Commodity Price Inflation - Managing the cost to your business
Insight Contacts
Graham Dagnall
National Head of Litigation
DD +44 (0)151 907 3111
M +44 (0)7798 700 487
Add vCard View BiographyPeter Allen
Head of Food Group
DD +44 (0)7774 137 712
M +44 (0)7774 137 712
Add vCard View BiographyDate: 05/07/11
The consequences of commodity inflation currently permeate every business decision. Each month CPI/RPI growth generates fevered speculation as to how cost increases will impact on everything from interest rates to consumer confidence and the recovery of the domestic economy.
For businesses operating in the food sector, inflation is a harsh reality. Experience of it at the coal face has been a seemingly inescapable increase in input costs – wheat, sugar, palm oil and a host of other essential materials involved in the production process.
Our food clients have a common need: legal and commercial advice in the face of hikes in input costs by suppliers. However food processors and manufacturers occupying the middle ground in the supply chain may have more room for negotiation and options to preserve margin than they think.
Reviewing your supply terms
If you get the call from your supplier raising price increase issues the first thing you should check will be your supply contract. Is it a long term contract or a “framework” or "call off" arrangement that the supplier can break easily? Is there an obligation on the supplier to supply for a fixed period or to a minimum volume?
Is it really all that clear that a price increase can be imposed or is there room for argument based on the pricing schedule? Suppliers will always try to persuade you that the pricing provisions allow for an increase but that may not be clear cut. Also consider whether the parties have successfully limited or excluded liability under the supply agreement.
Force majeure?
If the supplier is tied into minimum volumes or a longer term arrangement and the current pricing arrangements become unfavourable, it may claim a force majeure event to try to negotiate a price increase.
Even if there is a force majeure clause in the supply contract which permits cessation of supply, it will be far from clear that it would apply in the relevant circumstances particularly where the supplier’s issue is simply a rise in costs. All will depend on the cause of the sudden price rise and how a force majeure is defined in the supply agreement.
Alternative suppliers
If the contract is short term, or there are no committed volumes, the option is always open to switch suppliers (or at least threaten to do so). Is there sufficient competition in the market to use that tension to drive down the price? If there is a paucity of other suppliers there may be competition law issues in respect of the behaviour of your current supplier which you could investigate with your legal advisers, as stated below.
Commercial levers with suppliers
If the provisions of the supply agreement give you little room for manoeuvre, what other commercial levers are there for you to exercise? Are you able to increase your buying commitment/buy forward for a longer period in exchange for holding prices or reducing the increase? Can you buy additional and/or alternative products from that supplier to achieve better pricing? Are you owed service credits for previous failures by the supplier which you can offset or perhaps you could negotiate an option agreement going forward to “hedge” against future rises? Are you on a short notice period or coming to a break point in the contract which you can use for commercial leverage?
Abuse of a dominant position?
Some of the options discussed above in respect of your supply arrangements assume an alternative source of supply which you can use should you not be able to negotiate a settlement. However, what if the commodity or ingredient in question is provided by only one or a small number of suppliers? Do those suppliers have a dominant position which they are abusing? Are suppliers putting prices up in a synchronised way which might indicate collusion? Either of those behaviours could be illegal and expose the supplier to heavy fines and an action for damages.
Of course, sometimes you have to accept a price increase, because commercially and legally there is no alternative. That's when you check your contracts with your customers…and then pick up the phone.
