As a contract manager with strong procurement experience, having spent some fifteen years in large industrial groups, I have often faced a wide range of issues, among them the thorny choice between a firm price and an adjustable price. Widespread and initially reassuring as it is, the recent economic crises have shown just how unpredictable market price movements can be, and how lasting their effects. They have also exposed the limits of an overly rigid approach to price.
Opting for a price adjustment mechanism proves a far more successful strategy and a guarantee of calm in contractual relationships over the medium and long term.
That approach does, however, require a degree of finesse to build consensus, and through this piece I want to highlight how contract management, and more specifically procurement contract management, can make this mechanism genuinely viable over the long term.
The ever-present temptation of the firm price in commercial negotiations
This is not to say that negotiating a firm price and writing it into the contract is a false good idea. Quite the opposite: it is a mechanism designed to protect both parties, from excessive provisions (the customer) and from uncontrolled index movements (the supplier), and it can be relevant and offer several advantages depending on the context.
Indeed, for contracts indexed on stable prices, or on prices whose movement is predictable, and with relatively short durations, it is a good way of guarding against contingencies that could affect the financial terms of the contract. Contracted firm prices generally correspond to median prices, that is, the prices of the services at the mid-point of the contract. This means that prices are often higher than they should be at the start of the contract, and lower after that mid-point, relative to how the market moves.
Among these benefits we can also highlight simplified administration (no calculations, no communication or discussion about the effects of price movements, and so on), and the advantage of a degree of budget predictability.
That said, this choice, which is above all a cultural reflex, meets its limits where the industrial reality of markets exposes the parties to availability and/or economic contingencies, particularly over long periods. In such a situation it is more appropriate to move towards a consensus formula that will keep the contract fully workable, namely a price adjustment mechanism. That is not always the first reflex, even in sectors such as energy, construction or transport, and it can lead to inefficient negotiation and to deadlock.
Market volatility: an unpredictable and fraught reality
The recent economic crises, such as the COVID-19 pandemic and geopolitical conflicts, have had devastating impacts on world markets. We have faced uncontrolled price rises in raw materials such as stainless steel, semiconductors and their components, copper, oil, and so on.
These fluctuations and the absence of any readjustment mechanism can jeopardise the workability of the contract, because price movements are not taken into account, and lead to discussions based on imposed situations, which are generally not conducive to a lasting agreement.
This situation must absolutely be avoided so as not to create friction in the relationship between suppliers and customers. That unpredictability can be significantly reduced by taking these aspects into account at the upstream stage, both in the discussions and in the drafting of the contract.
The importance of choosing and drafting the price adjustment clause
As you will have gathered, the price adjustment clause is a mechanism for adapting the contract, for giving it flexibility in the event of economic contingencies. It allows the price to be adjusted against certain market indicators and ensures that the financial risks attached to market price increases are borne fairly.
It helps to reduce the tensions described above and preserves the balance of the contract. For that to work, it is important that it is developed jointly by the parties, so as to reflect the specific features of their activities and their sourcing strategies.
A fair price adjustment formula must, in my view, mirror the cost structure of the services to which it applies. Where, for example, we intend to apply it to manufactured products, care must be taken to ensure that each element scrupulously reflects the supplier's actual spend, the materials element, labour, indirect costs and a fixed element where industrial reality justifies it, but also the implications for the buyer and the way in which the buyer will be able to pass it on to its own customers.
The same is true of the collective pay agreements applied to labour, which must also be chosen with care. Can the ICHT (the French hourly labour cost index) be applied, or should a more specific index be used, such as the one attached to the metalworking collective agreement?
The more faithfully the indices reflect the reality of the services contracted, the less discussion they will generate about their selection and/or their application, and the more straightforward and widely shared their adoption will be.
I remain convinced that the more accurately you manage to assess the cost of a service or a good, the more relevant you are in building the formula. This work by the contract manager, who has to roll up their sleeves and get their hands dirty, is essential.
What approach should the contract manager take?
As we have seen, collaboration is essential in order to produce clauses that are realistic and acceptable to both parties. Open and transparent discussions make it possible to define relevant criteria and indices for price adjustments.
The pragmatic and efficient approach of procurement contract management is key to finding a way of making the agreed price adaptable. By its very process, this discipline naturally erodes the rigid stance of the fixed price and of a contract that cannot adapt.
Through their analytical ability and their understanding of requirements, the contract manager ensures that price adjustments are based on reliable and transparent data, but above all that the chosen mechanism is suited to industrial and market reality.
They act as a facilitator, assessing the factors that can influence price movements and setting clear criteria for when and how price adjustments will be made. They make sure, and this is perhaps one of the most important points, that the drafting of the clause and the mechanism for applying it are perfectly clear and precise.
Finally, their involvement will be key to keeping that clause alive over the long term. On that point, I would like to share the fact that a reference index set too early (thereby imposing an adjustment over a longer and unrealistic period) can have unsuspected long-term repercussions. The contract manager's task will therefore be to adapt these terms to market movements and to the company's activity and context.
In short, nothing should be set in stone. To achieve that, the contract manager must keep a constant watch and draw on the resources available to them. This is precisely what procurement contract management and the contract manager bring: a strategic asset for the effectiveness and the workability of the price adjustment mechanism.
Conclusion
The upheavals of recent years are forcing companies to rethink their approach to price negotiation and their contractual practices. Building into the negotiation, and into the minds of stakeholders, the acceptability of adjusting the agreed price during the contract and according to circumstances is a challenge that is more than necessary for the contract manager, faced with the "culture" of the firm price. It chimes entirely with the DNA of the discipline: a constant focus on improving performance and maximising profitability, while making sure that contractual relationships are robust, adaptable and strategically aligned with the company's objectives.