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Breaking Down Types of Vendor Contracts and When to Use Them

Breaking Down Types of Vendor Contracts and When to Use Them

Breaking Down Types of Vendor Contracts and When to Use ThemLaleh Hassibi
Vice President of Marketing

It’s hard to do business by yourself. Whether you run a software business, manufacture consumer products, or you’re in the energy industry, you will find yourself developing relationships with third-party vendors to ensure your customers receive the resources they need. In some cases, you may even be the vendor yourself.

A good vendor agreement can be a boon for both vendors and customers. The former will get financial support, and the latter will remain stocked with reliable, quality supplies. As a result, all parties can enjoy optimized business performances and nurture relationships.

In today’s blog, learn about the different types of vendor contracts and what they mean for your business.

What Are the Different Types of Vendor Contracts?

Vendor agreements outline the key terms covering the exchange of goods or services in return for compensation. They detail the services vendors will supply to their customers and the ways they'll get paid for them.

As vendor transactions can differ a lot, there are different types of vendor contracts. Some sellers may prefer to get paid for their time and charge an hourly rate, while others may require a fixed price. The length of the arrangement and quantity of supplies can also vary and influence the business contract.

Depending on these factors, the main types of vendor contracts are:

Fixed Price Contracts

In fixed price vendor contracts, both parties agree beforehand on a set price for the whole of the vendor’s services. These are standard contracts that layout concrete terms for the number of goods or services the vendor will provide for a fixed price. As such, vendor contract templates for fixed-price contracts should be the easiest to draft.

The payment terms in this type of vendor contract should reduce the risks from possible overruns, delays, market fluctuations, and other factors that may impact the product cost. If anything goes awry, customers will still receive their products or services, and the vendor will get fairly compensated.

Cost Reimbursable Contracts

When there are risks involved or the scope of work is uncertain, parties opt for cost-reimbursement contracts. In these vendor agreements, buyers reimburse the sellers for their work and offer an extra fee as a profit. Sometimes, sellers need to meet specific requirements to earn this fee, such as delivering services ahead of schedule or under the budget.

Under the umbrella of a cost-reimbursable contract, there are a few different types:

  • Cost Plus Fixed Fee: The payment outside of the initial product or service cost is fixed and agreed upon regardless of the vendor’s performance.
  • Cost Plus Award Fee: The profit payment is awarded based on meeting certain expectations for the project and may vary depending on performance.
  • Cost Plus Incentive Fee: This fee is granted based on a formula within the valid contract that determines incentives for project achievements.
  • Cost Plus Percentage of Costs: Customers agree to pay an additional percentage of the costs as the vendor’s profit.

These types of contracts put most of the responsibility on the business owner rather than the vendor. Cost-reimbursement contracts still come with a level of uncertainty, especially when it comes to final costs owed. However, they are helpful for high-risk or high-maintenance projects in which finding vendors may prove challenging.

Time and Materials Contracts

A master agreement that sets a specific time period to measure the offered services or goods is called a time and materials contract. In this case, the buyer and the seller agree to a specific hourly rate to compensate for the vendor's time. They also set a fixed rate for the used materials. Because of this, the cost at the end of the contract can vary.

However, you can mitigate some of this risk by determining an estimated amount of time the contract will take to fulfill. The calculations allow customers to predict the necessary budget and vendors to estimate how much pay they'll get. In case of changes in circumstances or predictions, one party should communicate them with the other as soon as possible.

Letter Subcontract

In emergencies, letter subcontracts may be necessary. These come in handy when a large project with many variables is in line and needs to start before the contract details get finalized. In this case, the buyer and the seller agree that a percentage of work will be completed during a "subcontract" phase (usually 40%).

It's worth mentioning that letter subcontracts require a statement of urgency from the requiring organization. These contracts can also be used only when a designee specifies that no other agreement is suitable. For example, a letter subcontract may be put in place if supplies are needed immediately — an official contract will get drawn up later.

Indefinite Delivery or Undefined Quantity Contract

An indefinite delivery or undefined quantity contract is drawn up for a precise timeframe, but not necessarily a specific amount of goods or services. It's a flexible option that identifies the minimum and maximum expectations but doesn't specify how many goods will get delivered in the end. Parties often use it as a master agreement to define the overall terms for multiple simultaneous projects.

The buyer and the seller usually set indefinite delivery or undefined quantity contracts for one or several years and agree on a specific amount to be paid to the vendor for the work done. When the term ends, the contract may be renewed or ended.

Distribution Agreement Contract

The vendor and a distributor enter this agreement to specify how, when, and where the products will get distributed. Basically, the manufacturer gives the distributor rights to sell, market, and allocate products through the contract.

The agreement further details the payment terms for the distributor, who usually earns a percentage of the sales and sometimes even gets relieved of the distribution costs. It also outlines whether the distributor-vendor relationships are exclusive or not. If yes, the manufacturer can't work with other parties as long as the contract is in effect.

Process Any Type of Contract With Vendor Contract Management Software

Contract lifecycle management is not always straightforward. With so many types of vendor contracts that you need to execute, keep track of, and renew or terminate, you may lose precious time, effort, and funds. Fortunately, you can make this process much more efficient with the right contract management tool.

At Lexion, we aim to help legal teams speed up their contract-related tasks with easy-to-use software. Our solution is specially designed to streamline the contract management process by allowing you to store data securely, block unauthorized access, collaborate with partners, share key metrics, and get visibility all with one platform. Visit us today and learn more about how Lexion software can simplify your contract lifecycle.

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