In our last post, we talked about the catastrophic demise of the Apple/GTAT supplier agreement.  One of the problematic legal aspects of the Apple/GTAT relationship that we discussed was the difficulty of negotiating a full-scale production agreement before product development is complete.  Until development is finished, parties to a supply chain agreement cannot know with sufficient precision what the technical parameters of the product are, what it costs to make, and what the market for it is likely to be.  Therefore, we recommended negotiating production and development phases separately – or at least reserving the right to re-open production terms, pending what happens in development.

The second problematic legal issue we see in the Apple/GTAT relationship falls into the category of what we call “product integration.”  If a supplier provides a component that has to work in conjunction with other components or in an environment that the supplier cannot predict or control, the supplier should be wary about guaranteeing performance, quality, or reliability.  In short, you cannot guarantee the operation of the thigh bone unless you know everything there is to know about the knee bone.

This maybe seems obvious, but problems happen in this area all the time.  We think because supply chain agreements often receive insufficient attention from executive management and insufficient review by legal.  Supply chain agreements are scrutinized far less than other corporate agreements.  Just think about it:  A $500 million corporate acquisition or divestiture would be crawling with lawyers – lawyers doing due diligence, lawyers getting legal opinions, and lawyers analyzing the esoteric aspects and consequences of the deal.  A $500 million supplier agreement rarely receives this kind of attention – even if it is international, even if it involves import/export issues, and even if it has to be approved by a regulator.  If corporate agreements are like a family, supply chain agreements are the red-headed stepchild.

In the Apple/GTAT case, according to GTAT, GTAT was responsible for fabricating the sapphire after it came out of the GTAT furnaces.  But the fabrication equipment and processes were chosen by Apple.  And according to GTAT, Apple’s fabrication equipment and processes produced errors a majority of the time.  Nevertheless, GTAT agreed to this arrangement.

Moreover, according to GTAT, producing sapphire correctly requires a stable and uninterrupted power supply.  But Apple, which owned the production facility, elected not to install a power backup, and on several occasions, power outages led to sapphire batches having to be thrown out.  GTAT repeatedly referenced a “sapphire graveyard” of discarded sapphire material – presumably the place with GTAT’s profits margins went to die.

Although GTAT did not control fabrication or power supply, GTAT was legally responsible for any errors that resulted from these processes.

To be clear, GTAT isn’t the only loser in the Apple/GTAT story.  There are no winners.  According to Apple, Apple advanced almost $500 million to GTAT and invested over $2 billion in the Mesa facility.  And it isn’t getting any sapphire.  When Apple was forced to switch back to glass screens for the iPhone 6 at the last minute, that can’t have been cheap.  We can make the case that America lost out too, since the GTAT deal was a rare instance where a tech giant “resourced” component production back into the United States.

And in addition to bankruptcy, GTAT faces a dozen shareholder lawsuits and multiple federal investigations of its executives – common locusts at the end of a bad supply chain contract.

The bottom line is that, supply chain relationships are partnerships.  Although it is normal for buyers to have greater bargaining power, if both parties to the supply chain contract do not succeed, then ultimately neither of them do.  A supplier who is getting a bad deal will find a way to cut expenses and add profit back into the program – usually at the expense of quality, customer service, and flexibility.  A better, more balanced, and more realistic supply agreement generally benefits all parties.