Volume Commitment in Your Beverage Agreement: Should You Sign It?
Your draft beverage contract comes in with language that defines the term of the agreement as the latter of a date or when you have purchased a certain volume of product. Should you strike the language and fight for a time-only term or just leave it there? When should you fight a volume-based term? And when should you allow it?
The answers lie in your beverage supplier’s view of your beverage deal. When my firm analyzes a beverage contract, we look at it from the point of view of the beverage company. We use their economics, their equipment costs, their depreciation schedule, and their volume assumptions. That last piece, volume assumptions, is an important number that drives the ultimate economics of the deal.
The cost of a deal to the beverage company depends on how much they are spending versus
how much revenue the deal will generate over the life of the contract. They allocate fixed costs, such as equipment, service, and overhead over the total volume you will purchase during the term. If they can fix that total volume by getting you to agree to a volume commitment, it makes the picture of their total cost and profit quite predictable.
So that’s why they want the volume commitment. But why do you want it? In general, you don’t. There are three big reasons why you don’t want it. (And quite a few smaller points why you don’t want it.)
1. It Makes the Term Unpredictable
I have seen contracts stretch from ten-year deals to twice and even three times that long because of ill-conceived volume commitments. Yes, I’ve seen a ten-year volume-based contract stretch to a projected thirty years. While three times the projected time-limit is quite unusual, it is very common to see two to 5 years of extra time on a volume commitment-based contract. It is the norm, not the exception. And it can be avoided.
This unwanted elongation happens because restaurant chains divest outlets, close restaurants, focus on tea or coffee instead of soft drinks, or just plain never had the ability to purchase as much as the beverage company said they might.
2. Carbonated Soft Drink Consumption is Declining
Carbonated soft drinks are still a huge part of your mix. The soft drink companies are right – don’t ignore their importance to your profit story. But let’s understand the facts. Ten years ago, eight out of 10 beverages sold in the United States were carbonated soft drinks. Today that number is somewhere between 5 and 5.5 out of ten. That’s a significant drop in share. More than 25 share- points lost in ten years. According to Fortune Magazine, U.S. carbonated soft drink volume has shed 1.4 billion cases of sales over the last decade. That’s 33.6 billion servings gone. 1,2 Because of this, a contract that is dependent on carbonated soft drinks will end up stretching the time it takes to fulfill the commitment. The answer is to avoid the commitment and stick to a time-bound contract.
3. There is No Benefit to You
There is no benefit to you of signing a volume commitment. All volume commitments I have seen have a time or volume component – whichever is later. So even if you grow fast enough to beat the volume commitment, the time-bound portion of the contract will keep you in the contract until the time expires.
In general, there is no good reason to allow a volume commitment into your contract.
Of course, there is an exception. If one of your goals is to bring a significant sum of money forward to the beginning of the beverage contract so that you can achieve some larger initiative, then maybe you can consider the volume commitment. But understand that you are, in effect, taking a loan from your beverage partner.
They, in turn, expect you to pay back that loan through your purchases of their products. In this case, your volume commitment acts as a promissory note. You’re not likely to get the loan without it. My advice is to get a loan elsewhere if you can. When the volume commitment stretches your contract past the due date, you will have limited ability to negotiate a new deal. The price increases over the life of the current contract will have made the existing contract unfavorable versus the industry standards by then.
The bottom line: don’t sign a volume-based term. It makes things very predictable for your soft drink supplier, but very unpredictable for you.
1: Fortune Magazine, carbonated soft drink volume slid for both Coca Cola and Pepsi. By John Kell March 26th, 2015
2: Fortune Magazine, Bottled Water Continues to Take the Fizz Out of Diet Soda, By John Kell April 19th, 2017