Long Term Supply Agreements – An Overview

Longterm supply agreements (LTSA) are Buyer and Seller agreements for supply of goods or service or both. Unlike purchase orders (project contracts) which are not project specific, LTSAs are also for longer durations as the objectives of an LTSA need time to start yielding results.

LTSA s are common in several industries mainly for supplies of goods/components, e.g. automobile sector. The auto makers outsource a large number of components. These LTSAs are non-exclusive as buyers need large quantities and flexibility. As a result, they often enter LTSAs with multiple suppliers.

In other sectors, such as power generation, fuel supply to a power producer is often tied up for a long duration. The fuel seller is obligated to meet the buyer’s demands (the power producer), and only after meeting these commitments can the seller sell any surplus fuel to other customers.

As is obvious from the above typical examples, both Buyers and Sellers are induced to such LTSAs because while the Buyer is assured of supplies at agreed prices over a longer duration, the Seller too has a guaranteed offtake as these LTSAs generally contain a “minimum quantity take or pay provision”.

The parties to an LTSA work together to continuously optimize the cost by joint efforts. The end users certainly benefit from such LTSAs as the end product price and delivery are optimized continuously. This is also one of the key objectives of an LTSA.

EPC (Engineering, Procurement, and Construction) project contractors also outsource a significant portion of their scope, as these projects require specialization across various electro-mechanical and civil systems. LTSAs between EPC contractors (buyers) and sellers (sub-vendors/consultants) are mutually beneficial for the reasons mentioned earlier. However, in the case of EPC contractors, the scope involves suppliers and services for both the bidding phase and the order execution of successful bids. LTSAs for EPC projects typically require some minimum commitments from the buyer to the seller in terms of the number of bids, scope details, etc., to ensure that the seller can maintain the necessary resources for quick deployment thus ensuring timelines. Many EPC contractors have entered into such LTSAs with sub-vendors for supplies and services like engineering and project management. In this case, the buyer is assured of pre-tender and post-order support, while the seller is guaranteed a steady work capacity through the LTSA.

A few observations on the subject:

• LTSAs are strategic alliances and generally emerge /evolve from good experience of earlier buyer /seller purchase orders. Some LTSA s (e.g. component supply) are signed based on bids from short listed sellers.
• LTSAs could lead to continued cost competitiveness and reduce lead times – this needs open
  exchange of information and ideas and the support and encouragement of senior managements of the buyer and seller.
• To realize the objectives of an LTSA, a minimum period of 3 years is generally the norm (with a provision to extend the duration).
• LTSA, lay down the price to be paid for supplies/services or the framework for the prices to be worked out for project specific orders.
• LTSAs incorporate all the normal contracting clauses (both technical and commercial). Individual Purchase orders are generally issued project wise with project specific conditions and prices derived for the LTSA.
• Even though LTSAs are long-term, it’s crucial to include provisions for exit or termination in case the business landscape changes, or unforeseen challenges arise. This ensures both parties can exit the agreement without significant risk or penalty.
• When a Long-Term Supply Agreement (LTSA) is executed for more than five years, it is essential to incorporate review mechanisms, either annually or bi-annually. These reviews help adjust for market fluctuations, inflation, and changes in business strategy, ensuring the agreement remains fair and aligned with evolving market conditions.
• In a long-term supply agreement, the delivery level formula specified in the contract is used to evaluate the supplier’s performance in fulfilling delivery commitments. This assessment may lead to potential penalties or incentives based on the achieved delivery level. The formula is as follows:

     Level of Delivery = ( Quantity Delivered / Annual Contract Quantity ) × 100

• This calculation considers all force majeure events and jurisdiction-specific restrictions applicable to the project.

LTSAs are extremely beneficial if the parties perform bearing in mind the primary objectives i.e. continued improvement in competitiveness. Management support and encouragement for open sharing of information is very essential. LTSAs for EPC projects is evolving and will be a market driven necessity in time to come.