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An output contract, also known as an entire output contract, is an agreement in which a manufacturer or producer of goods agrees to sell its entire production of a specific good to a single buyer. In turn, the buyer agrees to purchase all of good that the seller is able to produce, regardless of the buyer's actual needs.
Output contracts have several advantages for the businesses that enter into them. Sellers in an output contract can focus on production of a quality product, and don't need to worry about sales or distribution to multiple outlets. The benefits for buyers include exclusive rights to what is hopefully a quality product, and, like the seller, the buyer doesn't have to manage relationships with several suppliers. In addition, because the buyer has agreed to purchase the seller's entire output, the buyer can usually negotiate a good price due to the seller's reduced costs.
On the other hand, output contracts can also be problematic: If there are changes in the market for a particular item, sellers who are locked into output contracts can miss opportunities to sell at a higher prices. In addition, if a buyer unexpectedly goes out of business, the seller will have to scramble to find a new buyer. Buyers are also at risk. If the demand for a product or its market value unexpectedly declines, the buyer may be stuck with a product that it either cannot sell or must sell at a loss.
An alternative to an output contract is a requirements contract. In a requirements contract, the buyer only agrees to buy as much of a product as it actually needs from the seller. In return, the buyer agrees that the seller will be its only supplier of that particular product. In this situation, as long as the seller is able to meet the purchase requirements of the buyer, the seller is free to sell to other buyers.
One potential problem with both types of contracts is that they can technically allow one party to disregard its obligations to the other. A seller in an output contract could stop or slow production, claiming that it had produced all it could. In a requirements contract, a buyer could refuse to buy anything from a seller, on the grounds that it no longer "required" the product.
The Uniform Commercial Code prescribes "good faith" as a way of protecting the interests of both parties: If a seller's production of a good outpaces what is normal for that product, a buyer is not necessarily obligated to purchase all of it. Good faith also extends to the seller: While a seller in an output contract can't refuse to produce a good because the good is not sufficiently profitable, if a seller goes into bankruptcy, it may be at liberty to cease production.
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