I received the following inquiry from a reader:
As you know, goods or services can be purchased by means of purchase orders issued under a master contract or by POs that aren’t issued under a master contract—I’ll refer to the latter as “stand-alone” POs. They can be issued for one-off purchases or on a regular basis as part of an ongoing relationship.
When you have a master contract, the general terms—in other words, everything that doesn’t relate to deal-specific matters such as product and price—are contained in the contract; the purchase orders issued under the contract contain just the deal terms. Furthermore, the general terms in a master contract are negotiated. By contrast, when you buy something using a stand-alone purchase order, the general terms are contained in the PO along with the deal terms, and those general terms are determined unilaterally by the purchaser rather than negotiated.
So what’s your take on the general terms in a stand-alone PO as compared to those in a master contract? Should they be equally comprehensive, or should those in a stand-alone PO address fewer topics more concisely and more evenhandedly?
Currently, the general terms in my company’s master contracts aim to be comprehensive, but those in our stand-alone purchase orders are shorter. One big reason for that is that including general terms in a PO makes demands on the supplier. Because the general terms in our stand-alone POs won’t have been negotiated beforehand with the supplier, they’re a source of delay, in that the supplier has to read through them and, after having done so, may balk at one or more of the general terms. And the longer the general terms are, they greater the likelihood of delay, and the greater the risk that the supplier will decide that given the extra one-sided verbiage, they’d rather not do the deal. Sometimes we end up having to negotiate; other times we agree with the supplier that if any conflicts arise, we’ll resolve them according to the Uniform Commercial Code.
This is of great interest to me because our legal department has prepared a new set of general terms for our stand-alone PO that essentially mirrors the general terms in our template master contract. That means the new set of general terms is comprehensive and one-sided in our favor. It’s also three times longer than the general terms we currently use for stand-alone POs. I’m torn between wanting to protect our company by using a comprehensive set of general terms for all our transactions versus wanting to use a shorter set of general terms so as to expedite our stand-alone PO transactions, most of which are low-risk. I’d be interested to hear what you think.
I don’t have direct experience with this issue, but here’s my first-principles take on it:
I can understand wanting to have the same general terms apply to purchases under a master contract and purchases under stand-alone purchase orders: your concerns as a purchaser are the same in both contexts.
But you have to consider the transaction costs. With a master contract, the parties have decided that they’ll be doing enough business together to warrant incurring up-front the transaction costs involved in negotiating a master contract. By contrast, with a stand-alone PO, you’re dealing with a single transaction—it would presumably not support the same level of transaction costs.
For purposes of illustration, here are a couple of hypothetical scenarios with make-believe numbers:
Acme and AlphaCo negotiate a master contract for Acme’s purchase of widgets from AlphaCo. In negotiating the general terms they incur $10,000 of transaction costs. They anticipate that Acme will purchase $1 million of widgets over the life of the contract.
By contrast Acme and BetaCo elect to have Acme purchase widgets from BetaCo using stand-alone POs. Acme orders 1,000 widgets for $10,000, using a purchase order that contains the same general terms as it used in the master contract with AlphaCo. The order placed with BetaCo is worth 1% of the expected value of purchases under the master contract with AlphaCo.
BetaCo’s transaction costs could well be less than Alphaco’s: with a one-off transaction, not as much would be at stake, so BetaCo might well be willing to accept some general terms without any haggling. But it wouldn’t be reasonable to expect the transaction costs incurred by Betaco to be 1% of the transaction costs incurred by Alphaco—the time it takes to read and understand the general terms would be the same for both transactions.
And it wouldn’t be realistic to expect that just because it’s a one-off transaction, BetaCo will accept all the general terms without negotiation. After all, a supplier that’s willing to give concessions in each one-off transaction could soon find itself with a portfolio of unfavorable contracts.
And it pretty much follows that if a comprehensive set of general terms in a stand-alone PO causes BetaCo to incur disproportionate transaction costs, closing the deal would cause Acme, too, to incur additional transaction costs as it engages in discussions with BetaCo.
So it may be that for the deal to make sense, the general terms in any stand-alone PO issued to BetaCo would have to be significantly shortened and made less one-sided so as to reduce BetaCo’s and Acme’s transaction costs.
Of course, BetaCo’s transaction costs could well be reduced drastically the next time Acme submits a stand-alone purchase order. But that assumes that the same BetaCo personnel are handling the second PO as handled the first. And more to the point, in handling the first PO, it would be risky for BetaCo to assume that it would in effect be able to amortize its transaction costs over the course of future purchases: for all it knows, Acme’s first PO could be its last.
So I’m sympathetic to the notion that for purposes of stand-alone purchase orders, it make sense to cut back a set of general terms used in a master contract and make them less one-sided, even though they reflect legitimate concerns.
I’m sure readers will have their own practical—as opposed to theoretical!—take on this.