Contract renegotiation puts pressure on supply chain

Manufacturers and industry observers say purchase orders and other business agreements are among the first casualties of 21st-century economics as contracts are increasingly broken or renegotiated.

According to a special report in Financial Post Edge, offshore competition from manufacturers with deep pools of cheap labour is relentless, and multinational customers are wielding increasing clout in contract negotiations.

According to one source, this is causing somewhat of an “underlying shift in business morality”.

The report quotes James G. McPherson, a commercial corporate lawyer with Toronto’s Aylesworth Thompson Phelan O’Brien LLP, who says “Whether [it results from] mass communications or shrink-wrapped contracts or reverse acceptance of things, it seems that-just the way marriages are- it used to be that a deal was a deal. Whether it was on a piece of paper or a handshake, you thought it out beforehand, and unless it was really pretty much a catastrophic breakdown, people tried hard to fulfill their obligations. But it seems now that people don’t understand fundamentally that that is what a contract is about.”

In a cited 2003 Deloitte Touche Tohmatsu report on global manufacturing’s increasing complexity, 57% of 400 companies surveyed had moved production facilities to lower-cost locations; 67% reported outsourcing manufacturing operations; and, 15% of the North American companies surveyed no longer had manufacturing facilities in their home markets.

Canadian manufacturers also face challenges with world energy market volatility and Canada’s rising dollar.

The chief economist for the Canadian Manufacturers & Exporters (CME), Jayson Myers, says while his organization does not compile statistics on renegotiated contracts, higher production costs in North America have forced companies to simplify their supply chain by cutting suppliers.

“A lot of customers seeking to reduce their base costs, especially in such industries as automotive, try to do it “on the backs of their suppliers … they’re looking at getting more and more changes within existing contracts or trying to open up and renegotiate a contract. This goes on all the time but when times are tough, larger companies in particular look for a cost advantage and have a lot of muscle power when they’re dealing with smaller suppliers,” says Myers.

This new trend in renegotiating contracts has seen a real squeeze in the manufacturing supply chain, as customers demand suppliers share the pain of market downturns.

John Bell, of Polymer Technologies Inc., makes more than 600 highly sophisticated parts for the North American automobile industry. Earlier this year, Bell says, Magna International Inc. told Polymer it wanted a 27% cost reduction from the parts supplier over three years. Magna accounts for roughly 20% of Polymer’s overall annual sales of $50-million.

This deal also had serious logistic consequences for Magna in terms of switching parts production programs, and supply-chain pressures forced Polymer to chop $4-million off its annual $14-million payroll. In January, the company employed 455 people; by August there were 366 employees.

Today, while contracts between companies remain legally binding documents, pursuing a broken written agreement through the courts has practical limitations for companies. And though contracts remain key to business relationships, they’re not the only key, says Steve Van Houten, the president of the Purchasing Management Association of Canada.

“There’s always a balance to be struck between what the contract says and what has changed in the business environment and what the relationship is between the parties. The contract is an important starting point, but it’s often leavened by the business reality.”