Question

Certain technologies industries, such as the software development companies, are faced with constantly changing innovations, technologies, short product life cycles, modular designs, frequent manufacturing changes and demanding customers.

Under these conditions, what type of relationship would you recommend for a critical component supplier? And what additional measures would you include in this contract to protect your business and supplier relationships?

Answer 1

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Fixed-price contracts are less attractive for the supplier, for goods and services characterized by high process or technical uncertainty. However, if the purchased has a fair estimation of the cost structure of the manufacturer, then cost-based contracts can be preferable because they permit either upward or downward adjustment of the price, depending on the supplier's efforts. If the supplier can potentially reduce costs by quality improvement, then all contracting parties can benefit from an incentive contract.

It also 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 (Dastmalchi, 2006). 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.

Measures to include in this relationship are - 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. The other measures are warranty and epidemic failures, termination rights and obligations, intellectual property protection. Also change management and product obsolescence and quality requirements.