Contracts are an important part of procurement in supply chain management; it is crucial to have a clear understanding of how a contract and related terms are defined.
Contract – An agreement between two or more competent persons or companies to perform or not perform specific acts or services or to deliver merchandise. A contract may be oral or written. A purchase order, when accepted by a supplier, operates as the highest level of a contract except where a long-term contract exists. Acceptance may be in writing or by performance, unless the purchase order requires acceptance in writing.
Understanding this definition requires reviewing the definition in more detail.
Competent Persons or Companies
In a supply chain, the purchasing agent for a company might be the only person authorized to obtain goods and services, even though other people in the company might also be considered competent to do so. Companies should create policies that state which positions are agents for the company and have the authority to enter into an agreement with another party.
This implied authority to act on behalf of the company might seem obvious when an employee has a company-issued title of Purchasing Manager; however, other positions that also influence purchasing decisions or might be considered agents. Some examples of such positions include R&D, human resources, production, sales, and marketing. In addition to stating who are considered agents with the authority to purchase, company policies should also include what can be purchased and the maximum amount.
Company Policies and Contractual Concerns
Examples of concerns that should be addressed in the company policy include:
The human resource department may work directly with an employment agency to obtain temporary employees or on a regular basis work with another company for subcontracting when internal capacity is a concern. In these instances, is the HR department required to work with purchasing to obtain a purchase order, or is a variation of an annualized contract negotiated?
Subcontracting – Sending production work outside to another manufacturer
Annualized Contracts – Negotiated agreements with a supplier for one year that sets pricing, helps ensure a continuous supply of material and provided the supplier with estimated future requirements.
If a purchasing agent is authorized to enter a purchase order for over $1 million for raw materials of production, does this also mean they enter a contract for capital equipment for the same amount? Is the monetary limit per purchase order, or per line on a purchase order?
Supply chain professionals should understand and adhere to policies for obvious reasons but also be aware that they may be subjected to personal liability if contracts extend beyond what is authorized.
Common Law – Law flowing from judicial decisions over the years rather than from legislative action.
Purchase Orders as Contracts
“When accepted by a supplier” is the key phrase when using a purchase order as a contract. Acceptance of the purchase order initiates the agreement, particularly if no prior contact exists. Some companies request suppliers accept the order in writing, while other companies consider the performance of the contract as acceptance. The methods of acceptance might be included as part of company policy.
Purchase Order – The purchaser’s authorization is used to formalize a purchase transaction with a supplier. A purchase order, when given to a supplier, should contain statements of the name, part number, quantity, description, and price of the goods or services ordered; agreed-to terms as to payment, discounts, date of performance, and transportation; and all other agreements pertinent to the purchase and its execution by the supplier.