Hardware Supply Chain & Sourcing POST 8 OF 16

The companies that kept producing through the 2021 semiconductor shortage had mostly done one thing differently in the years before it: they had signed long-term agreements. The companies that hadn’t were at the back of the queue, paying spot market prices for whatever was left.

A Long-Term Agreement — LTA — is a contract between a buyer and a supplier that commits the buyer to purchase defined quantities of a component over a defined period, typically 12 to 36 months, in exchange for the supplier guaranteeing availability and, usually, price stability. LTAs exist because semiconductor manufacturers and other component producers operate capital-intensive businesses with long investment cycles — building a new fab takes 3 to 5 years and costs $10 to $20 billion. They need demand visibility to plan that investment. Buyers who provide that visibility — by committing to purchase volumes in advance — get preferential access to capacity in return. Buyers who don’t provide that visibility are served from whatever capacity remains after committed customers are served.

The financial structure of an LTA involves obligations on both sides. The buyer commits to purchase a defined volume — sometimes with flexibility within a band of plus or minus 20% — and accepts that if it doesn’t take the committed volume, it may forfeit deposits or pay cancellation fees. The supplier commits to make the capacity available and, in many agreements, to hold a defined price for the contract period. The buyer is accepting volume commitment risk — the risk that its forecast is wrong and it ends up committed to more volume than it needs — in exchange for availability assurance and price protection. The supplier is accepting price risk — the risk that market prices rise above the contracted price — in exchange for demand visibility and revenue predictability.

The value of an LTA is entirely a function of market conditions. In a normal market with ample supply, an LTA provides price stability and procurement simplicity but doesn’t create significant competitive advantage — components are available from multiple sources at similar prices regardless. In a constrained market — exactly the conditions of 2020 to 2023 — an LTA is the difference between having components and not having them. Customers with LTAs had their allocations honoured. Customers without LTAs discovered that their supplier relationships, however warm, did not translate into supply priority when capacity was fully committed to contracted customers. The value of an LTA is, in a sense, an insurance premium — it costs something in normal times, and it pays back enormously when a disruption occurs.

Capacity reservations are a related instrument — agreements that reserve manufacturing capacity at a supplier or contract manufacturer for a defined period, without necessarily specifying the exact components to be produced. They are particularly relevant for companies with high-volume, consistent production requirements, where the constraint is not just component availability but production slot availability at the factory. Companies that had capacity reservations at key assembly factories going into the post-COVID production ramp were able to execute their production plans on schedule. Companies that assumed capacity would be available on demand discovered that factories were fully booked by customers who had reserved capacity months in advance.

For investors and executives, LTAs and capacity reservations should be understood as risk management instruments with balance sheet implications. They create contingent liabilities — the obligation to purchase defined volumes — that should be disclosed and understood. They also create significant value in constrained markets, which should be recognised when evaluating a company’s supply chain resilience. Ask a hardware company to show you their current LTAs: which components are covered, what volumes are committed, at what prices, for how long, and what the cancellation terms are. The coverage of their highest-risk components by LTAs is a direct measure of how seriously they have managed their supply chain risk. And the terms of those LTAs — particularly the volume commitment flexibility and the cancellation provisions — define the financial exposure those instruments carry.