Apple: Still a Penny Wise and Pound Foolish?

There’s been a lot of press lately about the business relationship between Apple and GT Advanced Technologies (“GTAT”), which started when GTAT unexpectedly filed for Chapter 11 bankruptcy in early October. The most recent revelations came a couple of weeks ago when Daniel Squiller, the COO of GTAT, filed a declaration with the U.S. Bankruptcy Court District of New Hampshire. The declaration provides a summary of the events leading up to the bankruptcy filing, including details of the contract between the two companies — a relationship that Mr. Squiller described as a “heads I win, tails you lose” proposition for Apple. For example, here are a couple of the contract terms he references in the declaration:

– The pricing for sapphire [which GTAT was to produce] was the lesser of (i) the price agreed between the parties, (ii) the “not to exceed” price listed on a schedule, (iii) 95% of the lowest price offered by GTAT to any of its customers or (iv) 99% of the quoted price in a bona fide offer to Apple from another qualified source. There was no pre-established formula to adjust the pricing to account for specification or process changes.

– GTAT must accept and fulfill any purchase order placed by Apple on the date selected by Apple. If there is any delay, GTAT must either use expedited shipping (at its own cost) or purchase substitute goods (at its own cost). If GTAT’s delivery is late, GTAT must pay $320,000 per boule of sapphire (and $77 per millimeter of sapphire material) as liquidated damages to Apple. To put this figure in perspective, a boule has a cost of less than $20,000. Apple, however, has the right, without compensating GTAT, to cancel a purchase order in whole or in part at any time and reschedule a delivery date at any time.

According to Mr. Squiller, when GTAT’s management team expressed concern about some of the contract terms, Apple said that “all of its suppliers agree to such terms and there was no room for negotiation,” and then said, “Put on your big boy pants and accept the agreement.” (For the record, Apple had filed a motion with the court to keep Mr. Squiller’s declaration under seal, saying his comments were untrue and defamatory, but the motion was denied).

Let’s put aside for a moment GTAT’s responsibility for accepting a lousy, risk-laden agreement and focus just on the terms of the contract, which I assume are true (otherwise, Mr. Squiller would be guilty of perjury).

How can Apple, a company that is so innovative in so many aspects of its business, also be so ordinary (or worse, the opposite of innovative) in others?

I first raised that question more than two years ago when Apple was receiving a lot of negative press about its supplier practices in China. A January 2012 article published in The New York Times, for example, focused on many topics, including the poor working conditions at Foxconn, but here is the excerpt that caught my attention the most:

Apple typically asks suppliers to specify how much every part costs, how many workers are needed and the size of their salaries. Executives want to know every financial detail. Afterward, Apple calculates how much it will pay for a part. Most suppliers are allowed only the slimmest of profits.

So suppliers often try to cut corners, replace expensive chemicals with less costly alternatives, or push their employees to work faster and longer, according to people at those companies.

“The only way you make money working for Apple is figuring out how to do things more efficiently or cheaper,” said an executive at one company that helped bring the iPad to market. “And then they’ll come back the next year, and force a 10 percent price cut.”

Almost three years later and Apple is apparently still “a penny wise and pound foolish” — one of the ten ailments of traditional outsourcing relationships, which Kate Vitasek highlights in Vested Outsourcing: Five Rules that Will Transform Outsourcing. Here is an excerpt from the book:

We have all heard the warning to not be a penny wise and pound foolish. Unfortunately, many procurement professionals still labor in the Dark Ages and have not taken the maxim to heart. Too often companies profess to have an outsource partnership but, behind the scenes, they focus solely on beating up their service providers to get the lowest price.

Last week, Kate wrote a blog post about the “lose-lose” deal between Apple and GT Advanced Technologies, where she said the following:

I don’t want to beat up on Apple too much because I have not reviewed the supplier agreements. However, from what I can see that is now public — especially Squiller’s declaration — their approach is the exact opposite of the Vested business model for supplier relationships, and ultimately has created a true “lose-lose” situation. The question is, can Apple continue to get away with heavy-handed, muscular approaches with its suppliers?

Game theory teaches us the answer is “no.” Yes, Apple can clearly get some short term “wins,” but this approach ultimately will backfire and will create a supply chain that is “unsustainable,” as GT’s Daniel Squiller noted.

Apple is often lauded for being a supply chain leader, but when it comes to building highly collaborative business relationships, it appears that Apple is still a Company of Yesterday — that is, a company that takes a “What’s in it for Me?” approach, where negotiations are viewed as a zero-sum game with a clear winner and loser, and the goal is to always be the winner, instead of a “What’s in it for We?” approach, which in Vitasek’s words, “flips conventional negotiation on its head and shifts the perspective to where it belongs: viewing the relationship as the substance of the deal, not merely a ‘once and done’ transaction.” (For related commentary, watch my video interview with Kate Vitasek and Jeanette Nyden, authors of Getting to We).

Now, back to GT Advanced Technologies, which has to accept some (if not equal) responsibility for the failed relationship. Why did the company accept the deal? According to Mr. Squiller, “In GTAT’s business judgment, based on facts and circumstances known to GTAT in October 2013, the deal with Apple offered significant opportunities for it, and GTAT elected to proceed.” It’s clear from his declaration, however, that GTAT had raised serious and valid concerns with Apple about the terms of the agreement before accepting it, and as Apple pointed out in its defense, GTAT is a “sophisticated publicly traded company” with its own lawyers. In my opinion, GTAT accepted the agreement because, like so many suppliers and service providers, it lacked the discipline to say no and walk away from a marquee customer dangling a very large revenue opportunity in front of it (emphasis on revenue, not profitability). They were like sailors lured by the Sirens’ song, straight to a shipwreck.

Neither Apple or GT Advanced Technologies put on their big boy pants when they negotiated this agreement. Instead, they slid on their overly-worn and outdated “What’s In It for Me?” polyester pants, and the results speak for themselves. Companies of Tomorrow have thrown those pants away and are taking a more enlightened approach to developing highly collaborative business relationships, a Vested approach where We is greater than Me.

For related commentary, see Collaborate? Sure, Except I Don’t Trust You and Amazon Inside P&G Warehouses: A Case of “What’s In It for We”