Contents - AL-Tax

7.3 Value of Customer Relationships 1097.3.3 Established Customer RelationshipsRelationships with key customers are very important to disk drive suppliers andmagnetic disk suppliers alike. As Western Digital Corporation expresses it, “[o]urability to maintain strong relationships with our principal customers is essential toour future performance. If we lose a key customer [or] if any of our key customersreduce their orders of our products or require us to reduce our prices before we areable to reduce costs, ...thenouroperating results would likely be harmed.”To a significant extent, close customer relationships are a natural outgrowth oftechnical collaboration:[The] abilitytohaveour designteamsworkin...closeproximity toour customershas,inpart, facilitated the strong and collaborative customer relationships that we have establishedwith these large disk drive manufacturers. We devote significant time working with ourcustomers to produce disks that are highly specialized and customized for our customers’particular technological requirements, and these close relationships provide added insightinto our customers’ product and technology roadmaps. 11Long term contracts between suppliers and customers are the norm in both magneticdisk and disk drive markets. However, they are largely for the benefit of customers,as Seagate Technology observes in the following commentary:OEM customers typically enter into master purchase agreements with us. These agreementsprovide for pricing, volume discounts, order lead times, product support obligations andother terms and conditions. The term of these agreements is usually 12 to 36 months,although our product support obligations generally extend substantially beyond this period.These master agreements typically do not commit the customer to buy any minimum quantityof products, or create exclusive relationships. ...In addition, with limited lead time,customers may cancel or defer most purchase orders without significant penalty. Anticipatedorders from many of our customers have in the past failed to materialize or OEM deliveryschedules have been deferred or altered as a result of changes in their business needs.Correspondingly, independent magnetic disk suppliers generally have volumepurchase agreements with their major customers. However, as with disk drive suppliers’OEM customers, buyers of magnetic disks (disk drive suppliers) do not makebinding commitments through these vehicles, as previously noted, and are not penalizedfor the cancellation of orders.Therefore, while constituting a formidable entry barrier, established relationshipswith customers do not enable magnetic disk suppliers to earn above-normal rates ofreturn. More particularly: Established customer relationships do not enable magnetic disk suppliers to innovateless rapidly or to charge constant (or increasing) prices for their disks. Tothe contrary, as previously described, suppliers’ dependence on a small numberof customers that (a) have internal disk manufacturing capacity, (b) mustthemselves contend with steady declines in their disk drive selling prices, (c) are11 See Komag, Incorporated’s Form 10-K filing with the Securities and Exchange Commission,covering its 2006 taxable year.