My colleague Gene Ciemny recently wrote about the increase in pulp and paper costs after an extended period of price stability.
While there are common threads across contracts in different industries, there are also important distinctions in market dynamics, industry customs and terminology specific to various industries. Let’s explore some of the key factors to consider in vendor contract negotiation for paper.
Prebates, Signing Bonuses: Found Money Either Way
Upfront incentive payments, often referred to as “signing bonuses,” are relatively common across industries. In the paper world these are called “prebates” and are frequently paired with ongoing rebates earned by meeting agreed-upon volume levels. Many clients are not aware such incentives are available; even those who are aware often lack the market insight to calibrate the full value of their book of business in a competitive marketplace.
This important economic component of any agreement is also susceptible to being overlooked – or at least shortchanged – in a renewal scenario. Vendors calibrate their upfront incentive offers to generate payback over the term of a contract. When renewal time comes, it’s entirely logical for buyers to negotiate for another incentive.
Stepping Off the Escalator
An escalator clause accounting for changes in the cost of raw material inputs is commonplace in paper contracts. These clauses became afterthoughts during the long period of price stability, but are now re-emerging as a hot topic. Nearly all of the related formulas use the industry standard RISI index of paper cost as a baseline. The formulas themselves can vary widely, however. For example, a $10/ton increase in the index (a typical increment of a pricing change) may drive as much as a 2% increase to the total invoice.
The flaw to this logic is that vendor costs consist of many more components than raw paper. Costs in many of these areas (set-ups, printing and die cutting, for instance) have actually been on declining trends, thanks to industry consolidation, automation and the realization of operating efficiencies. Compensating a supplier for changes in commodity prices outside of their control is appropriate. The challenge arises in devising a formula to accomplish this without padding margins for unaffected inputs.
The Price of Quality
Bargaining for the lowest possible price is wonderful, but quickly becomes a hollow victory if the result is elevated defect rates or late deliveries that drive up the total cost of ownership. Consider a beef or chicken manufacturer reliant on packing cartons. If these arrive flawed or after the agreed upon date, who pays for the inventory spoilage? With proper expertise, an equitable formula-driven solution can be devised to protect both parties. These can vary markedly by industry, depending on the nature of inventory.
Another factor that was often overlooked in recent years but is again becoming essential is a contract clause ensuring priority in supply allocation. With paper integrators now operating at 98% of capacity following a wave of consolidation, it’s essential for buyers to guarantee their supply of corrugate during spikes in demand. No one wants to shut down an assembly line for lack of boxes in which to ship finished product.
The paper industry is in the midst of shifts in dynamics that, while hardly unprecedented, have not been seen in over a decade and are probably new to most managers in their current roles. With proper expert advice, these challenges can be addressed without undue impact on the bottom line or unanticipated operational hiccups.