Today’s breaking Wall Street Journal article provides a great case study on the impacts of not properly managing contractual supplier relationships.
First consider the type of supply arrangement this represented. This was an important and emerging new technology, one that would produce manufactured sapphire to cover the face of all of Apple’s new iphone products. According to the WSJ, “GT made furnaces for producing sapphire…. GT told Apple in March of last year that it was developing a furnace that could produce a sapphire cylinder, known as a boule, weighing 578 pounds, more than twice as large as what were then the biggest boules. The larger boule would yield more screens, reducing costs….Apple offered to lend GT $578 million toward building 2,036 furnaces and operating a factory in Mesa, Ariz. Apple would buy and retrofit the factory for an additional $500 million and lease it to GT for $100 a year.”
This type of purchase, nearly half a billion dollars, and for a supplier that is unique with an emerging new technology, puts this category of sapphire squarely in the middle of the “strategic category” for the traditional “Kraljic” category portfolio matrix. Based on traditional supply management pedagogy, strategic categories require a great deal of attention, information sharing, and joint collaboration to ensure that the right mutually beneficial outcomes occur.
The second part of this challenge is understanding what type of supplier Apple was dealing with. According to the WSJ, “GT was intrigued, because the agreement would provide more consistent revenue than equipment orders. Moreover, GT’s business making equipment for solar cells had fallen on hard times. GT’s 2013 revenue was down 66% from two years earlier.” In other words, GT was also a “high risk” supplier, in that they had indicators of having had previous financial problems and had made bad technology investments in the past….read on…
Mapped to a “supplier preference” matrix, this would indicate that GT was definitely viewing Apple as a preferred customer, and would fall into the “Develop” category, or a supplier that is not doing a lot of business with Apple, but has the customer as a strong developmental prospect. But because they were high risk, a prudent supply manager would want to watch them closely.
In terms of a procurement strategy, everything looked copacetic and had fallen into place. GT’s stock price took off when Apple and GT signed an agreement to seal the deal. Apple would lend GT $578 million toward building 2,036 furnaces and operating a factory in Mesa, Ariz. Apple would buy and retrofit the factory for an additional $500 million and lease it to GT for $100 a year.
Shortly after, in fact a few days later, the first sapphire boule came out of the furnaces, and it was badly cracked, and deemed unusable. Soon, it became clear that the manufacturing problems were more than a single batch, and that there were major problems with the process itself.
At this stage, there should have been daily onsite meetings, so that Apple and the supplier could work on the technical issues together, and identify the source of the problems. Instead, GT continued to flounder, hiring over 700 people for jobs that didn’t exist, as capacity was not up and running yet. They struggled with quality, production planning, and failed to meet deadlines. Rather than have regular communications, Apple failed to conduct due diligence and project planning. GT, fearing that Apple would leave them stranded, continued to try to work through the problems on their own, and continued to experience difficulty.
This is a textbook case, in that it demonstrates the importance of managing strategic relationships through careful performance measurement, human interaction, joint problem solving, and project management. It also demonstrates the critical nature of joint technology development. Apple was essentially funding the project, but not providing the human capital and knowledge required to make the technology viable. GT was afraid to ask for help, and preferred to clam up and continue to work on their own. In the end, both parties failed to do what was needed to manage the relationship. In the end, both parties failed to do what was needed to manage the relationship.
This doesn’t appear to be a one-time event either. Another blog on the WSJ website interviewed Apple suppliers, and two key lessons came out of it:
“To long-time suppliers, GT is a reminder of two lessons they learned long ago: Don’t rely too heavily on Apple and don’t make promises you can’t keep. Follow these, they say, and you probably won’t end up like GT.”
“Apple always asks the suppliers to expand their manufacturing facility to meet the rush demand for its new product, but we have to make our own judgment as the big orders only last for a few months,” said a manager at an Apple supplier. “For example, Apple might want us to increase 100 production lines, but we would only add 50 to 60 gradually.”
The screen maker Wintek was another supplier that over-expanded on Apple hopes. The company expanded its facilities on the prospect of growth, but ended up losing new orders when Apple shifted to new technology to make screens thinner, people familiar with the matter said. The company has suffered major operating losses. The subsequent word is out in the supplier community, that Apple is very demanding of their suppliers, but not always committed.
The blog also notes that “Apple has built up an army of supply chain managers over the past few years to squeeze costs, people familiar with the matter said. Many of these were hired directly from suppliers, so they know exactly where suppliers’ costs are. Apple’s contract manufacturers have seen their profits margins shrink as Apple flexes its muscle on component pricing, the people said. Apple has also tightened its oversight of factory conditions, which means higher costs for suppliers who have to comply with the measures.”
The approach to ruthlessly pursuing price reductions and using the marketing power is certainly one that traditional procurement executives have used for years, but one which everyone in the industry is recognizing as obsolete. And the results are also predictable. On October 6, GT chief Mr. Gutierrez told Apple that his company had sought bankruptcy protection. GT shares collapsed 93% on the news, wiping out roughly $1.4 billion in market value. The story demonstrates why simply “checking the boxes” on sourcing strategies aren’t enough; people actually need to manage and communicate with their suppliers, especially the important strategic ones.