What’s your New Year’s resolution?
Want to get in shape, or maybe get more organized? How about taking care of some annual business tasks that you may be putting off, like cleaning up your contracts? It’s the perfect time of year to knock this often neglected item off your to-do list.
Many manufacturers fail to annually review and revise contracts – but the reality is you really can’t afford to skip this step.
The ongoing supply chain dilemma is largely consumer-driven, and manufacturers worldwide have been wholly unprepared to handle the pandemic’s perfect storm of increased demand coupled with resource reduction. While some analysts anticipate a return to normality in late 2022, others say the economic turbulence could last for another 24-36 months. Can contract reviews be tedious? Yes. Are carefully crafted contracts also central to your financial success in the New Year? Absolutely. Below, we’ll outline some critical steps your manufacturing team should consider taking as we ring in 2022, to ensure your customers are satisfied, and your contracts are working for you.
Rising materials prices make it crucial for manufacturers to limit risk in their client agreements.
Bottlenecks, delays, equipment shortages, and shutdowns have created disruptions across the board leaving some manufacturers in precarious positions. At this point, we can all agree that pandemic clauses are necessary, not only due to COVID-19 but also to protect from future pandemics and similar situations. To avoid being tied up in unrealistic contracts and producing for a loss because of mounting material costs, carving out changing cost clauses will be essential in 2022 and beyond. Cost structure changes are necessary during these tumultuous times. Manufacturers should typically hold prices for a specified number of days but should have a clause in the agreement stating that if the contract is not released for production in a set number of days, then a price adjustment can be made by the manufacturer.
In response to increased price volatility in the current market, it’s wise to insert extremely open-ended language in the contract itself and/or in the manufacturer’s clarifications exhibit attached to the contract, which entitles the manufacturer to a change order for any increase in materials pricing throughout the manufacturing process. As these provisions shift 100% of the risk to the client, manufacturers should be prepared for clients to try to tailor the contract to share the risk. Some clients may include a contingency line item to address certain unforeseen costs that arise during manufacturing, including materials price increases.
Another approach some may take is to set a threshold percentage above which the client covers price increases and below which the manufacturer bears the risk. Here, the client and manufacturer would agree that the client covers the amount of increased cost if the cost incurred is 10% above the line-item amount shown in the schedule of values. If, for example, the cost of lumber increases by only 9%, then the manufacturer is responsible for all of the increased cost. However, if the cost of lumber increases by 15%, then the manufacturer is responsible for 10% of the increased cost, and the client must cover the remaining 5% of the increased cost. This approach sets a clear standard for addressing price increases and may provide enough flexibility to allow the price volatility to subside.
The time is now to ask yourself, is your team operating as cost-effectively as you can be?
The start of a New Year signals fresh opportunities to recharge, reinvigorate, and reinvent your practices. Dedicate some valuable time to examine your process and determine what’s working, and what’s not. Of course, there’s no one size fits all approach for your operation, and each client relationship is unique. Regardless of how you approach current and future contracts, the most important thing to remember is to address the uncertainty of material price escalation clearly. The information contained in this article is provided for informational purposes only and should not be construed as legal advice on any subject matter. We highly recommend you contact your attorney to thoroughly review all contract language. If you have any questions for our team of financial and tax professionals or would like help evaluating what effect increasing materials prices may have upon your latest project, please do not hesitate to contact our dedicated team.