It’s hard to do business by yourself. Whether you run a SaaS company, manufacture consumer products, or you’re in the energy industry, you’ll 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!)
Regardless of which party you represent, a good vendor agreement can be a boon for both vendors and customers. The former will get financial support for providing their product or service, and the latter will remain stocked with reliable, quality supplies. As a result, all parties can enjoy optimized business performances and favorable relationships.
Let’s talk about the different types of vendor contracts, when to use them, what to look for when drafting or reviewing a vendor agreement, and what they mean for your business.
What Is a Vendor Contract?
Vendor contracts (or vendor agreements) outline the key terms covering the exchange of goods or services in return for compensation. These agreements detail the services vendors will supply to their customers and the ways they'll be paid for what they provide.
Just as there are many different types of businesses, vendors, and customers, there are many ways to structure the finer details in a vendor agreement. 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.
What Are the Different Types of Vendor Contracts?
Because vendor transactions can vary, there are different types of vendor contracts to meet a variety of business needs. The type of vendor contract you use could be among these common examples.
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 lay out 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 be 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’re 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.
You can mitigate some of this risk by estimating the 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 receive. In case of changes in circumstances or predictions, one party should communicate these changes with the other party as soon as possible.
Letter subcontracts may be necessary in the case of mismatched timelines or emergency projects. 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 and an official contract will be drawn up later.
Indefinite Delivery or Undefined Quantity Contracts
An indefinite delivery or undefined quantity contract is drawn up for a precise time frame, 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 terminated.
Distribution Agreement Contracts
The vendor and a distributor enter this agreement to specify how, when, and where the products will be 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 is sometimes even relieved of the distribution costs. This agreement also outlines whether the distributor-vendor relationships are exclusive or not. If they are, the manufacturer can't work with other parties as long as the contract is in effect.
What should be in a vendor contract?
The terms in each type of vendor contract will vary (this is true for most types of contracts), but there are a few key elements that all well-constructed vendor agreements share. Whether you’re the vendor or the customer, make sure you identify the following provisions in your next vendor contract.
Scope of What’s Being Provided
This includes the product or service the customer expects to receive, as well as how the product or service will be delivered. Provide as much detail as necessary to ensure that both parties know exactly what to expect.
Schedules hold people accountable and help to ensure both parties receive what they need on time. The agreement should state when the vendor will receive payment, when the products will be delivered, and when the agreement is up for renewal or termination.
This goes beyond the price of the product or service; payment details should outline when payments will be made, who they should be directed to, and how they will be received. This section could also include the agreed-upon form of payment as well as any penalties for late or outstanding payments.
Even favorable vendor-customer relationships may need to end, or at least specify a time to reevaluate the agreement. Build in a clear end date for the vendor contract so that it can be terminated or renewed, depending on your needs. Outline possible reasons for ending the agreement early and what steps either party should take to do so.
Potential consequences should be clearly stated in the event that either party fails to uphold their side of the contract. While you hope for the best and aim to partner with businesses you can trust, including consequences helps to mitigate potential risk and let everyone know what to expect if an agreement goes sideways.
Process any type of Vendor Agreement with Contract Management Software
As you can see from the wide range of vendor agreements, contract lifecycle management isn’t always straightforward. With so many types of contracts that need to be executed, tracked, renewed, or terminated, your teams may lose precious time, effort, and funds just trying to keep everything in order—and those resources should be directed toward high-value tasks instead. 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 all of 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. Learn more about our Workflow solution for vendor contracts, or dig into our recent webinar on How to Effectively Negotiate a Limitation of Liability Clause.