Provisions to Consider in the Group Purchasing Agreement
Documenting the purchasing arrangement between the buying group and each of its approved vendors is an absolute must.
With potentially millions and perhaps even billions of dollars changing hands, this is no time to time to rely upon a handshake or just a term sheet to confirm the deal. It is also not a good idea to rely upon the vendor’s contract form to set out the terms of the deal. It is unlikely that vendor’s form will be helpful or favorable to the group. Their form is designed to protect the vendor’s best interests–not those of the group. Another problem with using the vendor’s form is that each one will be different, so that there is no consistency in legal terms in the contracts between the group and its approved venders. Further, if the vendor does not have experience in working with buying groups, the sales forms it has on hand, will not likely fit the arrangement. It is not uncommon for a vendor’s agreement to treat the group as if it were the buyer of the goods or services being furnished, rather than the group’s members.
Accordingly, for those reasons, it is imperative that the group have its own form to present to vendors. The form will vary, depending upon whether group is actually buying the goods from the vendor and then reselling them to its members, the members are taking title and delivery of the goods, but the group is assuming financial responsibility for the payment of such purchases, or as is often the case, the group is simply arranging for the purchase of the goods by its members who will be directly responsible to the vendor for payment. Regardless of the arrangement, there are many commonalities each version of the vendor agreement will share. It is important that the business terms be clearly set out. It is equally important that legal terms that protect the group and its members be included.
The format of the Purchasing Agreement can also vary widely. One approach we have seen work well is to place the business terms at the front of the agreement, followed by the legal terms. Often the business terms will fit within the first page, including room for the signatures at the bottom of the form. The legal terms can be attached as an addendum under the heading “General Terms and Conditions,” for example.
Business Terms
The business terms of the form serve as an excellent check list to make sure that the group has explored all possible benefits to itself and its members, leaving nothing on the table. A vendor will seldom provide all the benefits detailed in the form, but in the process of going through the various possibilities, it is possible that the vendor might make one or two additional concessions it had not planned on doing at the outset. Some of the more common benefits offered to the group and its members are explained below as follows:
(a) The most common incentive is a volume rebate program. Typically, the vendor offers an ascending array of discounts contingent upon reaching certain volume levels of purchasing. For instance, a rebate program might be structured like this:
Purchase Volume Percentage Rebate
$1,000,000 1%
$2,000,000 2%
$3,000,000 3%
$4,000,000 4%
The vendors usually prefer to pay these rebates annually, but the group should ask to be paid quarterly. The highest level rebates achieved should go back to dollar one so that if the group made $4,100,000 in purchases, the entire amount of purchases would receive the 4% rebate, as opposed to just the $100,000 of purchases over the $4,000,000 mark. Sometimes a group can successfully persuade a vendor to guarantee the highest level of rebates during the first year or two as the members undertake the difficult process of changing over to the vendor’s line from the old vendors. Therefore, if the group only makes $1,500,000 of purchases during the first year, they would nevertheless receive the full 4% rebate on that amount in that example.
(b) Another common incentive is to give the group a special discount off the normal selling price. Such discounts typically range anywhere from 1 to 10%. When used in combination with the volume rebate program, it obviously makes it more difficult for the group to hit its target goals, because they are paying less for the goods. It is not a bad problem to have, however.
(c) Vendors almost universally offer prompt payment discounts. With the group purchasing power behind the program, the vendor will be more inclined to extend out the length of time within which the payment to be made to qualify for the discount. Instead of having to make the payment by the 10th of the following month, it could be as late as 60 days following the date of the invoice. The amount of the discount might be increased, as well.
(d) Some vendors will pay a group headquarters allowance. This is paid to the group to help support its administrative cost in operating the group, thereby making the increased purchasing power available to the further benefit of the vendor. Such group discounts are usually based upon a percentage of volume but are not contingent upon achieving any particular level of volume. Again, the vendor should be encouraged to pay this as frequently as possible, rather than waiting until the end of the year.
(e) Another incentive a vendor can offer is to extend the terms of payment, so that instead of requiring that the payment be made within 30 days, they could set the terms of equal payments at 30, 60 and 90 days. If a vendor is not willing to offer this on an ongoing basis, they might be willing to consider it for an opening order.
(f) One of the key impediments to the member getting onboard with a new vendor’s program is the problem of the existing inventory it has from the old vendor. To help the members in this process, new vendor could offer to purchase the old vendor’s inventory at cost (in the form of a credit) as part of its “change-over program.” Of course, this is not necessarily unique to group purchases, but it should be a component of a group’s purchasing program.
(g) The group should secure a shipping performance guarantee from the vendor. Significantly reduced prices are of little value if the group is unable to purchase and receive the products when they are needed. To make the shipment guarantee effective, there should be some type of penalty associated with the failure to fulfill a certain percentage of orders placed by the members. Usually, the shipping performance guarantee percentage is 95% or higher.
(h) The warranty program of the vendors should be spelled out. The group could consider negotiating a special penalty arrangement if members experience more than a small threshold percentage of returns of the vendor’s product.
(i) The group may also be able to negotiate a commitment from the vendor to buy back obsolescent products as the vendor comes out with newer ones.
(j) Vendors recognize that it is in the vendor’s best interest for the group to develop a marketing program to help the members to sell the products. Accordingly, vendors are often willing to help underwrite the costs of developing an effective marketing program for the group. Contributions could either be a flat amount or a percentage of the purchasing volume.
(k) Vendors are often willing to offer a cooperative advertising arrangement whereby they will reimburse the members up to a certain percentage of any advertising costs mentioning the vendors’ goods. As part of the group deal, the vendor may offer to forgo requiring proof of advertising and simply contribute a percentage of all advertising costs involving their goods.
(l) Vendors recognize the value of being able to attend the group’s meetings and are willing to pay for that privilege. Some groups require that they pay a flat amount or a small volume percentage each year for this privilege. Other groups invite them to sponsor a dinner or reception by paying for the costs associated with that event.
Legal Terms
Although many of the legal terms in a group purchasing contract mirror those found in regular purchase orders placed by a distributor to its vendors, there are some key differences that are noteworthy. Some of them are:
(a) The unique relationship of the parties should be explained. In most cases, the members are not signing the agreement, but are intended to benefit from it. Under the law, that makes them third party beneficiaries. The purchasing agreement should make specific reference to the rights of the members under the agreement, even though they are not primary parties.
(b) Whether or not the group is considered a buyer of the goods and will be held liable for the cost of the goods should also be clearly delineated. If the purchases and payments for goods are to be made by the members, this provision should state that the group is not liable for any failure on the part of a member to meet its obligations to the vendor.
(c) One of the most important terms is the indemnity provision. The group and each of its members should be indemnified as to any claims arising against them involving the sale or use of the goods acquired from the vendor, as well as other events that should be spelled out in this clause. Vendors will sometimes seek to make this provision mutual, but they seldom succeed in having the groups agree to indemnify them.
(d) As important as it is to have the vendor agree to indemnify the group and its members, it is equally important to have this indemnity backed up by adequate insurance coverage. The Group Purchasing Agreement should require the vendor to have coverage in at least the amount it specifies, and that the group and its members should be named as additional insureds, as evidenced by insurance certificates each year. If the group has numerous members, the vendor might be reluctant to provide insurance certificates for the members. A middle position would be to require the vendor to provide such certificate to a member upon its request. The gold standard of insurance coverage is broad form vendor coverage which covers not only the distributors, but also all resellers downstream from them. At the other end of the spectrum is the vendor who purports to be self-insured. They seldom are as creditworthy as an insurance company. One other important note about insurance is that under broad form vendor coverage, the group is not automatically named as an additional insured. So, the vendor needs to make arrangements with its insurance agent to make sure that is accomplished.
(e) It is wise to include a representation from the vendor that the agreement does not violate the Robinson-Patman Act or any other laws. For a buyer to be held liable for participating in a price discrimination scheme, it must be proven that the buyer did so knowingly. With this representation included, it is much easier for the buyer to prove he had no knowledge of any violation of the Robinson-Patman Act.
(f) Another provision especially applicable to buying groups is a requirement that the vendor provide the group quarterly reports of the purchasing volume of each of the members, so that the group will know how to allocate the volume rebates among the membership. Having current information is also needed, so that the group will know when it is getting too close to making the next rebate threshold, so that the members can be encourage to make an extra effort to support that vendor, thus enabling them to hit the next target (see the rebate example above).
