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March 3, 2003

7 Min Read
Words of Wisdom: The benefit of the deal

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Bill Tobin is a plastics processing consultant and president of WJT Assoc., based in Louisville, CO.

When I first started in the plastics business the participants were more polite than they are now?everyone made money, so we all supported each other. The buyer bought, the molder molded. Business was good, so life was nice and everybody made money.

Over the years, however, with the advent of give-backs, reverse auctions, tasks, and relentless price pressure accompanied by expectations of continually improved response time, the playing field has witnessed a bloodbath, with the major fatalities being the molders.

Purchase Orders
But the well-informed molder has not been rendered defenseless. A molder?s best protection has always been the purchase order. Here are three types of purchase orders common to the molding industry, with descriptions of how they work:

  • The one-time purchase order: If you?ve ever ordered a catered meal for an office party you understand the concept of the one-time order. Neither the buyer nor the molder has any particular reason to expect future business. With a purchase order in hand the molder orders material, schedules machine time, runs the parts, and ships them complete with an invoice. The transaction is complete.

  • The blanket purchase order: The master purchase order ships against releases based on a rolling forecast. Part pricing is based on long-term volume. It is a modification of the one-time order because the purchase order will expire on a specific date, but within the time limits of the order there is a mutual expectation of business for both the customer and the molder. A firm schedule of shipments is made for the relatively near future, i.e., 30 to 60 days. Future orders are forecast. Every week or two the firm orders and forecasts are updated.

    In this relationship the molder has the luxury of building more stock than ordered, ensuring a continuing supply of product to the customer. These contracts usually have an authorized maximum and minimum inventory level with a guaranteed purchase. The molder ships off this bank of inventory. When the inventory hits a certain minimum level, it triggers the building of the inventory back to the maximum level.

    The three key elements in this kind of purchasing system are 1) the continual update of the forecast and orders; 2) a written guarantee to purchase the ?bank? if the agreement is prematurely terminated; and 3) an adjustment clause to pay for product pricing if the master purchase order?s volume/pricing structure is not fulfilled.

    Most molders, in anticipation of hundreds of thousands of dollars in sales, forget the following three possibilities. Here are some questions to think about: What happens if the forecast is never updated? What happens if the master purchase order?s pricing structure was based on 15 million parts purchased over a 12-month period, for example, but you only shipped 100,000 during the year? What happens if you have a half million dollars worth of parts in your warehouse and your customer refuses to buy them?

    Blanket purchase orders must not only have a means of doing business but also an exit strategy agreed upon ahead of time.

  • The just-in-time purchase order: JIT is probably the most abusive to the molder. Its assumption is that the molder has idle capacity that is always available and an infinite supply of raw materials ready to be molded. Nice fantasy, but that isn?t how the molding industry works.

    The molder?s solution is to work exactly like the blanket purchase order system but without the luxury of a forecast or any guarantee of purchases. This means the molder builds a bank of parts whose levels are determined by whatever the molder deems prudent. In many cases this inventory is carried at the molder?s financial risk.

    wordsofwisdom.jpgMinimize Your Risk
    JIT is an extremely one-sided way to do business. It is the marriage of the one-time order with the pricing structure of the master purchase order. What lawyers call ?the benefit of the deal? lies exclusively with the customer. The molder takes all the risks. But since JIT is becoming a fact of life, here are some strategies to minimize your risk.

    Most molders quote jobs by sending a fax of the quote, and then mailing the hard copy. On the back of the hard copy are the molder?s terms and conditions. Most customers place the job first by fax, then mail their hard copy with a photocopy of the front page of the molder?s quotes. Significant by its absence when you receive the customer?s purchase order are the molder?s terms and conditions. By beginning production based only on this amount of paperwork the molder has just agreed to every term and condition the customer wants.

    The response to this one-sided agreement is to fax back a letter of agreement restating your quote, your customer?s purchase order number, and your terms and conditions, and then begin production.

    The next item must be an exit strategy. You can no longer assume your customer will do the right thing when the job is moved to another production source or the product is no longer marketable.

    If you agree to a JIT relationship before you begin production, you need a separate signed agreement guaranteeing the purchase of all nonreturnable raw materials, work in process, and standing inventory.

    The standing inventory is usually the sticking point. The most common phrase used in these documents is that the customer will purchase the finished goods inventory up to but not exceeding a three-month supply based on the prior orders. The customer will also pay any restocking charges or purchase any goods that are unique to this product.

    Get a Guarantee
    When dealing with large companies, usually the company representative (the buyer) is authorized to sign such agreements with his company guaranteeing the purchase. When dealing with small or entrepreneurial companies, this document must be the owner?s personal guarantee. Too many times small businesses go bankrupt and leave the molder as a creditor with racks full of useless inventory. Since the entrepreneur has protected his personal assets from his own company, getting a personal guarantee will go around a lot of legal proceedings you?ll need in bankruptcy court.

    While exit strategies and documents protecting the molder?s interest might seem logical and necessary, most customers will balk at signing any guarantee agreement. On one hand, this is perfectly logical. You are asking the customer to participate in your risk and they?d rather not, thank you. On the other hand, investing material, labor, and machine time is the way a molder makes his living. Taking all the risk is easy when times are good. But the molder should look at what happens if customers decide labor rates in China are appealing and they pull the job.

    You may also think that since you are already in a JIT or blanket purchase order relationship you can?t come in and ask for a guarantee. You can. JIT is really a series of one-time orders with (legally) no expectation of future work other than an ongoing business relationship. Each release is actually a new order. Your insistence on a guarantee is not beyond the scope of normal business. Blanket purchase orders are routinely breached, guaranteed shipments are pulled up or pushed back, and forecasts are not updated in the prescribed manner. This is breach of contract. Because the contract is breached you can ask for the guarantee.

    When the buyer balks and threatens to pull the tooling, the very nature of the blanket order or JIT is to the molder?s advantage. There is no in-house inventory at the customer?s facility. If you stop shipping parts, the buyer will quickly suffer a loss substantially more than you?ll lose by neither shipping parts nor releasing his tooling to another source. If the buyer wants to play hardball, you can too. It?s only fair to ask for your side of ?the benefit of the deal.? If a molder doesn?t have an exit strategy, the cost is usually high, and sometimes fatal.

    Contact information
    WJT Assoc., Louisville, CO William J. ?Bill? Tobin
    (303) 604-9592
    [email protected]

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