“We need you to approve a price increase – our prices have gone up and we need to pass that on to you.” How many times have you heard this in your discussion with your contract manufacturer (CM)? Price increases are a reality that OEMs must face from time to time, but they become a bigger problem when the CM can not substantiate the increase in a manner that is understandable – and agreeable – by the OEM. The culprit here is the lack of transparency to the price structure used to manufacture products.

While it may be tempting to place the blame on the contract manufacturer, the reality is that most OEMs bring this on to themselves. In a mad scramble to respond to operational pressures and get a quote from a contract manufacturer, they look only at the bottom line product price – or a superficial breakdown at a very high level – rather than asking for an explanation of the cost structure. In our practice, we have found excessive focus on the bottom line price to be a risky approach that opens the door for surprises, conflicts, and strained relationships between an OEM and a CM. In other words, this final number is worthless unless you know what is behind it.

There are a number of variables that can make the pricing pendulum swing in one direction or another. Here are the three most common factors that lead to surprises in product price:

• AVL (Approved Vendor List) errors on the BOM (Bill of Materials): With tens or hundreds of components on a product’s BOM, it is unlikely that you will find no discrepancies or mistakes on the AVL. The mechanism for information exchange regarding the BOM is usually a PLM (product lifecycle management) software, a download from the MRP, or excel spreadsheets. Since OEMs and CMs are often on different tools, information accuracy often gets lost in the translation from one tool to another. Furthermore, the problem of AVL errors is exacerbated by the evolving portfolios of component suppliers.
  
  
• Component pricing dependencies: When component suppliers are quoted by your CM, you need to understand the underlying assumption for the component prices that are quoted to your CM. For example, who provided the quotation, the component manufacturer, a distributor, or a broker? Is the price stable and secured through a contractual agreement or is it a one-time quotation? Also, on what volume breaks and minimum order quantities were the component prices based? Unless you have granular visibility to how your BOM is quoted, you will face weekly, if not daily, purchase price variance (PPV) requests.
  
  
• Mark-ups, Labor, and Profit: Many contract manufacturers claim that their price structure is confidential. While this is a valid claim, it should not be used as an excuse to shield what is behind the quoted product price. We have often stated that an OEM-CM relationship should be not viewed as a traditional customer-supplier relationship. In fact, CMs want to be – and should be – treated as a partner and be viewed as an extension of the OEM’s manufacturing organization. This necessitates that they provide transparency and help outline risks associated with the price they are quoting you. At the same time, you should respect the confidentiality of the information they share with you and provide assurances that you will not disclose it to their competition or misuse the information. Also, don’t get fixated on picking away at their profits or gross margins. Like all other business entities, contract manufacturers exist to make a profit for their shareholders. If they are not financially healthy, you will be the first to feel the pain. Instead, try to understand the rationale behind their mark-ups, labor rates, assembly and test times, and other relevant cost drivers.

We can unequivocally say that you should walk away from a contract manufacturer that is not price-transparent and resists providing you with a break down of their cost structure. Lack of price transparency will mean one of three scenarios: (1) you will be bombarded with unfavorable PPV requests, (2) there is so much “fat” in your product’s mark-ups and margins that your CM can still be profitable despite all these variations, or (3) your CM doesn’t have a good grasp of its own cost structure.

With years of experience in manufacturing outsourcing and supply chain management, Symphony can provide you with the analytical know-how to achieve the right level of granularity, as well as industry benchmarks on key cost drivers. If you feel we can be of assistance, please contact us at info@symphonyconsult.com.