Letter to the Editor: Innovation, Investment & Contractual Terms

An anonymous contribution

Anon
Anonymous

One of the characterising features of the last recession was the surprising degree to which manufacturers held onto their employees, with far fewer redundancies transpiring than should have been anticipated given the magnitude and duration of the slowdown.

Given the scarcity of engineering skills this was good news indeed for employer and employee alike, but there remains a strong dichotomy: the only reason for a company to have retained a greater number of employees than current need dictated – thereby sustaining a blow to productivity – would be that a resurgence was anticipated and being planned for.

This being the case, it’s perhaps surprising that now many supply-chain companies are busier and order-books recovering, re-investment levels remain stubbornly low; the innovation looked for in their suppliers by the Primes and Tier-1s to drive down total cost of production is lagging the overall recovery and higher than historically ‘normal’ levels of cash are being retained in companies.

Of course, we could all think of a broad array of potential causes from confidence in the solidity of the recovery to worries with regards future availability and cost of borrowing.  Whilst these are undoubtedly both elements in the overall jigsaw, I think there’s another ingredient and a more wrong-headed one from the perspective of long-term competitiveness.

In many industrial sectors, the proportion of out-sourced material in a Prime’s total cost of manufacture can be between 70% to 85% with a trend for this proportion increasing with the Prime focusing more on assembly and servitisation of their product.

In other words, the importance of suppliers to the final cost position of the end-customer is both large and growing.  Recognising the increased risks this brings, there has been a commensurate drive towards having long-term agreements (LTAs) which seek to manage this risk through mutually beneficial commitments over an extended period of time.

If the negotiating parties were of roughly equivalent magnitude, the balance that would arrive from the resulting negotiations could be expected to give rise to an LTA that provides confidence of continued supply for the customer, whilst offering a bankable commitment for the supplier to invest against.

However, compared to our peer-group economies, the UK has a disproportionate number of SME manufacturers and the result of a bank of in-house corporate lawyers on one side and a typically, legally unrepresented SME board on the other is often manifestly one-sided and unfair.

For instance, sample of problem terms include:

  • It is not unusual to be requested to make a non-returnable, up-front ‘contribution’ in respect of being allowed to tender – disingenuously referred to as a “Supplier Participation Contribution” by one respected aero-engine manufacturer.  From our end of the telescope it looks more like a ‘bung’.
  • Cancellation at convenience clauses have become the norm, which though as a supplier you may be told, “but we’ve never invoked this clause”, immediately removes any connotation of “Long-term” from the LTA in the eyes of any financial institution.
  • An LTA negotiation is seen as an opportunity to bully the supplier into accepting extended payment terms with 75 to 120 days becoming ubiquitous.  What was ear-marked for growth capital has instead to be used to plug a new and un-necessary gap in cash-flow.
  • Cost-competitiveness clauses that allow the Buyer to cancel the LTA if at any time they can find the product cheaper elsewhere.

So much for partnership.

This isn’t the whinging of an SME that wishes life was easier. On the contrary, conspicuous by their absence from the above list are liquidate damages for non-performance and warranties. I expect to be held to account for my product and expect to see that reflected in an LTA. But the ultimate contract simply has to pass a ‘reasonableness’ test and be bankable.

To be told by an OEM buyer that your payment terms are being changed “because we can” is un-ethical and short-sighted, but above all else, stupid.  Suppliers want and need to invest in process innovation to drive-down cost of production, suppliers need to see their customers succeed, and the Primes need a globally cost-competitive supply-chain.

So why on earth would you set-out to achieve this by robbing your suppliers of their working capital and unilaterally imposing un-balanced contractual terms?

A number of British OEMs and other UK-based Primes are progressively sourcing a greater proportion from overseas.

I do not believe this is, of itself, a strategic objective as the UK is generally seen as an attractive base from which to do business. However, without a re-appraisal of the entire approach to the negotiation of LTAs with the manufacturing supply-chain, we will remain reticent to re-invest for something that is un-necessarily uncertain and for which we may not get paid for 3 months.

This is no clarion-cry for government intervention – I can think of few things more disturbing – but rather a plea for a more balanced and partnership approach to LTAs with appropriate weight given to having a long-term manufacturing supply-chain in the UK with whom to contract.