Could Proper Procurement Have Saved Apple and GT Advanced?

By now, you’re probably well aware of the Apple and GT Advanced Technologies (GTAT) debacle that’s been all over the news headlines. In case you haven’t been following this, GTAT makes sapphire manufacturing equipment and had hoped to also sell some special sapphire glass made from its most advanced equipment to Apple (there’s a cool video here on how the crystal is made). The $578 million exclusive contract was loaded with penalties, namely $50M per incident of any IP violation, and involved a series of milestone payments as production scaled up. Unfortunately…

  • GTAT couldn’t hit the performance targets in the face of apparent continual specification changes by Apple. The judge in the case used an analogy of a homeowner and contractor where the homeowner says, "It didn't come out the way I wanted to," while the contractor says, "Well, it would have come out that way if you didn't continue to change the specifications."
  • Apple planned to withhold its final payment (and obviously didn’t include the sapphire glass in its latest iPhone/iPad product releases like originally planned).
  • Cash was burning quickly at the plants ($1M per day). GTAT said that “sapphire manufacturing operations for the benefit of Apple is not sustainable” and has been winding down operations and expenses.
  • GTAT’s COO dumped a bunch of stock (more than $10M in 2014) prior to the bankruptcy announcement, including the day before Apple announced that the sapphire screen was not going to be used, as mentioned here.
  • GTAT surprised everyone when it filed for bankruptcy (and petitioned for secrecy lest any details get revealed that would invoke the contract penalties).
  • Both sides “lawyered up” and have burned millions more in legal fees.
  • GTAT’s stock has been delisted from NASDAQ and shareholder suits are being filed.
  • GTAT’s suppliers are also being impacted – especially the smaller ones.

Most recently, GTAT announced that it had tentatively agreed to a settlement with Apple, but it won’t be finalized for at least another month. GTAT hopes to retrench to its older and more stable business of making the equipment while getting on a payment plan with Apple and with creditors via bankruptcy court.

Learning From This Cautionary Tale of the Wrong Type of “Source to Settle”

So, from a procurement standpoint, what can we learn from this debacle? I’ll hit a few points, but please feel free to add your own thoughts in the comments section.

  • You have to manage strategic relationships strategically. If you manage your strategic suppliers like commodity suppliers without dealing with inherent complexity/risk of this type of relationship, it’s only a matter a time before you’ll get burned.
  • As a related point, you can’t completely make the supply chain risk free. Apple wanted the benefits of a captive, exclusive manufacturing process, but without the risk. Yes, Apple had to invest, but hoped to protect itself through onerous contract clauses. Shame on GTAT for accepting the risk. As the GTAT legal team said, "Our management foolishly accepted oppressive and burdensome terms and obligations - so now we are trying the Chapter 11 route to escape the noose we placed around our own necks." But shame on Apple for letting this hungry supplier set itself up (and Apple) for failure.
  • There is always a cost of treating risk and you have to be realistic in determining the amount. Some basic scenario planning is always in order in a high-risk venture. So, the contract should accommodate the “failure scenario.” As the old adage goes “Hope for the best, but prepare for the worst.” Hope is indeed not a strategy. The result is that this relationship is now getting messily unwound in the courts and in the public eye. Apple being surprised by the bankruptcy announcement is likely because it didn’t anticipate GTAT invoking the “nuclear option” and using it to unwind itself out of the contracts (or have it as a card to play at the settlement table).
  • Installing massive penalty clauses can seem to mitigate the risk when in fact those clauses can have unintended consequences. If you not only shift risk to a supplier, but also increase the risk exposure, and then don’t help the supplier reduce the cost of treating that risk you’ve created for them, you are actually increasing TCO and risk. In this case, GTAT felt its only recourse was bankruptcy – and that’s pretty sad. It’s also hard to collect penalties from a supplier who you’ve indirectly bankrupted.
  • If you treat a strategic supplier like a commodity and are not a trustworthy “customer of choice,” your suppliers will treat you the same way. Just last month (before the bankruptcy case was announced), GT said it expected to provide sapphire glass for the Apple Watch - news that pumped up GT’s stock quite a bit. Ironically, GTAT was featured in an article where Apple was being called a “brutally tough” customer and “kingmaker” (similar to how many companies have described Walmart).
  • A customer of choice is a partner whom a supplier can confide in to help the supplier work through a problem rather than hiding the issue for fear of being downgraded and cut out of new products. This is perhaps the biggest root cause in the ensuing problems.
  • Understand your strategic suppliers’ cost structures and dependency on your business. Basic FP&A (Financial Planning and Analysis) on GTAT’s financials would show that if its big bet on Apple didn’t pay off, it’d potentially take down the firm, and that hurts both parties. It is a classic prisoner’s dilemma, but the prisoners now are at least trying to work together to minimize damage so that GTAT can work through the bankruptcy issues, re-trench to equipment manufacturing further up the supply chain and try to pay Apple back and maybe even re-engage more strategically and realistically.
  • Increase your supplier monitoring (and enablement) activities when things start to go awry. I’m not sure why the supplier manager responsible for GTAT wasn’t getting more scrutinized and raising the alarm bells. Unfortunately, supplier management is a process that is not well invested in relative to sourcing activities. Based on an SRM study I led a few years ago, top SRM performers invest nearly 3 times the amount per strategic suppliers than their peers.
  • Technology is not necessarily the answer here for strategic supplier relationships, but top management at suppliers increasing their sales of their stock options might be a flag. So might delayed payments to their tier 2 suppliers. I’ll be curious to find out which predictive analytics/content suppliers will be back-testing their algorithms to see if they could’ve helped predict the GTAT bankruptcy.

Anyway, I’m not writing this article to bash Apple’s supply chain, although I always do a bit of an eye roll on many of the supply chain rankings where Apple scores so highly. Any large firm like Apple has likely experienced something like this – even if at a much smaller scale. I’m sure you can think of some more lessons here, and we welcome your comments, but the biggest thing is to learn from the mistakes and elevate your game.

Voices (7)

  1. B.R.Srikanth:

    Why did’nt GTAT ask for cost and time when Changes occured? I do not know whether GTAT was a Strategic Supplier considering Apple’s huge revenues but for GTAT, Apple was a strategic customer and should have scaled the problem to higher levels much earlier

  2. Koen Van Den Eeckhaut:

    What do you think of the current share price? Will it go down to 0?

  3. Pierre:

    The biggest question mark will be Apple’s reaction. They (and GTAT) don’t want GTAT’s COO’s missive to go public and have dirty laundry out there. Apple doesn’t want the publicity, but it has to look at itself in the mirror here and maybe try to ensure that its futue actions are the kind that they’d be OK having shared publicly. GTAT is in the same boat re: statements it made. And GTAT should’ve realized that bankruptcy isn’t just a management tool to use for negotiations. The judge essentially said as much and doesn’t seem to like either party calling the shots as such. Still, I hope the NH-based judge is using the bench for advocacy for NH jobs or otherwise, because the release of the documents might actually harm GTAT.

    The ball though is in Apple’s court. It needs to put its big boy pants on and swallow its pride when the GTAT COO’s deposition shines an unfavorable light on its previous actions. Especially if it wants its money back and get some return on its investment. Taking down GTAT only hurts itself, the affected supply chain, and the affected communities/economies.

  4. drifter:

    Mr. Mitchell, very well written article. With the recent Judges decision of unveiling of the “top secret” documents by late this week if a court approved compromise can not be made. Assuming my statement is correct. What kind of compromise do you think will come out? Or do you think exposure will happen? From what I have read and know of BK court, I think GTAT will come out with a better deal than they first expected. No Judge in their right mind will let GTAT come out of this with crippling debt for years and years hence the entire point of filing ch11.

  5. Pierre Mitchell:

    B&T, au contraire. I’m not against contracts or IP protection in and of themselves (although I think penalties are usually overrated because of some of their adverse effects), but it’s the relationship failure and risk management mistakes that ultimately led GTAT to feel it had no choice but to declare bankruptcy. GTAT gets its way by unwinding itself from the contract (although still getting on the payment plan) and is now back to selling its furnaces to anyone who wants a nice sapphire screen (albeit at a quality level that was not up to Apple’s ‘dynamic’ quality standards).

  6. B+t:

    Mistake? Apple kept a supplier of a potentially vital feature away from the competition.

  7. Anu Gardiner:

    Great points. Financial risk in the supply chain and how to price it and share it across organizational boundaries remains a relevant topic. Cisco paid out over $2B to its supply chain partners in early 2000s to save the supply chain from collapsing even thought it was not legally obligated to do so.

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