Co-Opetition - Adam M. Brandenburger [89]
An MCC is essentially the same contract with suppliers as with customers: it gives you a last look. The only difference is that this time you get a right to buy as opposed to a right to sell. Formally, an MCC with a supplier is a contractual arrangement between company and supplier that requires the supplier to continue supplying the company provided that the company agrees to match the best price anyone else offers the supplier for its resources. Just as customers typically pay more when they’ve granted an MCC, suppliers typically get paid less when they’ve granted an MCC.
In certain professional sports—notably, basketball and hockey—team owners have an MCC in some of their contracts with athletes. This ensures that they won’t lose an essential player without having the chance to match any competing bid. Of course, anticipating that the current owner will likely match any bid, rival teams have less incentive to bid for a player in the first place.11 The effect is to reduce the competition for athletes below what it would otherwise be.
In principle, games with suppliers should be exactly parallel to games with customers. But, in practice, the rules in these games are sometimes different. Most-favored-customer clauses and meet-the-competition clauses with customers are much more common than their supplier-side analogues. Our next rule, the take-or-pay contract, is really only seen on the supplier side.
Take-or-Pay Contracts
A take-or-pay contract is a rule structuring negotiations between companies and their suppliers. With this kind of contract, you either take the product from the supplier or you pay the supplier a penalty. For any product you take, you agree to pay the supplier a certain price, say $50 a ton. Furthermore, up to an agreed-upon ceiling, you have to pay the supplier even for product you don’t take. Naturally, this “penalty” price is lower, say $40 a ton. Thus, if the ceiling is 1,000 tons and you take 900 tons, you pay $50 a ton on the 900 tons you take and a penalty of $40 a ton on the 100 tons you don’t use.
Take-or-pay contracts are often seen in agreements to purchase commodity inputs, electricity, even cable programming. Suppliers in these businesses face large fixed costs relative to variable costs. In some cases, it’s also impractical for the supplier to store the output. As a buyer, you have enormous power to beat down price. For protection, the suppliers seek take-or-pay contracts—the larger the better. Of course, you recognize the exposure that comes from signing a take-or-pay contract, and you won’t agree to take more than you expect to use. That’s why take-or-pay contracts often end up being for amounts close to predicted demand.
By agreeing to a take-or-pay contract, you clearly help your supplier. The contract enables the supplier to plan production better. It also makes him less vulnerable to being held hostage by you later on. In return for providing him with this security, the supplier will likely reward you with a lower price.
But that’s not the only benefit you can get from entering into a take-or-pay contract with your supplier. Take-or-pay contracts can change the game in another way, too. They can affect the pricing dynamics in your industry by reducing the incentive of a rival to go after your customer base.
If a rival goes after one of your customers, he risks retaliation—that’s one of the Eight Hidden Costs of Bidding. If you have a take-or-pay contract with your supplier, that retaliation becomes a near certainty. To understand why, imagine that you expect to use 1,000 tons of input and have a take-or-pay contract for that same