Catalyst Contracts: incentivize mutual growth

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Everyone knows that buying in bulk is cheaper.  So why did my friend’s client insist last week that they will pay more to purchase higher volumes of the product/service? Shouldn't it be the other way?

Example of a Catalyst Contract

For anonymity, let's pretend that my friend runs The SPAM Corp. and lets say his client is Food On Demand Delivery (FODD), a startup in Mississippi.

In order for FODD to scale and grow fast they need to have a constant supply of SPAM on their menu. Its the only thing that will satisfy their client’s palate. And their clients are willing to pay good money for quality SPAM. The availability of SPAM is the crucial rate limiting step to FODD’s rapid growth. Obviously, they'd like to pay less as they purchase more SPAM, but the world SPAM production is already at peak canning limit.

In typical market forces, the The SPAM Corp. would simply raise the price of SPAM because it is such a hot commodity. They'd make a higher profit, but there isn't necessarily the incentive to rapidly scale production.  In time, they'd probably see the incentive to grow production, but this is at a rate slower than the rate the FODD company wants to grow.

In order for FODD to incentivize The SPAM Corp. to grow faster, they sign a contract where FODD will pay more per can of SPAM if they can purchase higher volumes of SPAM from The SPAM Corp.

In this way there is:

1. A direct incentive to grow The SPAM Corp. rapidly

2. A certain amount of 'extra cash' is being invested into the SPAM business through higher profit margins. This is crucial, as it helps promote rapid growth - which can sometimes be a ‘sloppy’ process.

Typically during expansion a company has figure out how to produce more of a product, and also how to do so more cheaply - as their buyers expect that. This is hard and takes time. But by allowing the price to actually rise with higher outputs, there will be more cash to inject into the business to fuel even more rapid growth. This creates a flywheel capacity to quickly grow larger.  It permits growth that is not as operationally efficient as if the growth had been slower.

3.  In a world where The SPAM Company could pursue many business strategies, by FODD coming along and proposing they will pay more for higher volumes of SPAM, they act as an external operator directly on the future direction of SPAM Corp.  Now SPAM Corp. desires to prioritize rapid expansion as a core business strategy, and prioritize sales to the FODD company. Symbiosis.

Outcome

If your business replies on an input from someone else, and they are a rate limiting step to your growth; consider creating a catalyst contract that will incentivize them to provide higher outputs.

In the tech sector, it’s easy to imagine agreements where scaling fast is advantageous to both companies, and such an agreement could work very well.

Bonuses?

A contention is this is just a 'bonus system'. Not entirely.  Typically bonuses are paid by the EMPLOYER to their production or sales team for achieving higher production targets.

But in this case, it is the CLIENT who is paying higher amounts, to purchase higher volumes of the product. Also, it is not he same as paying a ‘bonus’ for delivering the target faster, as the incentive is more closely tied directly into the product’s production.

It is weird for a client to pay more to buy more. But, in the right settings such as a limited quantity of SPAM, such contract is in the best interest of both parties.
 

Thanks to: Scott Acheson for his feedback

Taxi photo by: creative commons, CEphoto Uwe Aranas