"Do you need contracts with your component suppliers?"
It depends. For example, within your products there are probably components like standard capacitors, resistors, memory, etc. where your EMS (electronic manufacturing services) provider has more purchasing power and is in a stronger position to manage the supply relationship. And, if one component causes problems, there are plenty of alternative solutions for you to consider.
However, when it comes to critical, high value components – particularly those that are loaded with intellectual property and critical to the functionality of your unit – the game changes. In these cases, you are likely to have more influence because your company makes the design decisions and there is more at stake due to the higher dollar value of these components. Therefore, an agreement with the component supplier can go a long way towards reducing your risk of doing business, and can be a vehicle for finding a competitive advantage in the relationship.
Most OEMs negotiate agreements with their EMS partners. Why? Because moving from one EMS to another is no easy task and requires significant investment in time and resources. For critical components, it is usually more difficult and in some cases impossible to switch from one supplier to another due the high cost of redesign and re- qualification of the product. Here are some fundamental questions that you need to ask before deciding whether or not you need to secure your relationship with a component supplier through a supply agreement:
1. How critical is the component to the functionality of your product? If your product architecture is based on a semiconductor supplier’s chipset, for instance, the cost of switching platforms may be daunting.
2. What is the relative value of the component within your bill of materials? A high value component has a greater payback from the efforts to secure a contract.
3. Is the component either custom or semi- custom? If so, you will have more liability as demand decreases and more risk of supply shortages if demand increases. In either case, it is in your best interest to agree on a flexibility and liability plan before a triggering event occurs. You cannot count on your EMS partner to focus on these issues in the same manner that you would. The fact is, these critical parts are more important to your company and EMS companies often do not have the ability to exercise any influence over the component supplier because they are not involved in making design or sourcing decisions.
4. How much influence do you have with the supplier? If you are a valuable customer for the component supplier based on purchasing dollars, marketing value associated with your brand name, or technology leadership, then you are more likely to have more leverage in your negotiations.
Remember, the purpose of a contract is to document how you want to govern your business relationship and to provide adequate protections that you would not otherwise receive from your component supplier’s standard terms and conditions. In other words, if a component is important to your business, you want to make sure that you are getting preferential treatment from that supplier relative to their other customers.
Here are a few key areas where you want to provide protection for your business:
• Liabilities in cases of cancellations, reschedules, or a significant decline in forecast
• Upside flexibility to protect against demand fluctuations
• Allocation management during shortages
• Pricing changes
• Warranty and epidemic failures
• Termination rights and obligations
• Intellectual property protection
• Change management and product obsolescence
• Quality requirements
When is the best time to negotiate these contracts? The answer is simple: before you award business. By the time you design-in the part or start placing PO’s, you have limited freedom in moving to another solution, and with that comes a significant loss in your negotiation power. However, if you are already in that position, do not give up. Look for creative leverage points like the next design or awarding them a larger share of business.
If you have not yet locked yourself into a design, get your engineering and operations teams together to agree on an approach and send a consistent message to the component supplier. Remember that each business relationship is unique and you will get the most from your agreements if you tailor each contract to fit the relevant business conditions surrounding that supplier.
Creating and negotiating EMS and component supplier agreements is a key part of our consulting practice at Symphony. If you feel that we could be of value to your efforts in this area, we would welcome the opportunity to discuss it with you further. Please contact us at info@symphonyconsult.com or call (650) 948-3909.