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Controlling costs in long-term printing contracts

Folio: The Magazine for Magazine Management, Jan, 2000 by Alex Brown

By including provisions for price escalation and price review, publishers get all the advantages of stability, while also protecting their need to opt out if circumstances should change.

Hypothetically, a publisher would sign a 20-year printing contract but for three things: the potential of eventual disenchantment with the printer over quality and service; a worry that publishing objectives and print technology will change so much that the contract won't economically cover the services needed; and a still greater fear that the only way to keep costs in line is a periodic visit to the marketplace.

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I'm not recommending a contract that spans a generation, but I am asking you to think about those concerns in the context of three- to five-year contracts. In that light, here are some observations on three key financial aspects of the printing contract: term, price escalation and price review.

Long terms and termination clauses

Long terms may make many publishers jittery, but remember that printers tend to make their most substantial concessions in pursuit of longer terms. For printers, profitability rests on equipment utilization, and the more capacity they can sell into the future, the more motivated they are to make capital improvements. Therefore, a longer term can give a publisher not only a better price schedule, but also a healthier printer--one whose investment in technology will ultimately benefit the publisher.

Three naggging fears

What about the three nagging fears? To cope with quality and service problems, build a termination-for-cause provision that permits escape when substantial and objective problems emerge. And to address changes in specifications, add a termination window that flies open when, after good faith negotiation, your manufacturing requirements can't be accommodated. To make sure new technology and its savings don't pass you by, include a provision that calls for review of price and schedule when new equipment is utilized. And create a termination option if new technology is available elsewhere, but your printer has no plans to obtain it.

Understand, however, that termination provisions aren't a snap to negotiate. They aren't even easy to define with complete fairness to both parties. But the core concept is to put the agreement to a series of tests as events unfold. If at some point in the future a publisher simply would not choose a given printer were the current, objective conditions in place, we want the agreement to dissolve. Such a long-term agreement has conditional limitations, but many of them are under the printer's control-a point to emphasize in negotiation.

Controlling costs over time

But now we turn to the third fear. How can we control costs over time?

The price-escalation provision of a contract puts both printer and publisher in the unenviable role of economic forecaster. Even a three-year contract strains predictive skill, and a longer term agreement executed in today's climate of technological change, with its attendant profitability implications, starts to look a lot like horse-race handicapping.

First premise: The ideal escalation provision is one that preserves the printer's margin. It shouldn't increase gratuitously; it shouldn't decrease unfairly. If both parties have negotiated well, the original price schedule represents an equitable exchange of payment for services, and we want to maintain this relationship--even as the printer's true costs rise from inflation or fall from productivity improvements and improved economies of scale if the work itself increases in volume. The escalation provision, coupled with price review, can accomplish this task.

What risks are acceptable?

Second premise: Contracts allow you to assume risk or pay a price to avoid it. There are some risks a publisher never wants to take. For example, we might question the wisdom of allowing the printer to preserve his original profit margin if he demonstrates a special flair for poor management. There are other risks some publishing operations will take and others won't. If your organization is budget-driven, you might prefer to project costs accurately rather than to have a surprise, even a pleasant one.

Let's illustrate this concept further by looking at four possible structures for price escalation.

The simplest escalation is a fixed percentage, determined in advance. The contract can maintain this number, or call for this set increase after the first 12 months of production, and then move to an adjustment based on other conditions. Using this approach means replacing the risk of an unknown increase with the risk that the printing marketplace in general experiences lower increases.

There's a significant gamble here by both parties, and negotiating a fixed percentage escalation can be a contest of wills. A publisher will embrace this approach only if the fixed number appears to be lower than his prediction of the future. The printer accepts this structure only when convinced that the number is higher than forecasts of actual operating costs. In the end, both parties may be looking for an advantage here, rather than seeking a system that objective measurements will prove fair. Appropriately, this approach was far more common during times of high inflation--when the value of fixing a future price might well have been worth the downside risk of a moderation in inflation--than it is now. However, even now, there are real advantages here for a company concerned with projecting costs accurately.

Media Industry

Controlling costs in long-term printing contracts

Folio: The Magazine for Magazine Management, Jan, 2000 by Alex Brown

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