Overview
The Current Climate in the Automotive Industry
The Russo-Ukrainian conflict, supply chain disruptions and the lasting impact of the pandemic have shaped our world, leaving no industry untouched. The automotive sector, in particular, has experienced palpable effects and tensions in recent years. One recurring issue is the absence of vital provisions in contracts, leading to disputes over price adjustments, volume commitments, and risk distribution. These gaps have caused uncertainty for suppliers when faced with increased demand from original equipment manufacturers (OEMs), resulting in order cancellations and reductions.
For years, OEMs have been notorious for pressuring suppliers to lower prices. Recent studies show that Tier 1 suppliers now demand a four percent discount on average, surpassing most OEMs’ demands. Furthermore, volume manufacturers exhibit greater aggression compared to premium part manufacturers.
Buyers employ various strategies, such as seeking cheaper alternatives and demanding full cost breakdown calculations (CBD) to exert pressure on suppliers. Unfortunately, the suppliers’ concerns regarding rising personnel, raw material, and energy costs often fall on deaf ears.
To overcome this perpetual tug-of-war, all supply chain stakeholders and their respective legal counsel must embrace and understand each other’s perspectives.
A look across the Pond: Supreme Court Showdown
On 11 July 2023, the Michigan Supreme Court issued an opinion (in the case MSSC, Inc. v. Airboss Flexible Prods. Co.) that gives suppliers a powerful argument against blanket purchase orders and “non-binding volume estimates”.
The court’s opinion prevents OEMs, in our view, to have it both ways by claiming that all volumes are noncommitted while still expecting suppliers to deliver within estimates and as called for by the OEM in “releases” under blanket purchase orders for the lifespan of a vehicle project.
If an OEM wants an enforceable contract (in the US a so-called “requirements contract”), the OEM must say so in its contract by specifying at least some amount of product it is obliged to purchase. In the case at hand, the “blanket” purchase order lacked an essential quantity term and did, accordingly, not form a binding contract. The supplier was allowed to simply discontinue its supplies.
In practice, the decision will heavily benefit suppliers by balancing the scales of the bargaining power. By requiring a binding quantity commitment, the Michigan Supreme Court has eliminated the old argument that the original terms or the supply relationship with a supplier were binding for the life of the program. Suppliers now have more certainty as to anticipated volumes in a “requirements contract”. Any supplier currently supplying under a blanket purchase order that does not include a binding quantity now has further arguments to request price increases.
It remains to be seen what impact this opinion will have on the German market. However, the negotiating power seems to be shifting once again a bit towards the suppliers.
Navigating Contractual Challenges: Empowering Suppliers & the Key to Negotiation Success
Amidst growing discussions on price and volume demands, the legal literature has been exploring suppliers’ rights from all angles. As traditional contractual agreements often favor the OEMs, leading legal experts now seem to emphasize alternative approaches that leverage statutory rights for suppliers in order to break free from unproductive negotiation cycles with the OEMs.
Apart from that, we think that success in negotiations with OEMs / Tier 1 Suppliers depends in our experience, in particular, on the following:
1. A deep understanding of its decision-making structures and budget competencies.
2. Having in-depth knowledge about the various negotiation customs employed by OEMs and comprehensive understanding of the business approach of key decision-makers and their teams.
3. Appreciating the OEMs’ / Tier 1 Suppliers’ respective internal challenges (e.g. risk management vs. procurement), reporting obligations, preferred channels of communication, tactics to prolong negotiations and last but not least “budget sovereignty”.
This is a significant advantage for our clients, as our experience allows us to not only anticipate (and thereby dismantling the OEMs / Tier 1 Suppliers’ argumentation), but also effectively involve relevant stakeholders higher up the chain of command at the respective OEM / Tier 1 Supplier, should this be necessary in order to make progress in the negotiations. Our results speak for themselves: Sustainable price adoptions, reduction of negotiation duration, limitation of liability claim risks.
With our in-depth knowledge of this industry, understanding of the commercial drives for the suppliers and our understanding of the global legal landscape, we are convinced to really add value for our clients. Reach out to us to brainstorm ideas and to identitfy solutions which work from a commercial and legal perspective.
