What’s the value of a contract? How to determine contract value and why we should value it.
I recently had a conversation with a representative of a highly reputed German research organization about negotiating R&D collaborations. He started off by asking whether lawyers would also assist in negotiating the contract price. We then talked about consideration and other contractual conditions when I realized that we should have talked about a related but different topic: contract value. Now that is a bit of a business approach you might say, however, we are entering into contracts because we want to do business, don’t we? I believe that among negotiating parties the concept of contract value (except for its scientific aspect) has different priorities depending on the jurisdiction and cultures you are dealing with. And why would a lawyer write about a topic that seems to have such an intrinsic business aspect? Well, because we lawyers are the ones who are supposed to protect your contract value. We are the ones getting input from all different ends when negotiating a deal: management, finance, controlling, quality assurance, sales, product management, research & development, etc. – and they all put their value on the deal and have their particular concerns on protecting it. Price does matter, however, value is not only determined by cash.
For the sake of discussion, following are two easily accessible definitions of “contract value” that you would typically find in pertinent dictionaries: “final negotiated or proposed price of a contract” (Business Dictionary) or “final bargained or suggested costs of a deal” (The Law Dictionary) (note the difference!) apart from the various definitions in specific industries or EU regulations. Personally, I think that the value of a contract is made of both, the price you get and the costs you have. I do believe, however, that you should not limit your analysis of “price” and “cost” to direct monetary compensation to be made to, or receive from, your contract party.
When considering “costs” related to a deal, parties often seem to focus at costs such as price (compensation), development and production costs, transportation costs in relation to a product’s market price over the term of the anticipated contract. However, and admittedly depending on a party’s professionalism, it seems that (other) contractual conditions (i.e., the terms of your deal) rarely are considered as costs in terms of contract value. Perhaps that’s psychological (business believes to do the “real” deal whereas the lawyers are doing “their thing”), however, a clear negotiation strategy must include a valuation of all of the terms you are negotiating. To illustrate, let’s take the simple example on the relationship between price and warranties from a 101 sales training: the profits of a sales contract can be significantly diminished the more (longer) warranties the seller needs to provide. As a statistical matter, the longer the warranty term the more warranty cases may arise. Thus, when selling (consumer) products in a different jurisdiction (abroad), a look at the prevailing warranty conditions can be enlightening since a product price calculated on the basis of a 90-day warranty may not uphold in a jurisdiction with a mandatory two-year warranty (e.g., for consumer products).
So what would you want to look out for considering contract value when structuring or negotiating a contract? I would distinguish between internal and external parameters. Internal parameters (parameters that may be directly influence by a party) would be factors such as price, transaction costs, development and production costs, procurement, vendor quality, production quality, future product enhancement, representations and warranties, liabilities, costs for potential dispute resolution (which goes along with governing law and jurisdiction). Further parameters can also be dead locks or unclear contractual provisions (risk of litigation). External parameters (impact from third parties) could be market changes, increasing number of competitors, future competing technologies, or regulatory changes. All of the above points can mean additional costs that need to be benchmarked against “price” and/or the quid pro quo of the other party. Most likely you will never be able to avoid all these risk factors from materializing. However, you should consider possibilities to protect your interests in the negotiation process. Of course, typical remedies could be indemnifications or limitations of liability, as applicable, however, usually there are several ways of structuring an agreement to appropriately protect both parties’ interests. It is certainly beneficial to negotiate price in relation to volume, however, when, e.g., selling a technical device you may also want to consider reps & warranties, regulatory requirements, liability and jurisdiction as cost factors. Some controllers can tell that albeit tremendous sales by a sales department, quality issues or changes in the regulatory environment sometimes can turn margins negligible.
In particular when doing business abroad often unsought issues such as governing law, jurisdiction, and venue can prove as hidden cost factors if not wisely considered: What is it good for to have an agreement with a good price if you are uncertain about its enforceability, you have to subject yourself to litigation in an unknown jurisdiction, and suddenly deal with unforeseen strict regulatory hurdles? Eventually, the value of a right is only as good as the cost of enforcing it.
So, would lawyers assist in negotiating price? Sure, however, always with a look at the myriad of factors that also determine contract value.
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