"What strains OEM-CM relationships?"
It is not uncommon to see OEMs (original equipment manufacturers) and CMs (contract manufacturers) sitting across the table intensely solving problems and disagreeing on an approach - that is the nature of an outsourced manufacturing model. But, what is unfortunate is the number of back and forth bickering in which both sides spend an excessive amount of time with a win/lose approach, with no one to blame but themselves for failing to have the tough conversations early in the relationship. As we look back at our experience in the outsourced manufacturing model and search for the root causes of strained relationships, some themes begin to emerge which we would like to share with you in this newsletter.
1. Too much focus on bottom line price.
This is perhaps one of the most detrimental and naïve approaches to managing your contract manufacturer. Here, we are not talking about the focus on price instead of total landed cost – that is a whole separate issue which is not within the scope of our discussion. We are talking about a lack of understanding of the cost structure that is behind the quoted price. These prices have an entire cost model behind them, including the cost of materials, cost-of-acquisition (or material mark-up), labor, test, GS&A, and profit.
There are a whole host of mistakes that can be shielded by an attractive bottom line price, which is why you must ask to see a complete cost break down, including a costed BOM (bill of materials). Without it, you will have no idea of what assumptions went into the quoting process and will find yourself either paying a huge margin or constantly negotiating price adjustments. It is also critical for you to know what reasonable percentages, rates, and margins are suitable for your products based on the location of manufacture.
2. Minimal understanding of liabilities.
When you generate the forecast, how does your CM use it to pipeline material? Who is responsible for the material that is pipelined if your forecast drops or your product is prematurely obsoleted?
Liability disputes are generally the number one source of OEM-CM litigation in the electronics industry, as was evident from the industry meltdown of 2001. That is because few companies, OEM or CM, spend the necessary time understanding the process and expectations behind the forecasts and orders that are flowing back and forth in the supply chain. This breakdown also exposes component suppliers to undue risk when OEMs and CMs start pointing the finger of the blame at one another. Liabilities should be discussed before a crisis occurs and documented in a contract or material liability agreement.
3. Missed revenue shipments.
Everyone knows that forecasting is an art, and that demand fluctuates; there is no secret there. However, your supply chain's ability to respond to demand upside can make a significant impact on your revenues, time-to-market, and market share. Few OEMs truly understand how much real flexibility they have in at their CMs and component suppliers. We stress the words “real flexibility” because despite some upside percentages negotiated between an OEM and CM, there is rarely any “meat” behind those numbers in terms of inventory, business processes, and metrics.
If you are concerned about a spike in demand, look deep into the methodology that your contract manufacturer has employed to ensure that the appropriate manufacturing capacity and component supply has been allocated.4. Warranty service and the reverse supply chain.
Although warranty disputes are infrequent, when they happen, the magnitude of impact can be very significant, particularly in the event of epidemic or catastrophic failures. Misunderstood expectations can lead to significant financial exposure, especially in the case of small and medium size companies.
For example, what should the CM warrant in the event of a product failure? What responsibility should lie with the OEM and what should be the responsibility of component suppliers? Failure modes attributable to workmanship, components, or design flaws can lead to an entirely different set of expectations by each side.
The four problems noted above are only a small subset of what can go wrong but we see them as the main culprits in straining OEM-CM relationships. They usually arise when companies rush into doing business without enough discussion on tough issues upfront.
When operating under aggressive sourcing timelines, OEM companies tend to overlook the details and fail to document key operational terms, usually in the form of a contract, only to face surprises down the road. By then, there is financial exposure and one side must lose for the other to win, hardly a formula for a successful long-term relationship.
Symphony Consulting has significant experience in creating and negotiating contracts for OEMs and contract manufacturers. If you have any questions or feel that we can be of service, please contact us at info@symphonyconsult.com or call (650) 948-3909.