An LSA or Lot Sizing Agreement is a contract between a buyer and supplier that defines the terms for procuring goods over a certain period of time. An LSA aims to improve efficiency and lower costs by setting guidelines around order frequency, delivery lead times, pricing, and more. Let’s explore LSAs in more detail.
What are the key features of an LSA?
An LSA contract typically includes the following key components:
- Defined period of performance – The LSA will specify the duration it covers, such as 1 year.
- Product specifications – The LSA lists the items, materials, or product categories covered.
- Pricing terms – Pricing is established upfront for items covered by the LSA.
- Order frequency – The LSA defines how often orders can be placed, such as weekly or monthly.
- Order quantities – Minimum/maximum order sizes are outlined.
- Lead times – Supplier lead times for delivery are agreed upon.
- Inventory and stocking requirements – Minimum inventory levels may be required.
- Freight terms – Shipping related costs and responsibilities are defined.
- Reporting requirements – Data sharing expectations, such as on inventory levels.
- Termination provisions – Conditions under which either party can exit the LSA.
Defining these terms upfront creates a framework for streamlining procurements between the buyer and supplier.
What are the benefits of an LSA?
LSAs offer several notable benefits for buyers and suppliers:
For Buyers
- Cost savings – Set pricing can lead to volume discounts.
- Supply assurance – Securing supply availability for forecasted needs.
- Inventory reduction – Order frequency aligns with demand.
- Lower procurement costs – Reduces resources for repeated contract negotiations.
- Efficient ordering – Defines streamlined repeat order process.
For Suppliers
- Increased revenue – Guaranteed business over contract term.
- Operational efficiency – Enables production planning with demand visibility.
- Lower selling costs – Eliminates repetitive contract negotiations.
- Improved cash flow – Payment terms specified in LSA.
The results are win-win, with both parties benefiting from the LSA relationship.
When is an LSA contract appropriate to use?
Key situations where an LSA makes sense include:
- Ongoing supply needs – Steady or predictable demand is well-suited for LSA.
- High transaction volume – Reduces procurement costs for frequent purchases.
- Custom/complex items – Secures supply for specialized products.
- Leverage total spend – Optimizes large annual expenditure across categories.
- Capacity limitations – Ensures access to constrained supply.
An LSA is less applicable for one-time buys or highly fluctuating/uncertain demand. The contract aims for repeat procurement of known quantities.
What are the key elements in an LSA?
Let’s look at core LSA components in more detail:
Products/Materials
The LSA will specify product categories, SKUs, materials, or items covered. This could be broad (e.g. raw materials) or narrow (specific finished goods). Defining the scope provides clarity on what is being procured through the LSA.
Period of Performance
The contract duration sets the timeframe for LSA terms to apply. Typical periods are 12 months, 24 months, etc. Some LSAs include options to renew/extend. A defined duration enables planning around the LSA relationship.
Pricing Terms
Pricing in an LSA aims to provide savings over traditional spot buying. Discounts may apply for volume commitments or thresholds. Pricing structure options include:
- Firm fixed price – Set unit price for item(s) regardless of quantity.
- Tiered/step pricing – Price per unit decreases at defined order quantities.
- Index-based pricing – Price can fluctuate relative to an index like raw material costs.
Order Frequency/Size
The LSA defines the acceptable frequency and size of orders. Minimum or maximum order quantities may apply. Lead times for delivery are also established.
Inventory Stocking Requirements
Suppliers may need to maintain target inventory levels of items covered by the LSA. Safety stocks may be required to enable quick delivery. Buyers get visibility into inventory through periodic reporting.
Freight Terms
LSAs define freight-related responsibilities between buyer/supplier for terms like:
- FOB (Free On Board) Point
- Freight Cost Payment
- Logistics/Routing
Reporting Requirements
Data sharing provides visibility between buyer and supplier. Requirements may include:
- Inventory Levels
- Demand Forecasts
- Delivery Metrics
- Quality Issues
- Corrective Actions
Termination Provisions
The LSA will define conditions under which either party can exit the contract, such as:
- Breach of terms
- Failure to meet performance standards
- Change in financial condition
- Force majeure events
- Change in strategic needs
Well-defined termination clauses protect both parties’ interests in the LSA.
What are the steps in the LSA process?
A typical LSA process involves the following steps:
- Needs assessment – Determine suitability of an LSA based on spend analysis, demand patterns, etc.
- Supplier selection – Evaluate suppliers on capabilities, expertise, capacity, and value for items in scope.
- Negotiation – Discuss and define all LSA terms outlined in this article.
- Contract finalization – Formal sign-off on LSA by all parties.
- Implementation – Onboard suppliers, establish processes, and execute LSA.
- Governance – Manage relationship, monitor compliance, track savings, address issues jointly.
- Renewal review – Assess performance to consider extending/modifying LSA.
Careful upfront planning and continued engagement leads to successful LSA adoption.
What are some key LSA pitfalls to avoid?
When implementing an LSA, some potential pitfalls include:
- Using an LSA when demand is too variable vs. stable enough to commit volumes.
- Not defining products/volumes clearly enough or leaving too much flexibility.
- Selecting supplier(s) that lack capability or capacity to meet expectations.
- Inadequate data sharing and coordination post-contract.
- Letting alternative spot suppliers disrupt buying discipline from LSA.
Proactive LSA planning and governance helps circumvent these missteps.
What are some best practices for LSA success?
Some proven best practices that support effective LSA adoption include:
- Analyze 12-24 months of past spend and forecasted needs when shaping LSA.
- Reduce number of LSA suppliers to focus volume for maximum leverage.
- Centralize LSA ownership under procurement vs. individual departments going rogue.
- Use should-cost modelling to negotiate fair LSA pricing for both parties.
- Establish executive-level governance for LSA performance and issue resolution.
What are some key LSA metrics to track?
Metrics are critical for monitoring LSA effectiveness. Key examples include:
| Metric | Definition |
|---|---|
| Spend adherence | % of target spend going through LSA |
| Savings vs. benchmark | LSA spend vs. relevant benchmark (last year, market prices, should-cost) |
| Order cycle time | Average time from order to delivery |
| Perfect order % | % of orders delivered in full, on-time, and without defects |
| Inventory turns | How frequently inventory sells/replenishes in a period |
Tracking metrics identifies opportunities and ensures LSA goals stay on target.
What laws or regulations apply to LSAs?
LSAs, as contracts between businesses, are not directly governed by specific procurement laws, but general contract law applies. Relevant laws include:
- Common law – The basic principles of contract law developed through court rulings.
- Uniform Commercial Code (UCC) – Provides model laws around sales and commercial transactions adopted by states.
- State contract laws – Regulations within each state covering contracts between businesses.
Additionally, LSAs should adhere to applicable laws regarding fair competition without collusion between parties.
What are some examples of companies using LSAs?
Many companies across industries utilize LSAs to streamline procurement. Some examples include:
- Walmart – Retailer with LSA for plastic packaging materials from suppliers.
- Verizon – Telecom with multi-year LSA for network equipment purchases.
- Coca-Cola – Beverage company using LSA for canned product supplies from metal provider Ball Corp.
- Boeing – Aerospace firm with LSA for fasteners and other production components.
- U.S. Postal Service – Government agency with LSA for mail transport equipment and supplies.
Conclusion
LSAs provide a strategic approach for companies to optimize their procurement through contracted arrangements with suppliers. By defining product scope, costs, processes, and metrics upfront, LSAs enable streamlined purchasing with lower risks and costs. However, they require careful analysis and planning for successful execution. Companies that implement LSAs thoughtfully can realize significant savings and supply chain efficiencies over the contract period.
