My caution light is flashing. Apple Inc. (Nasdaq: AAPL) committed to spend $3.9 billion over the next two years with several advanced LCD manufacturers. In the release of its first quarter results, Apple's COO, Tom Cook, stated that the company had executed long-term agreements (LTAs) with multiple vendors to guarantee availability of advanced LCD panels for the iPhone and the iPad.
Without knowing more about the details of the agreements, it is impossible to evaluate whether or not these agreements are winners for all parties involved. I have no doubt that Apple sees value in committing to the expenditures. I am also confident that the major LCD manufacturers that worked with Apple on these deals -- LG Electronics Inc. (London: LGLD; Korea: 6657.KS) , Toshiba Corp. (Tokyo: 6502), Sharp Electronics Corp. , and Samsung Electronics Co. Ltd. (Korea: SEC) -- would surely welcome a large pre-payment and guaranteed sales. So, it's an obvious win-win for all parties, right? Why, then, do I see an increasing number of flashing caution lights whenever I think about LTAs?
On the face of it, LTAs make good sense. But if you've ever been on the supply side of an LTA, you almost certainly have a fistful of reasons to think otherwise. And it’s not a fistful of dollars we're talking about. More and more, larger companies are enticing suppliers with highly attractive revenue potentials in exchange for guaranteed delivery and fixed costs, meeting difficult stocking requirements, working through weak forecasting models, and wrestling with an overall inflexibility on the side of the buyer. Often blinded by the revenue, suppliers will enter into LTAs that would normally cause apprehension.
For the supplier that is also the manufacturer, the potential for long-term agreements to turn into supply chain nightmares is greatly reduced. But in this case, the supply chain risk actually lies with the manufacturer's smaller customers and distributors. Since the original contract manufacturer (OCM) can re-prioritize production and scheduling to meet the requirements of an LTA for one customer, it can also leave others waiting for product and having to handle the frustration of missed deliveries and the consequences of constantly pushed-out due dates.
A supplier that is not the OCM has an opportunity for profitability under an LTA agreement. If the profit is dependent on the performance of the manufacturer and on the supplier having a reasonable customer, supplier beware. From this standpoint, LTA agreements can definitely be a challenge. From a customer's viewpoint, shifting the burden of performance to the supplier can be a definite winner. But this only holds true if the supplier genuinely takes on the responsibility to execute consistently.
While a contract can bind two parties in black-and-white in terms of dollars and deliverables, an LTA has to be crafted more in the spirit of a partnership agreement. Both parties must have each other's interests and welfare in mind. This is not always easy. When you review or negotiate a long-term agreement, remember: It is long-term. If an agreement is later discovered to be unbalanced, it will seem like a really long, long, long-term agreement. I think that having open dialog with clear communication and expectations of performance is critical, regardless of which side of an LTA you're on.
I encourage suppliers to be absolutely sure that they can perform 100 percent, even through the what-ifs. You can imagine how a $3.9 billion opportunity from Apple could cause any supplier to overestimate its ability to perform and place itself in jeopardy. Having said all this, I believe shining bright lights on LTA contracts can cause my caution light to dim. How about yours?