For small and medium-sized business (SMB) owners, managing supplier relationships is a crucial part of daily operations. Whether you’re buying raw materials, services, or other essential resources, the supplier contract is a vital document that outlines the terms of the deal. Yet, many SMBs often focus only on price, delivery times, and availability when reviewing supplier agreements, overlooking other critical aspects that can expose them to serious risks.
In this blog, we’ll explore some of the hidden risks commonly transferred to SMBs in supplier contracts and highlight key elements of a supplier agreement that every business owner should carefully review before signing.
The Focus on Price, Delivery, and Availability
When sourcing goods or services, the immediate priorities for most SMB owners include:
- Price: Ensuring the cost aligns with their budget and market pricing.
- On-time delivery: Ensuring goods arrive when expected to avoid disruptions.
- Availability: Making sure that the supplier can consistently meet demand.
While these factors are undeniably important, they represent only a portion of the total picture. Supplier contracts often contain complex terms that, if left unchecked, can transfer significant risks to the buyer.
Key Elements of Supplier Agreements to Carefully Review
Liability Clauses and Indemnity
One of the most critical sections in a supplier agreement is the liability and indemnity clause. Suppliers often include terms that limit their own liability in the event of problems, shifting the burden onto the buyer.
For example, a supplier may insert a clause stating that they are not liable for damages beyond the cost of the goods or services provided. This can be dangerous for SMBs, as the cost of disruptions or defective products can far exceed the price paid. In some cases, SMBs could find themselves responsible for product failures, customer claims, or even third-party lawsuits.
What to Look For:
- Ensure that liability is proportional to the risks involved in the transaction.
- Negotiate terms that protect you from unforeseen damages or customer claims resulting from faulty goods.
- Limit your exposure by ensuring mutual indemnity, where both parties share responsibility based on fault.
2. Termination and Exit Clauses
It’s essential to understand how you can get out of a supplier agreement if things go south. Many contracts lock businesses into long-term commitments without providing clear pathways for termination, even if the supplier fails to deliver on their promises.
Some agreements include auto-renewal clauses, which automatically extend the contract without explicit consent, leaving SMBs tied to underperforming suppliers. A lack of a clear termination process can result in significant financial losses if you are forced to continue working with a supplier that is not meeting your needs.
What to Look For:
- Clear and reasonable exit clauses that allow you to terminate the contract in case of poor performance, late deliveries, or other breaches.
- Avoid automatic renewals without a notification clause, requiring suppliers to remind you before the contract is renewed.
- Look for penalty-free exit options after a reasonable notice period.
Price Adjustment and Escalation Clauses
While you may have agreed to a competitive price today, many supplier contracts contain price adjustment clauses that allow the supplier to increase prices during the term of the contract. These escalation clauses might be tied to external factors like raw material costs, inflation, or other market conditions, which can lead to unexpected price hikes.
If your contract allows for such adjustments without setting clear limits, your SMB could face rising costs that squeeze profit margins and hurt your bottom line.
What to Look For:
- Ensure that any price adjustment clauses are clearly defined with reasonable limits.
- Negotiate for caps on price increases or build in notification periods so that you can prepare for potential cost adjustments.
- Tie any price changes to objective and transparent metrics, such as a specific index or third-party market standard.
Intellectual Property (IP) Rights
If you’re working with a supplier to develop proprietary products, designs, or even marketing materials, it’s essential to understand who owns the intellectual property (IP). Some supplier contracts may include clauses that assign ownership of any innovations or designs to the supplier, even if your business is the one driving the creative process.
This can be particularly harmful for SMBs developing new products or services, as losing ownership over key intellectual property can stifle growth and innovation.
What to Look For:
- Ensure that your contract clearly defines ownership of intellectual property and that your business retains rights to any IP that it contributes to or develops.
- If collaboration with the supplier is involved, negotiate for joint ownership or licensing terms that allow your business to use the IP freely.
Delivery and Performance Guarantees
Many contracts include delivery schedules and performance benchmarks, but often, the penalties for failure to meet these targets are minimal or nonexistent. If your supplier fails to deliver on time or doesn’t meet agreed quality standards, it can have a ripple effect on your business—delays, production issues, or dissatisfied customers.
Without clear penalties or compensation for missed targets, your business may be left shouldering the cost of the supplier’s failures.
What to Look For:
- Insist on clear performance guarantees and penalties for non-compliance, such as late deliveries or substandard quality.
- Ensure that any delivery timelines are reasonable and backed by clear remedies if they are not met.
- Include contingency plans in case of supply chain disruptions to ensure minimal impact on your business.
Force Majeure Clauses
A force majeure clause allows a supplier to excuse themselves from their obligations in the event of extraordinary circumstances (e.g., natural disasters, pandemics, strikes). While these clauses are important for both parties to protect against unforeseen events, some contracts may include overly broad definitions that allow the supplier to walk away from their responsibilities too easily.
In recent years, especially during the COVID-19 pandemic, force majeure clauses have come into sharp focus as businesses scramble to understand the limits of their contracts.
What to Look For:
- Review the definition of force majeure events to ensure they are reasonable and not overly broad.
- Clarify what happens to delivery obligations in the event of a force majeure event, including timelines for resuming services or sourcing alternative suppliers.
- Negotiate terms that limit the duration of force majeure claims, so your business isn't left in limbo.
The Importance of Diligence in Supplier Contracts
Supplier contracts are a lifeline for SMBs, but they also come with potential risks that can harm your business if not carefully managed. Focusing solely on price, availability, and delivery times ignores the broader picture. Liability, price increases, IP rights, and termination clauses are just some of the many elements that SMBs need to review in detail to protect themselves from unfavorable terms.
Proactive Steps for SMBs
To avoid getting caught off guard by hidden risks in supplier contracts, here are a few proactive steps you can take:
1. Hire Professional Help: It’s often worth the investment to have a legal professional expert review contracts before signing to catch any unfavorable clauses or hidden risks. While attorneys are a great resource to help review legal terms, professionals such as Total Optim Solutions with decades of supply chain experience can help you negotiate commercial terms in the agreement as well as manage your supplier relationships for long term agreements.
Negotiate: Supplier contracts are negotiable, even if they are presented as standard agreements. Don't hesitate to ask for changes to protect your business.
Regularly Review Agreements: Even after a contract is signed, regularly revisit your supplier agreements to ensure they continue to meet your business's evolving needs.
Conclusion: Protect Your Business by Reading the Fine Print
Supplier agreements are complex documents, and SMB owners must go beyond the basics of price and delivery to protect their interests. By carefully reviewing and negotiating key contract terms, SMBs can avoid the costly pitfalls that many face when they overlook the fine print.
As your business grows, so too does your reliance on suppliers. Taking the time to fully understand and negotiate your supplier agreements isn’t just a best practice—it’s a necessary step in safeguarding your company’s future success. Don’t leave your business vulnerable by ignoring hidden risks; instead, take control of your supplier relationships to ensure long-term stability and growth.
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