What is a Multi Year Contract?: Everything You Need to Know
What is a multi-year contract? This type of long-term contract lasts longer than one year and offers your vendors some financial stability.3 min read updated on January 01, 2024
Updated November 12, 2020:
What is a multi-year contract? This type of long-term contract lasts longer than one year and offers your vendors some financial stability. It also eliminates the need for them to look for new contracts. Long-term contracts should be an option for clients who are ready to work with you for an extended period of time on short-term deals.
Multi-year contracts have the added benefit of saving you from spending time looking for new vendors each year or dealing with annual renewals of existing contracts. It's normal for businesses to have concerns about the risks of multi-year contracts, but if these agreements are drafted correctly, the benefits outweigh the risks.
How Inflation Influences Multi-Year Contracts
Market forces and inflation can cause supply costs to increase. Therefore, some vendors may want reassurance and some type of guarantee that the value of the contract will increase as the cost of living rises. You may agree to adjust the price annually based on the rate of inflation, provided there aren't any special pressures on the vendor's bottom line. An example would be the price of oil.
You can set a fixed rate of increase each year ahead of time. Or, you can tie payments to the specific inflation rate each year by determining a specific date for when prices will change and come to an agreement on a specific inflation index.
If you conduct business in an industry where the market price changes regularly, like gemstones or oil, you may have to look at other options. You can consider a price adjustment based on the cost of your vendor's supplies each year. For example, if you're working with a diamond vendor, you may agree to annual price increases based on the average rate diamonds increase in value. Another alternative is to have a vendor submit annual reports that demonstrate the increasing supply costs; then you can agree to cover the supply cost difference each year.
Ultimately, it's up to you to decide on a pricing strategy that works best for your business and your suppliers.
Difference Between Multi-Year and Multiple-Year Contracts
A multi-year contract is for supply purchases for longer than a year. Multi-year contracts buy more than a year's supply of a material without the need to establish or exercise an option for each purchase year after the initial one.
What are IDIQ Contracts?
IDIQ contracts are a type of indefinite-quantity contract. These offer an indefinite quantity of services or supplies, with some described limits, within a fixed period of time. Both quantities and delivery dates are undefined until there is a delivery order or task scheduled under the contract.
Procurement Side Benefits to Multi-Year Contracts
There are some advantages to multi-year contracts from a procurement point of view:
- Better supplier discounts
- Help safeguard procurement against large price fluctuations
- Saves resources, effort, and time
- Develop strategic alliances with suppliers
With service-based multi-year contracts, many suppliers will ask to include a clause that allows for a COLA, or a Cost of Living Adjustment. The supplier and the buyer can make a mutual decision on the source of the COLA to make the adjustment each year.
It's important for suppliers and buyers to create long-lasting relationships because it can create more benefits for both companies. When suppliers are offered a multi-year contract, it can bring a better commitment from them because they feel some reassurance.
You may even have a supplier who demands a multi-year contract from the start. This is typically the case when the supplier is offering upfront investment, like in a co-manufacturing situation. Suppliers want a guarantee that there is a long-term relationship to offset the initial startup costs and ensure they see some benefits from their investments.
How to Avoid Pitfalls with a Multi-Year Contract
- Include an early termination or break-away clause to establish performance benchmarks and address any potential issues related to the supplier's performance.
- Verify you do a full RFP exercise and review responses carefully since it's not easy to switch to a new supplier in between contracts.
- Take TCO, or Total Cost of Ownership, into consideration for the contract's duration, rather than just annual costs when you decide who to award a contract to.
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