Take-or-pay contract

A take-or-pay contract is a rule structuring negotiations between companies and their suppliers. With this kind of contract, the company either takes the product from the supplier or pays the supplier a penalty. For any product the company takes, they agree to pay the supplier a certain price, say $50 a ton. Furthermore, up to an agreed-upon ceiling, the company has to pay the supplier even for products they do not take. This “penalty” price is lower, say $40 a ton.

Take or pay contract is very common in the energy industry, in particularly the gas sales.

Advantages

1. Reduces risk to the company's supplier, in return for which they can ask to pay less.
2. Reduces a rival’s incentive to come after the company's customers by making retaliation a near certainty.

Disadvantages

1. Increases severity of price war if deterrence fails.