What are vendor contracts?
A vendor contract is an agreement between a business and a supplier for the provision of products or services that the buyer will use to conduct its own business. These goods and services can range from computer equipment, to raw materials for manufacturing, to food for an office’s break rooms. The vendor agreement defines deliverables and deadlines and ensures that each party knows its obligations with respect to the business relationship.
What is included in a vendor contract?
The vendor contract lays out the terms and conditions of the agreement between the parties. In general, it should include at least the following five elements:
The agreement must delineate precisely which goods or services the vendor will supply. It must also specify the amount of product that the vendor will provide (e.g., for physical goods) or the length of time for which the vendor will continue to provide its service (e.g., a software license or a retainer for a law firm’s legal services).
In addition to enumerating the items or services being sold, it’s often a good idea to establish what sorts of work, business effort and time commitment the buyer expects of the vendor. In the case of an agreement for the completion of a project, the contract should explicitly state what conditions the vendor must meet in order for the parties to agree that the project has actually been finished.
Agreeing on these parameters up front can help to prevent conflicts later.
2. Term and deadlines
If the vendor will complete one or more discrete projects for the buyer, then the agreement must contain specific deadlines for their completion. If a project contains several components, it might be a good idea to outline them separately and agree on a deadline for each stage of the project. A contract for ongoing services or the regular delivery of supplies must identify the beginning and end of the time period during which the vendor will provide its goods or services.
The contract must set out the price the buyer will pay in exchange for the vendor’s work, including currency denominations and deadlines for submission of payments. If the price is subject to change over time (e.g., a bank’s interest rates for a revolving line of credit), then the agreement needs to explain exactly how the vendor will calculate the price, and at what intervals the price may shift.
If the buyer bears responsibility for covering the cost of goods sold, as in a construction contract, then the agreement must establish expectations for how the vendor will select those goods, and set a limit on the vendor’s budget.
If the agreement terminates partway through the vendor’s work, then the contract can also provide for partial compensation. For example, if the vendor ordered expensive parts to fulfill a customer order, but the customer canceled the order, the parties might agree that the buyer will recompense the vendor for the expenses incurred up to that point.
4. Liability and indemnification
In the event that something goes wrong, it’s always better to have determined up front which party is responsible for what. Agreeing on liability and indemnification in advance can preempt costly, time-consuming court battles that ruin business relationships. For example, if it becomes impossible for the vendor to fulfill its obligations and the buyer’s business suffers as a result, then an indemnification clause can specify exactly what the vendor owes to the buyer in order to mitigate the losses.
5. Termination and renewal
The contract must set out how the agreement terminates, whether or not the vendor fulfills its obligations under the contract and receives payment from the buyer. This includes determining under what conditions each party has the right to unilaterally terminate the agreement. For a contract based on a finite project, termination might be automatic following the vendor’s receipt of payment from the buyer. On the other hand, a contract for an ongoing service such as a software license might provide for automatic renewal unless and until the buyer affirmatively terminates the agreement.
Types of vendor contracts and vendor contract examples
The parties to a contract can negotiate any arrangement that is mutually beneficial. However, here are three of the most common price structures for vendor contracts:
A fixed-price contract is one in which the price or rates the buyer will pay are set entirely in advance. The vendor must absorb any fluctuations in the cost of providing its goods or services. This type of contract offers predictability for buyers who have strict budgets. It’s potentially risky for vendors whose costs are highly variable, but the benefit of avoiding cost-plus pricing is that a vendor that efficiently manages its costs can bring in higher profits.
Software licenses are a common use case for fixed-price contracts in the business world. The buyer pays a set monthly or annual fee, usually based on the number of employees who need access to the software application. The software vendor covers costs related to development and support. While vendors take those costs into account when setting prices, the contracted price doesn’t rise if, for example, the company has to hire contractors to ramp up development before launching a new version of a feature.
Also known as cost-reimbursable contracts, these agreements are priced based on two factors. The first component of the price is the cost of the goods or services being sold. The buyer reimburses the seller for any required inputs that the seller purchased in order to perform its work, such as parts, labor, or subcontractor fees.
The second part of the price is an additional fee. This fee might be a predetermined percentage of the incurred costs, or the contract might institute an incentive plan to reward the vendor for completing the work early or under budget.
Construction projects frequently use cost-plus contracts. The construction company has the security of recouping all of the costs that it incurs in the process of completing the work. As long as the contract contains reasonable limits on the project’s overall scope and budget, the buyer is in turn protected from runaway costs and arbitrary fees.
Similar to cost-plus contracts, these agreements also have two elements to the price. One is a wage, agreed upon in advance, for each hour (or other specified unit of time) of work completed. The other part is reimbursement for any materials the vendor uses in order to complete the work.
Businesses often use time-and-materials contracts to engage law firms that bill by the hour. The lawyers track the time they spend researching, writing, and doing other work related to providing legal advice to the client.
They then charge legal fees by applying each lawyer’s hourly billing rate to the total time that (s)he spent on the matter. In addition, it’s typical for clients to reimburse outside counsel for other expenses related to providing their legal services, including travel and fees they incur for using legal research databases.
Five best practices for vendor contract management
Now that you know what to look for in different types of vendor contracts, here are five best practices for managing your organization’s agreements with suppliers — and some tips on how artificial intelligence (“AI”) can supercharge your team’s contract lifecycle management.
1. Centralize contract storage in a secure place
If your organization still relies on outdated, manual processes for contract management, one easy step you can take is to move to a more efficient, secure storage solution. When sensitive documents are scattered across various hard drives and even filing cabinets, it’s difficult to ensure that confidential information doesn’t fall into the wrong hands. An online storage solution that balances accessibility with industry-standard security features can prevent unauthorized access.
In addition, using your own standard contracts, stored in your own contract management system, can alleviate concern about vendor breaches potentially exposing sensitive information regarding your company.
2. Establish uniform workflows
With the business’s contracts securely stored and managed in one accessible, online location, it becomes much easier to streamline and standardize workflows for contract creation and review across the entire organization. A leading contract management platform can eliminate issues such as document version control by automatically keeping track of the most current draft and requiring your approval before incorporating any of the other party’s suggestions into the agreement. Role-based access also allows you to ensure that people on different teams inside and outside your organization can access the specific documents that they need to see, and only those documents.
3. Create templates and preferred language
Having a contract template in place makes it easier not just to draft new contracts, but to ensure that your business’s needs are protected. Instead of starting from scratch, cobbling together bits and pieces of other agreements, or relying on the other party to supply their own template and incorporate your requests, you can determine what language your business needs and create a template to use as the starting point for all of your vendor contracts going forward.
Even if you’re using your vendors’ standard agreements, having optimal versions of the specific clauses you need can make it faster and easier to request those additions from the vendor during contract negotiation.
This is one area where AI can exponentially speed up your workflows. Machine learning algorithms leveraging the power of natural language processing can quickly read all of the contracts in your business’s portfolio. If the AI is pre-trained, then it should already be able to recognize dozens of standard provisions contained across a variety of contract types. The AI can then expedite the creation of new contract templates based on your business’s unique needs with the same level of quality as a skilled human writer, eliminating hundreds of hours of manual review and drafting.
4. Track agreements automatically, not manually
Manually tracking deadlines, rates, and obligations across myriad vendor agreements can be risky. If you miss just one deadline for opting out of an auto-renewing contract, you might find yourself stuck with a provider you no longer want to use. Miss a payment deadline, and you could be in breach of contract.
AI can do the rote work of tracking contract data for you so that you can spend less time manually parsing information and more time focusing on strategic decisions, such as selecting the optimal suppliers for your business and negotiating better contract terms.
5. Review contracts before they’re up for renewal
If you’re always rushing to put out fires and manually prepare new documents just in time to meet last-minute requests, then you might not have many chances to review your vendor contracts far in advance of their renewal or termination deadlines.
If you don’t have time to carefully review your agreements, you could be stuck with unfavorable terms that no longer benefit your business, or worse yet, a vendor you would not have kept using if you’d had more time to review the agreement and your other options.
AI gives lawyers and procurement managers more time and information to analyze their contracts and make strategic decisions that are in the best interest of the business. When you take back control of the time you’ve been spending manually preparing and reviewing every agreement, contract management can become a source of business intelligence and strategic advantage for your organization.
Evisort’s industry-leading AI transforms in-house legal and procurement teams into sources of core strategic insight for the business.
Ready to learn more about how Evisort’s cutting-edge AI can boost your vendor contract management? Schedule a demo today!