Who Knew In-Flight Catering Contracts Could Be So Tasty?
Surprise pricing terms can be very painful, like when a 30 year airline catering contract includes a profit guarantee clause.
Airline meals may be dull, but the in-flight catering contract between Asiana Airlines and Gate Gourmet Korea is anything but. It includes a rather tasty profit guarantee that, over the course of the 30-year contract, could saddle Asiana with losses in excess of $300M.
Image Credit: SAS Museum (CC BY SA 2.0) showing airline catering in the '60s when flying was fun. This is not an Asiana meal.
How did this happen? Well, this is another case of contract renewal gone bad. Asiana’s previous contract with LSG Sky Chefs Korea was up for renewal in June 2018. Rather than simply extend that deal, Asiana’s parent company got involved and demanded investment in a related company as part of the catering renewal. LSGK said no (and filed a complaint with regulators), but rival Gate Gourmet was willing, so long as there was a profit guarantee included.
The pricing terms for the new deal referred to CPI adjustments and some of the usual stuff you’d expect to see:
The terms and conditions for all prices for meals and other Services as of the Commencement Date shall be no less favourable to either Party than the current pricing terms paid by Asiana for any services provided at the Stations that are the same as or similar to the Services. The pricing terms shall be adjusted based on inflation, CPI increases, cost pass-throughs and menu and service changes in accordance with this Annex 1.
But, nestled amongst the pricing terms was a statement that: “The net profit as committed in the Business Plan will be preserved.” This sentence left Asiana exposed to serious price risk.
Operationally, things didn’t get off to a great start, with the newly formed Gate Gourmet Korea (GGK) suffering a fire at its production facilities and being unable to supply meals on the first day of the new agreement. According to reports, most of Asiana’s international flights were delayed that day (81 out of 82 flights), and a dozen flights took off without meals. Airline food may be boring, but boring food is better than no food.
It didn’t take long for the pricing terms to trigger a dispute, which went to arbitration before an International Chamber of Commerce Tribunal in Singapore. Long story short, in 2021, GGK won, and Asiana was required to make the payments (including the profit guarantees) as described in the catering contract. In May 2022, Asiana’s appeal was rejected by Singapore’s International Commercial Court.
Rubbing salt in the wound, Asiana was also fined $6M by South Korea’s Fair Trade Commission for the catering contract saga, and an appeal of that fine was rejected last month.
What lessons can contract managers, sourcing and legal teams take away from this?
First, when switching strategic suppliers, always have a plan B. Before you go cold turkey on one supplier, you had better be sure the new supplier is going to deliver. Having a period of overlap between the old and new contract is one way to maintain continuous service if there are delays on the part of the incoming supplier. In this case, LSGK was not inclined to help once its contract expired, and there was no overlap requiring it to do so.
The second lesson is that contracts, once signed, are very hard to get out of. You can’t simply declare that the pricing is unreasonable and expect a court to save you. If you have toxic clauses like the Asiana contract did, you should at least know about it and have a plan for resolving the problem before things turn ugly. The last thing you want is to be discovering serious price risks during M&A due diligence. Clauses like the profit guarantee can be deal killers. Luckily for Asiana, this dispute was already out in the open when Korean Air bid to acquire them.
What risky pricing terms are lurking in your contract portfolio?