Contracts are used in all areas of life, both business and personal.
They serve as reliable documentation showing that you and another party have come to a mutual agreement about the terms of a certain relationship, purchase, or transaction.
In this case, procurement contracts provide a framework for the relationship between your business and its vendors, and any duties or responsibilities owed to one another.
Thinking of negotiating procurement contracts might give you a headache. But, a solid, well-crafted contract can help you minimize legal risks and make cost-effective purchasing decisions for your business.
What is a procurement contract?
A procurement contract is a legally binding agreement between two parties regarding the purchase of goods or services.
You may also hear it referred to as a purchase contract.
The goal of the procurement contract is to protect both the buyer's and seller’s interests in the exchange.
It sets the foundation for a stable and reliable supplier relationship by laying out each party’s obligations in writing.
Specifically, the contract ensures the buyer will receive a specific quality of goods or services at a certain price and delivery schedule. In return, it guarantees the supplier will be promptly and appropriately compensated.
The importance of procurement contracts
When you’re running a growing business that relies on a few key suppliers, you need to know that you can count on them to deliver critical goods or services that your company depends on.
But, your vendor needs the confidence that they will be paid for their work and recoup any costs they’ve incurred to provide their goods or services.
Procurement contracts are meant to protect your interests just as much as the vendor’s, helping to establish a mutually beneficial relationship.
With the contract in place, you know the exact quantity and quality of goods or services the vendor will deliver to you, and on what timeline.
On the other hand, the vendor has a clear understanding of how much you will pay them in exchange, and on what terms.
Thus, a procurement contract eliminates any confusion or conflict about the terms of your relationship.
It gets both parties on the same page about what is expected and provides a guarantee that you will each receive what was promised.
If either party fails to meet their obligations, the contract should include a clear path for recourse to mitigate any potential business disruptions.
What’s included in a procurement contract?
Procurement contracts can come in a number of formats, which we’ll discuss below.
However, there are some common elements that you’ll find clearly defined in most procurement contracts, such as:
- Involved parties: the buyer (your business) and the seller (the vendor or supplier)
- Scope of work: a description of the products or services the seller will provide and any specific parameters, quality, or standards they must meet
- Terms of delivery: the delivery schedule for the procured goods/services, the shipping method that will be used, and any inspection requirements to check for defects or quantity errors
- Confidentiality agreement: the definition of any information or trade secrets that need to be shared between the buyer and seller for the sake of procurement but should not be shared with outside parties, where applicable
- Pricing and payment terms: the pricing structure and any applicable fees, taxes, or surcharges that will be imposed, as well as the preferred payment method, schedule, and applicable late fees or penalties
- Quality and performance standards: the performance metrics or KPIs that the buyer will use to assess the quality, accuracy, and timeliness of the buyer’s goods or services
- Termination and renewal: the grounds for termination or renewal of the contract and any procedures to follow
- Dispute resolution clause: the procedure to resolve any disputes or conflicts between the parties over the terms of the contract, such as mediation, arbitration, etc.
The 3 types of procurement contracts
Each purchasing agreement is unique, so the contract will need to be altered accordingly to fit the specifics of the arrangement between the buyer and seller.
No matter how you tweak the contract, they typically follow one of three structures:
Fixed-price contracts
As the name might suggest, a fixed-price contract defines the exact amount you’ll pay for specific goods or services, usually at a specific minimum order quantity.
These fixed pricing terms will last over the duration of your contract.
For example, you may negotiate a one-year agreement with a vendor where they will deliver two pallets of raw materials each week at $650 per pallet.
A fixed-price contract will likely include most of the elements we described above, with the main differentiator being the pricing and payment terms.
Here are the main types of fixed-price contracts you can use:
- Firm fixed price (FFP): the buyer pays a fixed amount for a certain quantity of goods or services no matter the costs the seller incurred to deliver them
- Fixed price and incentive fee (FPIF): the seller will receive a fixed fee and can be compensated with a bonus if they hit certain standards, like making an early delivery
- Fixed price with economic price adjustment (FPEPA): the buyer agrees to a fixed fee though may allow for price adjustments in certain circumstances, typically for situations that are outside the seller’s control
When it’s most beneficial: Fixed-price contracts are a good idea for items you consistently need to support operations.
These contracts lock you into a certain negotiated price that you’ve determined is profitable for your business.
So, you’ll pay the same amount for items no matter how input prices or operating costs fluctuate on the vendor’s side.
Cost-reimbursement contracts
Another common type of procurement contract is a cost-reimbursement (or cost-plus) contract.
Using this structure, the buyer agrees to pay a fixed price, plus compensation for any additional costs the vendor incurred directly or indirectly to develop, produce, and deliver goods or services.
The seller will typically provide an estimate beforehand to ensure the buyer can allot the appropriate amount of resources to the transaction. However, the exact price will not be determined until after delivery.
When it’s most beneficial: This type of procurement contract is best when there’s some uncertainty around the full amount of work the project will entail and the total costs the seller will take on to deliver the product or service.
The two parties may agree on a ceiling for the highest amount that can be billed, which can help provide some security to the buyer around what they will eventually be obligated to pay.
Time and materials contracts
With a time and materials procurement contract, buyers pay for the direct materials and time the seller uses based on agreed-upon rates.
In many ways, time and materials contracts work as a hybrid of both fixed-cost and cost-reimbursement contracts.
Sellers set fixed rates for labor and materials, and the amount buyers pay will depend on how much is spent to produce and deliver the contracted goods or services.
In practice, you might agree to pay a vendor $85/hour for their consulting services, with an estimate that they’ll spend between eight to ten hours delivering their service.
Once the job is complete, they’ll send you a bill with the actual number of hours they worked on the job and a total amount due.
When it’s most beneficial: This can be a useful procurement contract when hiring vendors who charge based on their time, such as accounting firms, web developers, security solutions, and more.
It’s specifically helpful when you’re unsure of the exact scope of the project, meaning you’re not able to set a fixed price beforehand.
Effective procurement contract negotiation tips
Before you end up with a finalized procurement contract, you’ll need to negotiate the terms and parameters with the vendor or supplier.
Depending on the nature of your business and who your vendors or suppliers are, contract negotiations probably won’t be as intense as what you’ve seen in films.
In reality, it’s more of a collaborative effort to ensure both parties benefit from the contract and have a solid understanding of expectations before entering into business together.
To help you protect your best interests in a procurement contract, we’ve compiled a list of expert tips so you can confidently enter negotiations.
Do the prep work
Always do your research before going into negotiations with a vendor. Being familiar with their market, products, and services can provide you with some leverage during conversations and shows that you have taken an interest in their company.
As you’re preparing, make sure you have a strategy in place about what you’d like to achieve or what your priorities and ideal terms are. This can help you determine where you’re willing to bend, and what items are deal-breakers.
Be fair and flexible
Once you’re in negotiations, be willing to compromise. At the end of the day, you’re likely negotiating with vendors who you want to business with long-term. So, it’s probably not worth it to undercut them or feel like you have to “win” the negotiation–which can compromise your working relationship.
This doesn’t mean you have to put all your priorities to the side and cater to each of the vendor’s needs. But, you should understand that you might not get every single term you want, either.
Contract negotiations will set the tone for your relationship, so be transparent about what your objectives are so you can foster trust and good communication with the vendor from the onset of the engagement.
Set clear terms and conditions
One of the common pitfalls during contract negotiations is to leave terms ambiguous or open-ended.
This goes against the main purpose of negotiating a procurement contract in the first place, which is to create an objective document that clearly dictates the terms and expectations of the engagement.
Make sure you’re able to come to a consensus on each element, and clearly lay out the terms and conditions in writing. Verbal agreements alone won’t do.
Even if it takes a little longer to hammer out all the details, it’s better to put in the work upfront during negotiations than to assume the other party will agree with your positioning down the road.
In doing so, you’ll be able to minimize misunderstandings and legal disputes in the future, as there should be little in the contract that’s up for interpretation.
Include a termination clause
Don’t overlook the importance of including a termination clause in your procurement contracts.
It provides an exit plan for either party if the other is not meeting their contractual obligations.
Even though things might be friendly in the beginning, there’s no way to tell what the future might bring, and you don’t want to end up locked into a long-term contract with a vendor who isn’t pulling their weight.
Work with the vendor to include a termination clause outlining the conditions and procedure that either party can follow if they wish to end the contract.
Seek legal counsel when necessary
Remember that contracts are legally binding agreements that can have long-lasting implications on your operations.
Even if you feel prepared to handle the negotiations on your own, you may want to consider consulting with experienced legal counsel to help you construct a procurement contract with the proper terms, conditions, and phrasing to protect your business interests.
Meet your contractual obligations with on-time vendor payments
Once you have a solid procurement contract in place and you start making orders from a vendor, you need to make sure you’re holding up your end of the deal with accurate and on-time payments
With BILL’s automated AP solution, you can easily manage payments to vendors without the heavy administrative burden on your team.
Within the platform, you can import invoices with minimal manual entry, tailor approvals to fit your business’s needs and leverage 2-way sync to reconcile accounts faster and ensure you’re only paying legitimate invoices.
All the while, our system makes sure vendors are paid when they expect–keeping you compliant with the contract terms.
Get started with BILL today and see how your vendor relationships can benefit from automated payments.
