Remember that story we ran a couple of weeks ago on Tier 1 automotive company Johnson Controls suing their suppliers for violating purchase contracts by trying to pass through steel surcharges? Well, we had the opportunity to speak with one of those supplier’s attorneys, Fred Smith of Warner Norcross & Judd LLP representing MIG Wire and Tube who shared with us the ‘other side’ of these lawsuits filed by Johnson Controls (JCI).
Like most manufacturers using steel, MIG Wire and Tube’s steel pricing increased 86% from January through May of this year. And like most automotive suppliers, MIG Wire and Tube sold their seating components to JCI on a fixed price program. When I asked Fred if MIG Wire and Tube had entered into any type of long term raw material supply agreement with their suppliers, he said no, mainly due to MIG’s size and lack of market power. So why didn’t MIG sign a floating price contract on the sales side? Because it’s not standard automotive industry practice and prior to 2003 (the first year of crazy price spikes), it had not been an issue. And in all fairness, MIG engaged with JCI like most suppliers do with their Tier 1 customers, they bid on dozens of potential programs and live off the few programs they are able to “sell.”
The key issue in this case centers on the fact that most Tier 1 automotive companies issue blanket purchase orders. In fact, our experience suggests most industrial manufacturers also buy their metals requirements using blanket purchase orders. The actual volumes and quantities are typically only quantified by the Tier 1 supplier in a purchase order release based on demand information from the OEM. According to Fred, “these contracts, the blanket purchase orders, started evolving to ‘no commitment contracts.'” The business (and now legal) issue rests on one question. Are blanket purchase orders without a purchase order release valid contracts? The courts are starting to side with the tiered suppliers, “if there is no obligation to buy, then these contracts are pointless,” according to Smith.
There have been four cases in the courts that essentially challenged the whole notion of blanket purchase orders. At least two of the four that Fred mentioned, all involved automotive companies and their suppliers. No supplier or OEM has been willing to take the risk of letting this go to a decision. Previously, in each case, the parties have worked out a financial arrangement. And essentially, that is where it stands today. The Tier 1 automotive suppliers have resorted to filing suits with no notice against suppliers who have demanded price increases. In these cases, where no prior notice exists (meaning the Tier 1 and the tiered supplier are not already trying to re-negotiate the contract) the judges have been ruling in favor of the Tier 1 firms, forcing the suppliers to ship parts with no price increase. But contrary to all of the press which stated JCI won all of its injunctions, the case against MIG did not go the same way. Because JCI and MIG were already in contract negotiations, JCI could not go to the court filing an injunction without notice. This gives MIG the right to withhold shipment of parts. JCI then sued but will likely come to the negotiation table rather than risk the courts evaluating the efficacy of blanket purchase orders.
The reality is that the procurement industry has too much vested in blanket purchase orders. It may not be in anyone’s interest to see that get ruled illegal. In the meantime, the OESA (the automotive industry supplier trade group) has developed a model for contracts. Unfortunately, nobody is using it. The reality is that higher prices will need to be passed on down through the supply chain including to consumers. And since profit margins are so much less on smaller cars (which are the only cars selling), the ultimate burden of high steel prices will be yours and mine.