Clark Hill 2023 Automotive & Manufacturing Industry Outlook: Supply Chain
Obtaining Price Adjustments Under Requirements Contracts
Suppliers in the automotive industry often have fixed price requirement contracts with their customers for the life of a vehicle program. This means pricing, unless stated otherwise in the contract, is not subject to adjustment. In entering these contracts, suppliers rely on their cost experience when they quote pricing and largely take on all the risks associated with future costs and the profitability of these programs. Since 2020, with the onset of the COVID pandemic, costs to manufacture parts and components have increased substantially due to a rise in energy, transportation, labor, and raw material prices. For 2023, some analysts forecast that the landscape will stabilize; others are not so certain. What happens when suppliers argue they can no longer bear the brunt of these increasing costs and they look toward manufacturers to help shoulder the burden? We are seeing this play out in real time.
Requirements contracts with fixed pricing for the life of a program or platform are common in the automotive industry. What is not so common is the global economic roller-coaster impacting almost every supplier and that remains mostly unpredictable given the uncertainty of the Ukrainian War, climate change and trade wars brought on in part due to rising nationalism across the planet, among other things. In 2022, some suppliers with requirement contracts sought price increases from Tier 1 suppliers and OEMs due to these conditions and increased costs. Who was successful in having these requests granted? Typically, it was those suppliers that came prepared to the discussion and supported their requests with detailed financial data on a macro and micro level. While this did and does not guarantee a successful negotiation, it certainly increases the likelihood of obtaining some form of a pricing adjustment or other assistance. Further, these discussions and negotiations do not usually occur overnight but take time, effort, and persistence. Getting ahead of financial crisis is key.
In 2023, it is safe to say that some of these suppliers are already seeking a second adjustment (yes, in less than a year) given continued rising prices and uncertainty and some suppliers will be attempting to get their very first price adjustment. Suppliers should understand that the terms of their contracts control when achieving a price increase. And customers must grasp that suppliers can only shoulder so much of an inflationary environment on their own. It does little good to push a reliable supplier out of business or to force them into cutting costs to the point that it negatively impacts performance.
Notably, over the last year, the industry has experienced more suppliers threatening to stop shipping parts if they do not get higher pricing. Does this really work? Sometimes it does but it is not the best way to handle a customer, particularly if you do not want to lose the business. And customers who are on the receiving end of these threats will typically send a demand for adequate assurance of performance to the supplier. If a demand for adequate assurance does not trigger a continued commitment to supply, customers can file lawsuits for specific performance, which may also include emergency motions for immediate injunctive relief. Of course, if a customer is in a tight spot and acquiesces under duress to the price increase, they may do so under a reservation of rights, preserving their legal remedies for breach of contract so that they can sue the supplier for damages once they re-source the production to another supplier. Damages awarded to a customer against a supplier found liable for a breach of a production supply contract may include the difference between the cost of cover and the contract price together with any incidental or consequential damages. When dealing with a fixed-price requirement contract for the life of a program, the damages awarded could be staggering. Further the time and money spent defending a lawsuit should be a factor considered by suppliers in a risk assessment before taking a position or forming a strategy when it comes to seeking a price increase.
Here are a few tips for suppliers to consider when seeking a price increase:
- Analyze the contractual documents that govern the relationship with your customer and develop a firm understanding of your obligations under the contract;
- Do your homework on a macro and micro level as to your need for a price increase and be prepared to share this information with your customer regardless of whether you have a fixed-price requirement contract;
- Determine your risk tolerance for litigation as it can be distracting, expensive and unpredictable when it comes to a final result.
The views and opinions expressed in the article represent the view of the authors and not necessarily the official view of Clark Hill PLC. Nothing in this article constitutes professional legal advice nor is it intended to be a substitute for professional legal advice.
2023 Chicago Labor & Employment Conference
This program is designed to ensure that you and your business stay prepared and in compliance with new developments in federal and Illinois labor and employment laws.