In today’s industry, there is a tremendous amount of pressure on purchasing organizations to improve product quality, delivery, and responsiveness while also reducing costs. Development and maintenance of supplier relationships is the key to success for many OEMs and other manufacturers. 

The existing relationships a company has with their supply base can be a powerful competitive advantage. One way to achieve this advantage is the use of long-term purchasing agreements (LTAs). As both a buyer and purchasing manager, my responsibilities included negotiating LTAs between the manufacturer where I was employed and several of our metalcasting suppliers. 

This article will discuss the most important elements of a purchasing agreement and the pros and cons of using LTAs to manage relationships with metalcasting suppliers. 

When Do You Need an LTA with a Metalcasting Supplier?

Not all supplier relationships benefit from the existence of an LTA. Purchasing agreements work best when your company represents a significant percentage of a supplier’s sales. 

The purpose of an agreement is to ensure compliance, mitigate risk, and reduce ambiguity and conflict in procurement transactions. I personally have found that the existence of an LTA will reduce the level of “noise” in the buyer/supplier relationship.
This is not to imply that these are simple arrangements. Most of the suppliers I managed were not vertically integrated, meaning that the components we bought were cast by one supplier and machined by another. It would be much simpler if both were under the same roof, but for the most part, they are not.

Often, OEMs issue purchase orders to suppliers that provide “finished-machined” components. Those suppliers, typically machine shops, find a metalcaster and in turn issue purchase orders to the foundry. 

This scenario works fine until the foundry has a quality or delivery problem or wants to raise prices. At that point in the relationship, the buyer will now take on the role of “marriage counselor” between the machine shop and the foundry. 

In my version of this “situation comedy” the tier-one machine shop calls (usually at or after 3 p.m. on a Friday) to announce that their foundry is not delivering for one reason or another. The machine shop owner urges the OEM buyer to get involved because they have more “leverage.” Often, a call to the foundry will reveal some breakdown in communication between the two suppliers. For example, that a purchase order was not issued in a timely manner. To be clear, written agreements with metalcasters will not eliminate these scenarios but in my experience, they are greatly reduced. 

The absence of a purchase agreement essentially means there are only the purchase order “terms and conditions” to govern the relationship.  P.O. terms and conditions are satisfactory for transactional purchasing relationships that are suitable for material that can be procured from multiple sources––but they are wholly inadequate for components that a manufacturer designs and expects their suppliers to build. 

Long-term agreements between the OEM buyer and the metalcaster preserve the right of the final user of components (the OEM) to have a say in what foundries their first-tier machine shops use. The downside is that the OEM now owns the relationship and responsibility for resolving problems that will arise. The upside is that there now exists a playbook that clearly lays out the rules of engagement. 

I have found if the first-tier supplier understands at the outset that they are making a directed purchase from a metalcaster that their customer (the OEM) has chosen, the relationship will work better than the OEM taking “potluck” with whatever foundry the first-tier has selected. Additionally, many OEMs have the resources to audit and evaluate metalcasting suppliers. My company’s auditing team provided great value in recommending and evaluating casting suppliers.

Below, we will review what should be included in a long-term purchase agreement. It should be noted that LTAs require a lot of work to successfully negotiate.

LTAs Should Have the Following:

• Contract duration. When the agreement begins and ends.

• Termination conditions. What happens if the agreement is terminated early, or the buyer and supplier do not meet certain standards. Events that can trigger termination can be failure to perform, insolvency, and sometimes a change in ownership. This will also include a “Force Majeure” clause covering natural disasters, pandemics, war, civil unrest, and the like. 

• Pricing Terms. A price list for each existing casting will typically be included as part of any LTA. This part of the agreement will also detail when and how metal surcharges will be addressed. The agreement should have details of how surcharges are tied to independent metal market indices––the London Metal Exchange Index, for example. 

• Performance standards. Quality standards (PPM for example), delivery performance standards (95% on time delivery), and other expectations.

• Incentives. Incentives can include a cost reduction for added purchases or business. For example, the OEM may negotiate year-on-year cost reduction for each added $250,000 of purchase orders. 

• Penalties. Penalties could include the supplier paying for the cost of poor quality (COPQ). These provisions are typically viewed as the most onerous by the metalcasting industry; however, I found that my internal customers required that these provisions be part of any long-term agreement. This can be an opportunity to create a playbook on how parts are rejected by the customer and under what circumstances the metalcaster will pay for COPQ. You may even want to reference certain industry or company-specific quality standards. It would also be a good idea to provide for how disputes concerning COPQ charges are to be resolved.

• Warranty agreement. Warranty agreements will give details of how the supplier may take part in the OEM’s warranty program. These are usually complex provisions but essentially say that the supplier will agree to pay some part of warranty repairs when they are deemed to have been caused by defective castings.  

• Risk mitigation provision. Risk mitigation addresses situations where a metalcasting supplier’s ability to provide material may be affected by their down-tier supplier.

To adequately assess your foundry supply chain, you should ask your metalcasting suppliers about their sources and contingency plans to ensure uninterrupted supply in the event of adversity. The contract should have a clause on a periodic review of risk mitigation plans and information sharing. Wherever the risk is high, the supplier should be willing to hold added inventory.

• Preferential treatment. As the metalcasting industry has continued to consolidate over the past decades, it is important to understand your supplier’s business in terms of key customers and revenue contribution. It is to your advantage to negotiate for a preferential treatment clause and superior position in terms of the metalcaster’s other customers. This can also take the form of reserved capacity for upswings in business. 

• Data Protection and Confidentiality. Data privacy and security are vital in today’s world. Clauses related to data protection, data retention, and information sharing should be spelled out to prevent data breaches. Additionally, the sharing of proprietary information must be carefully controlled so that information is not inadvertently shared with your supplier’s other customers. 
• Innovation. Innovation is responsible for 85% of economic growth. To scale up innovation, OEMs are partnering with their suppliers on the development of new products. To avoid conflicts related to intellectual property rights, creative development, and profit sharing, it would be wise to include language that fosters an innovative culture.

• Financial disclosure. My company required all suppliers to provide essential financial information to prove their financial stability. This kind of information may be regarded as sensitive, and we took particular care to keep this type of information confidential. 
• Payments. This is important! Details about how long suppliers should be expected to wait before they are paid should be clearly spelled out (usually 30-60 days). These clauses may also detail how tooling is to be paid for.

• Tooling bailment. A tooling bailment agreement is a legal contract between two parties that allows one party, the bailor, to temporarily transfer possession of tools or equipment to another party. The agreement outlines the terms and purpose of the transfer, but it’s not a transfer of ownership. The bailor retains ownership of the property, but the bailee is given physical possession for a specific period. When the purpose of the bailment is carried out, the bailee must return or otherwise dispose of the property as directed by the bailor. 

In Summary

Long-term purchase agreements can be extremely beneficial to both parties. For the buyer, they provide assurance of supply, risk mitigation, quality assurance, capacity, and cost reduction. For the seller, they can provide a solid book of business and assurance that their OEM customer values the relationship enough to codify the terms of engagement and a “playbook” for how buyer and seller will treat one another. 

Of course, a possible downside is that an LTA can bind both parties into an unsatisfactory relationship for a prescribed period. Nevertheless, from my experience, LTAs can be a very beneficial way to do business.