Intelligent Deal Structure
Especially in a volatile environment, the careful drafting of contracts is of paramount importance. Well-produced contracts can be a significant competitive advantage in guaranteeing the availability of resources and capacities in the face of scarce supplies and supporting growth. Similarly, when raw material prices escalate, contracts can help ensure budgets are met.
In drafting the appropriate contract structure, the first step is to identify the risk position. This involves determining how high the exposure of the company is (that is, what proportion of sales revenues, costs, or net income would be affected), and how controllable the influencing factors are. This risk position then forms the basis for defining a goal.
If the goal is “planning certainty over the budget period,” this can be achieved through hedging. Depending on the company ’s appetite for risk, various instruments exist. The three most important are as follows:
Swap: A fixed price is agreed to independently of the actual market price
Cap: Only an upper limit is placed on market price fluctuations; if prices fall, the company can take full advantage of them
Collar: A range is defined, within which prices can follow the market fluctuations
One thing all these hedging instruments have in common is that they do not prevent, but merely delay, the effects of permanent rises in raw material prices, and they naturally give rise to costs. However, airlines that undertook aviation fuel hedging, for example, are in a much healthier economic position than their competitors who did not do so. Coping with raw material price increases over the long term, however, demands that these higher costs are passed on to suppliers or customers. Once again, intelligent contracts rise to the occasion.
If "supply security" is the goal derived from the risk position, then implementation calls for even more creativity than hedging. Drafting contracts that can secure capacities in a tight market is anything but easy, since they have to combine security with flexibility. They also need to include reliable rolling forecasts of demand in order to provide suppliers with transparency about the volumes that will be required in the future. When preparing such contracts for an airline, for example, the following should be asked:
What price mode applies in the case of reservations?
What is the time span for confirming / canceling / postponing a reservation?
On what terms can a reservation be canceled / postponed?
What pledges apply in the case of “rolling” forecasts?