Way to Global Optima- Effective contracting!

It is well known fact that a Contract is a multi-benefit instrument for procurement function.

Mostly, it is reckoned as a tool that outlines the roles and responsibilities of parties involved which also defines the rules for sharing of risk and benefits.

What gets unnoticed is the effectiveness of contracting to achieve or come closer to achieving global optima.

What is global optima?

To understand global optima, firstly one needs to understand what is local optima.

Local optima is the solution that gives the optimum value for that particular local function. Think of it as a particular dept. of supply chain, say transportation.

Transportation cost per unit would be minimum if full loading capacity of the vehicle is utilized to transport the items. That is the local optimum solution of transportation.

But if look at an overall supply chain cost, this local optima of transportation function can be detrimental as this might lead to increase in inventory carrying cost (storage, obsolesce, cost of money, material handling etc.) and hence, a sub optimal solution of overall supply chain cost.

Here our universe (global) is the overall supply chain cost which needs to be kept minimum as target.

In supply chain, which is actually not a chain but a complex network of multiple links (parties), one must try to strive for global optima to make it win-win solution for all the parties involved.

If it is not profitable for your suppliers, sooner or later, it will become non-profitable for you as well.

What does contracting has to do with it?

A buyer can frame the clauses, benefit and risk matrix in such a way that involved parties are motivated to maximum the overall profit possible and mitigate the risks involved.

Clauses like gain sharing or revenue sharing are few examples which look to incentivize both the parties fostering them to maximize the profit of entire system (global optima)

There are umpteen other mechanisms like buy back, discounts, cost reimbursable so on and so forth which when included at the right place in contracts, leads to an optimal supply chain.

It calls for a separate discussion on what kind of clauses can be included and in what conditions. Watch out this space for more on it..