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Four Management Challenges Related to Manufacturing Contracts

     

Outsourcing is a crucial strategy for manufacturing enterprises, allowing businesses to more efficiently and cost-efficiently procure critical components, tools, and services, thus speeding up production cycles. But this reliance on third-party suppliers – many of whom may be spread out across the globe – makes effective contract management even more of an imperative for protecting quality and reducing other risks that can affect production or increase costs.

As you consider your manufacturing contract strategy, here are four unique challenges to watch out for.

1. Addressing Inventory Exposure

Matching your needs for equipment and parts with your production output is a delicate balance: if you underestimate what you need, then you will likely experience stalls and delays within your production cycle as you and your suppliers scramble to fill the gap. Overestimating, meanwhile, can result in having to pay for items that you don’t need, and that may become obsolete by the time you are ready to use them. There are two crucial tactics within contract management for mitigating these risks:

  • Historical data: The more accurately you can forecast production and production needs, the better you can proactively address inventory exposure within new agreements or contract renewals. This forecasting is easier to do if you take the step of conducting contract postmortems at the conclusion of your agreements. As you review past contracts for performance, consider the remaining value – for example, unused parts – in previous agreements. Conversely, it’s also useful to analyze past agreements that did not ultimately meet your inventory needs. These past lessons can help you better pinpoint your needs moving forward.
  • Address your exposure within your contract: Market shifts and other unexpected changes mean that no matter effective you are at forecasting, you may get it wrong. Which is why it’s important to clarify within your contacts who is on the hook before an inventory issue arises. For example, if you do need more than expected, what is your supplier’s obligation to ramp up? How much notice will be required? Will there be a premium on pricing? By considering both under- and over-provisioning scenarios, and incorporating clear terms that address each, you can reduce the risk of costly inventory issues within your manufacturing contracts.  

2. Dealing with Regulatory Compliance

Whether you’re dealing with domestic or foreign governments, regulatory compliance is often a key challenge within manufacturing. Not only must manufacturers themselves adhere to often complex rules and regulations, but they must also ensure that all of their suppliers and original equipment manufacturers (OEMs) also meet the appropriate guidelines. While strong contract management practices are an important tool for ensuring that all compliance requirements are met, if you’re drafting each and every new manufacturing contract from scratch, you are adding needless complexity to the process, and increasing the risk that important requirements may be unintentionally omitted. Instead, consider developing standard contract templates for each type of supplier you work with. These should include standard clauses that address all of your compliance needs and your supplier’s obligation to meet them, including any documentation requirements. Your contracts should also clearly identify any penalties – including a possible termination clause – for failure to adhere to your requirements.

As regulations may change from year to year or under new administrations, make sure you periodically review your contract templates to ensure that all terms related to compliance are up to date. As you update these terms, make sure to archive old versions; as you renew legacy agreements, don’t forget to check whether a more recent version exists. A well-organized contract library cuts the work of finding the right contract type and version as you onboard new suppliers or renew agreements.

3. Eliminating Pricing Surprises

Not all of the manufacturing supplies you procure may be available at fixed prices, which can result in pricing fluctuations over the course of your contract lifecycle. But no one wants to be surprised to get a significantly higher than expected bill from a supplier. While there may not be much you can do about market forces, you can better manage this uncertainty by understanding the cost structure of the goods you are procuring, and proactively addressing pricing variances, periodic updates, currency fluctuations and other factors that can impact costs during the contract period. You may also want to include pricing caps and termination clauses, should levels surpass a certain threshold.

But if your contract is subject to variable pricing, it may not be enough to merely include these terms within your contract. It’s also important to have a plan to monitor pricing (and factors that will affect pricing) on a regular basis during the contract term so that if your agreement allows for it, you can make changes as necessary.

4. Ensuring Supplier Quality

As a manufacturer, the quality of your product depends on the quality of all of the parts and supplies used to produce it. This means that your reputation is directly linked to the ability of your suppliers to deliver a consistent level of quality. Your contract can help safeguard this, outlining not only the quantity of deliverables, but also their required state and the actions your supplier is required to take, or penalty they must pay, should they not deliver the goods as expected. Again, while including appropriate language is an important first step, it is also crucial that you monitor performance throughout the contract period so that you can hold suppliers to their obligations.

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