth, but instead, volumes have fluctuated wildly over the past few years.

Contracts can help suppliers manage volume uncertainty.  Because demand for vehicles is inherently unpredictable, few automotive supply contracts list a specific quantity. Under the law, however, contracts must have a quantity, unless they are expressly tied to customer requirements.  And if a customer provides an estimate of volume, the customer cannot demand an amount “unreasonably disproportionate” to that estimate.

Quotes often condition pricing upon actual production volumes being with a certain range of forecasted volumes, but most terms and conditions of purchase say the opposite: that volumes are not guaranteed, but prices are, regardless of volume. 

While the legal landscape is far from certain, suppliers have options to lessen the sting of volume swings:

1. Tie prices to volume ranges (e.g., require price adjustments for anything beyond plus or minus X% of projections).
2. Index variable costs (e.g., raw material) to market costs.
3. Treat any dedicated initial investment (e.g., capital and equipment) separately, akin to tooling, or amortize it over the lowest possible volume.
4. Communicate to sub-suppliers the volumes committed to the customer and lock those same volumes in with them.
5. Raise your floor: reserve the right to not only increase prices, but also reallocate capacity if forecast volumes do not materialize.
6. Lower your ceiling: document maximum capacity and do not promise a volume that you or your suppliers cannot reach.

The first time that you ask for these capacity protection measures, your customer will almost certainly say “no,” and may tell you that you are the only one asking.  But these tough discussions are happening, and those willing to have them are not only surviving, but prospering.

Before you enter into your next contract, think about your capacity and what will happen if volume is twice, or half, what you anticipate.  With see-sawing volume, capacity issues in the supply chain will surely continue.  Whether a rebound or a nosedive comes next, thinking through your contracts with both your customers and suppliers can only help your company.

For a more detailed version of this article, contact Dan Sharkey, partner, Brooks Wilkins Sharkey & Turco PLLC at 248.971.1712, sharkey@bwst-law.com, or consider attending “Mastering the Sales Process:  From Contact to Contract” on Nov. 15, 2011. 

The OESA Legal Corner is a monthly feature in OESA News.  OESA affiliate law firm members contribute short legal updates to keep members informed on critical issues affecting their businesses.  OESA enforces a strict policy of no legalese for these briefs.  For more information or to request or suggest a topic, contact Margaret Baxter at 248.952.6401 ext. 223 or mbaxter@oesa.org.