Business negotiators tend to want the best of best worlds. When reaching agreement, they want to pin down parties’ respective rights and responsibilities, but they also want to retain the flexibility they need to deal with ever-changing business conditions.
One solution to this apparent dilemma is to craft an umbrella agreement. What is an umbrella agreement? An umbrella agreement sets out general principles that will apply to more specific give-and-take contracts in the future. More specifically, an umbrella agreement might include clauses that stipulate whether the parties will share industry knowledge with one another, how they will set prices, and whether they will engage in subcontracting and under what terms.
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A framework between a soft-drink company and a grocery chain, for example, would typically cover issues such as exclusivity, invoicing, confidentiality, termination, and so on. By contrast, subsequent short-term contracts would involve price negotiation and perhaps promotional allowances for specific products.
Umbrella agreements are common between retailers and manufacturers, but sellers and buyers in a wide range of industries may benefit from negotiating such “mega-agreements.”
In particular, an umbrella agreement can help parties understand each other’s values and adapt to changing conditions, writes marketing professor Stefanos Mouzas of Lancaster University Management School in the U.K. in an article in the Harvard Business Review. As a result, an umbrella agreement allows parties to jointly innovate in response to new opportunities.
Hidden Pitfalls of an Umbrella Agreement
Theoretically, working on two different levels—a long-term agreement combined with shorter term, more detailed contracts—can benefit all parties by allowing customers and suppliers to create stable relationships even when market changes are largely unpredictable.
However, many umbrella agreements come with significant risks because they are poorly drafted, according to Mouzas. In particular, umbrella agreements often include vague language or rules that are impossible to enforce. They can also be inflexible, tying parties down to disadvantageous deal terms or, conversely, falling apart during the implementation stage. As Mouzas describes, a merger between Deutsche Bank and Dresdner Bank collapsed because the parties failed to clarify in their umbrella agreement whether Dresdner’s investment banking division was included in the deal.
There’s another risk of umbrella agreements, writes Mouzas in the Negotiation Journal: they can provide opportunities for the stronger to take advantage of the weaker party. How so? The stronger party might demand favorable terms in the umbrella agreement that limit the weaker party’s ability to come out ahead when they subsequently try to hammer out dollars-and-cents deals.
To take one example, suppliers often complain that they are held hostage by the general terms imposed by “big box” stores like Wal-Mart. Of course, the power imbalance can swing in the opposite direction under certain circumstances: some retailers grumble about manufacturers whose attitude seems to be “My way or the highway.”
Umbrella agreements give parties room to adapt to changing business conditions. When such contracts are one sided, however, they can tilt the bargaining table in future negotiations. Ground given up in an umbrella agreement may never be regained.
Negotiating an Umbrella Agreement Strategically
The best umbrella agreements “articulate companies’ values and their expectations for firms’ behavior in language that is binding and enforceable,” Mouzas writes. They are also flexible, giving parties room to revisit their goals and responsibilities down the line.
In the Harvard Business Review, Mouzas suggests a number of guidelines for business negotiators to follow when drafting umbrella agreements, including the following:
- Commit to working jointly by stipulating the scope of their agreement, how long it will last, and what each party will bring to the table.
- Articulate each organization’s values, such as ethics rules and risk tolerance, and include them in the umbrella agreement.
- Specify how often the parties will review and renegotiate the specific terms of their agreement.
- Establish how issues regarding pricing, performance, and so on will be resolved.
Another important step parties might take would be to include a clause in their umbrella agreement that requires them to engage in certain dispute resolution methods, such as mediation and arbitration, in the event of a serious conflict.
In sum, when an umbrella agreement is negotiated with care, it can go a long way toward strengthening and lengthening a business partnership. But you will need to avoid getting locked into an agreement that you later regret. Perhaps the best way to do so is to think through various scenarios—both positive and negative—that could unfold during the life of your partnership. By anticipating the risks and hazards of your relationship as well as the potential benefits, you will draft an umbrella agreement that takes a clear-eyed view of the future.
Have you ever negotiated an umbrella agreement, and if so, what advice would you add?
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