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CHAPTER-6

REDUCING THE COST AND INCREASING EFFICIENCY THROUGH

CONTRACT ADMINISTRATION

0601. General. In Supply Chain Management, contract is a vital subject.

For each and every business deal contract is a must. For BN it is no exception. We
buy lots of item from home and abroad every year. So, we must know how to
prepare a good contract. In this chapter, an attempt has been made to give
comprehensive idea how contract is prepared in light of International Supply Chain
Management with a focus on BN perspective.

0602. What is Contract? A contract is an agreement between two or

more persons (individuals, businesses, organizations, or government agencies) to
do, or to refrain from doing, a particular thing in exchange for something of value. In
other word, it is a voluntary, deliberate, and legally binding agreement between two
or more competent parties. Contracts can generally be written using formal or
informal terms, or they can be entirely verbal. If one side fails to live up to his/her/its
part of the contract, there's a "breach" of contract and certain remedies for solving
the differences are available. The terms of the contract, meaning, the who, what,
where, when, and how of the agreement, define the binding promises of each party
to the contract. A contractual relationship is evidenced by (1) an offer, (2)
acceptance of the offer, and a (3) valid (legal and valuable) consideration. Each
party to a contract acquires rights and duties relative to the rights and duties of the
other parties.

0603. Importance of Contract. A contract allocates the risk and rewards of

a transaction between the parties involved. In international trade as well as in
domestic trade, the sales contract has become the legal basis which binds at least
two parties; a seller and a buyer. The contract is even more important in international
trade due to the fact that the parties residing in different countries are subject to
various legal rules affecting the making and performance of the contract. Therefore,
the careful negotiation of such a document-and in particular of the clauses which will
define the respective right and duties of the parties will be the basis of a successful

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business relationship. Any discrepancy in performing a contract will automatically

end up, if not in a dispute, at least in a tense and unfruitful relationship between the
parties. Defence Sector is no exception. Bangladesh Armed Forces buys a large
variety of defence stores every year involving billions of dollar form international
market. So the contract plays a very important role while acquiring such items and
getting after sales services in befitting manner. For BN, it is more important because
of its technology oriented major purchase from international market. Deriving from
the above and according to the position, buyer or seller (otherwise referred to as
supplier) the contractual obligations will also vary.

0604. Buyer’s and Supplier’s Obligations

a. Supplier’s Obligations. To simplify, the essential obligations

of the supplier in a contract are as follows:

(1) Deliver the goods or service in the way, at the time, and
in the location that has been specified by the parties. This
implies organizing themselves in order to accomplish the
desired task.

(2) Deliver the documents that are related to the goods or

service such as the property title, certificate of origin, bills of
lading, insurance documents, manuals, etc, The goods may be
unusable without these essential items being provided.

(3) Transfer of title of ownership for a product can take place

at the time of agreement. On delivery, or after full payment.

(4) Assure the conformity of the goods. The quality, quantity

and kind of goods must conform to what is stipulated in the
contract. Thus, if there are hidden defects the seller should
replace the goods. The seller should also guarantee that the
goods are fit for the purpose they were intended to serve.
However, these requirements may be significantly reduced if the
seller has the opportunity to sell the product “as is”- that is,
making no representations about the quality of the goods and

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leaving the onus on the purchaser to verify that the goods

conform to the purpose.

(5) In general, act in good faith and deal fairly. This might
extend to a duty to counsel the buyer as to the best means of
fulfilling the contract.

(6) Civil liability to the manufacturer of the goods in the case

of injury to persons or objects. In the United States, this is called
product liability. In this case, in general, the manufacture as well
as the supplier is responsible for any damages caused.

b. Buyer’s Obligations. Broadly, the essential obligations of the

buyer in a contract are as follows:

(1) Accept the goods or services. The buyer must take

possession of the goods and accept these after inspecting them
( for example by CINS) in order to exonerate the seller’s
responsibility for non-conforming goods. Acceptance without
reservation implies conformity except for hidden defects.
Furthermore, the buyer must do everything reasonably
necessary for the seller to be able to deliver the goods or
services.

(2) Pay the agreed price. This includes the amount, the
timing, and the way of payment. DGDP usually makes 80%
payment on shipment of goods followed by submission of
shipping documents and 20% payment after acceptance by BN.

(3) In general, act in good faith and deal fairly. This might
extend to a duty to inform the seller as to difficulties of which it is
aware that might make the seller’s work more difficult.

(4) Accept civil liability in the case of injury to persons or

objects. In this case, the buyer may turn to the manufacturer as
well as the supplier as regards any damages caused.

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0605. Major Issues Related to Preparing the Contract

a. The major issues related to preparing the contract are:

(1) What the organization wants to obtain.

(2) What the organization wants to avoid.

(3) What are the options available, if all goes wrong, to

protect own organization so that the negative impact on the
business is the least possible.

(4) What should be included or excluded.

(5) Which are the actual clauses of the contract to be used.

b. What does the Organization Wants to Obtain through the

Contract?

(1) A product, a service, or a capital investment is being

procured for a set of reasons. This procurement will directly
impact the success of core operational requirement. Until what
is sought to be obtained in the contract is very clear, it is very
difficult for the contract drafter to prepare a contract.

(2) On a strategic level, BN should determine what type of

purchase is being envisaged. Is it for regular recurring needs
(i.e., clothing, spares, POL) with many suppliers available? If it is
for regular recurring needs, purchasing risks are likely to be
easy to define. This may mean that the “sophistication” of the
contract is reduced.

(3) If what is desired something that is readily available in the

market place, even if from few suppliers, or is it something that
is in short supply or that has to be customized to the
requirements of BN? For example, for NSD Chittagong we need
to have more advanced ERP software. Its choice may be to
purchase a relatively standardized “off-the shelf” software or
possibly investing to have semi-customized or customized
software prepared by outside software companies.

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(4) Building proprietary informational technology may provide

a net advantage for the organization, but there are issues as the
way of designing the software, the work to design it, the testing
of it, how to pay for it etc, as well as the updating of it after it has
been in place for a period of time. The selection of the supplier
of the services becomes critical as does the definition of what is
to be obtained from them. The internal technical requirements
may have to be articulated more clearly than in the off-the-shelf
scenario. A time frame should be clearly developed with key
milestones at various points.

(5) If we want to buy a ship, (off-the-shelf or new building) we

need to see what capabilities actually we want to achieve from
that ship and how to get it. Technologies, material requirement,
design package, its quality, delivery period, warranty, payment
terms, guarantee etc need to be clearly defined.

(6) These are examples of the types of issues that should be

addressed before drafting the contract. As they are clarified,
they help to assist the contract drafter in preparing the terms of
the agreement.

c. What does Organization Want to Avoid?

(1) Having established what our organization wants, we then

have to determine what it wishes to avoid.

(2) Each organization has its set of strategic choices. For

example, having higher or lower inventory (such as spares) is a
financial and operational choice that forms part of the
organization’s strategy like BN. An organization would prefer of
avoid risk to the production line, stock outs or changes of
suppliers. Avoiding low quality inputs may be another aspect of
the organization’s strategy that determines its sourcing and
therefore contracting approach.

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(3) Paying advances and dealing with suppliers requiring

advance payment bonds may be a way of doing business that
the organization wishes to avoid, preferring to work. However,
for critical purchase Govt may do advance payment if needed.

(4) Placing greater emphasis on quality performance, our

organization might seek Performance Guarantee (PG) or
completion bonds from the supplier as contractual tools to
ensure success. In DGDP it is usually practiced.

(5) Whether we are purchasing services, products or raw

materials, using single, dual or multi-sourcing may be another
critical issue. If we want single source (like aircraft, missile,
combat system etc), we may wish to avoid being placed on a
lower priority by the supplier. Thus getting a preferential status
may be required, e.g. through a long-term contract. However,
this may require modifications or customization in the way we
purchase which will involve added costs for our organization.
Supplier will have scope to exploit and dominate purchase. As
these issues are clarified, they help to assist the contract drafter
in preparing terms of the agreement.

d. Protecting Own Organization if things go Wrong.

(1) Knowing what we want to obtain and what we want to

avoid for a particular contract leads to foreseeing the options if
everything goes wrong.

(2) Building in ways for our organization to extract itself from

the contract, if necessary, is essential. Keeping the duration of
the contract short may be advantageous if there are readily
available alternative sources of supply. Performance Bonds is
other way of proceeding as well including an appropriate
termination clause. Clear dispute resolution clauses may
simplify the task to seeking relief.

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(3) On the other hand, the way in which our counterpart can
be liberated from its obligations should also be kept in mind. If
there are conditions that have to be fulfilled in advance of the
contract entering into force, there may be an issue as to who is
in the best position to complete those conditions. We will also
have to decide if there are any force majeure elements which
are appropriate for the particular circumstances of the contract.

(4) The important point is to think through the means

available to the parties to extract themselves from the
relationship, and make sure that the result is in line with our own
organization’s interest.

e. What should be Included or Excluded in a Contract?

(1) BN has to abide by different Govt rules and regulations

like DP-35, FRRIN, GFR, Armed Forces Procurement Policy etc
which puts many limitations unlike other company contracts. We
can’t include or exclude which contradicts with Govt rules,
regulations, or instructions and orders of the higher authority. we
must ensure we get optimum value for money from the signed
contract.

(2) For an industry a first set of concerns is the changing

nature of what is produced in-house for the manufacturing and
assembly of finished goods. The organization would purchase
raw materials, make the parts, and then include the parts in the
assembly process. Suddenly, a decision is taken to get out of
the parts production business and to focus of the assembly of
finished goods, as this is what the company does best (its key
manufacturing competence). To make this happen, the parts are
now to be supplied by another organization (or outsourced).

(3) The key point is that because the parts are now
outsourced, the production difficulty lies in having those parts in
sufficient numbers at the right moment for the assembly

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process. Risk of stalemate and blockage may occur, particularly

if the contract is of less priority to the supplier than to the buyer.

(4) To avoid such difficulties, the priorities have to be clearly

stated to the supplier in the contract. If it is a situation where the
buyer’s production priorities change often (may be due to the
needs of the ultimate client), then this risk has to be taken into
account in the contract with the supplier. Thus, the contract
might have to provide for a procedure for demand to be
communicated from the buyer to the seller at regular intervals.
These intervals have to be sufficiently in advance of needs to
allow the supplier time to set priorities and get the materials
needed to make the parts. Hence, information on the supplier’s
production cycle has to be included in the drafting of the delivery
schedule aspect of the contract.

(5) From local procurement (where the focus may be

essentially on price and delivery terms) to strategic sourcing
(where two or more organizations may be combining resources
and closely integrating their activities like ship building), the
potential number of options for contractual terms in tailoring a
specific supplier relationship are broadened.

(6) Above all, BN must ensure specific terms and conditions

are included/excluded from the contract for its own interest to
meet the short and long-term objectives.

Reducing The Cost And Increasing Efficiency

0606. There are various ways in which companies can compete, for instance
through offering lower costs than competitors or more innovative product design or
provision. The key advantages of an effective logistics capability are product
availability at low cost. The advantages provided by effective supply chain
management include lower cost and differentiation through added value.

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0607. Cost advantages seek to lower the total cost throughout the supply chain and
thus provide cheaper prices to customers. The reduction of the customer’s total cost
of ownership is critical to cost advantage. Often there is too much emphasis given to
acquisition cost or purchase price, and other costs are ignored. Total cost of
ownership seeks to understand the total costs of the product or service incurred by a
buyer, including- in addition to the acquisition cost-both ownership and post-
ownership costs. Ownership costs comprise the costs of:

a. Contract administration
b. Carrying inventory
c. Processing inventory.
d. Training
e. Operating equipment
f. Warranty
g. Maintenance
h. Repair
j. Downtime cost of equipment

0608. Post-ownership costs are those costs involved in the disposal or

managing the environmental consequences of the product or service.

0609. All of these costs will apply over the life cycle of the equipment.
Therefore, the durability of the equipment and its replacement cost will also be an
important consideration. The above costs must also take into account estimates of
risk involved in the transaction. Effective costs identification and analysis is best
provided by the use of a cross-functional team.

0610. To be successful, a supply chain must seek to achieve a high level of

efficiency. In this regard, companies seek to reduce their complexity, align their own
strategies and enhance integration within their internal supply chain or value chain in
order to obtain a cost advantage. This reduction in complexity, alignment of strategy
and integration must also take place amongst the overall supply chain members, so
as to ensure an efficient and timely flow of materials and information throughout the
chain, and so reduce the overall costs.

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0611. Cost advantages and efficient supply chains are best suited to industries with
relatively high volume and low variety product ranges, in order to take advantage of
economies of scale and the effects of the learning experience curve. economies of
scale occur when fixed costs are spread over a large number of standardized units.
Learning curve effects are found to be as important, if not more so, in such cases.
Learning curve effects are the advantages that result when workers have developed
the required skills and abilities to undertake tasks and understand processes.

0612. Logistics cost advantages result from the efficient use of capacity and the
reduction in inventory levels that come about as supply chain members integrate
their processes due to faster and more reliable information exchange.

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