We are sending you this newsletter ahead of our normal schedule and in response to the inquiries that followed our previous newsletter published last month. It appears that OEMs are concerned, to say the least, about the repeat of the 2001 inventory woes that choked the supply chain and led to unprecedented write-downs. While no one currently knows the magnitude of the current downturn, most agree that the lessons of the technology meltdown of 2001 must not be forgotten.

With this in mind, we have come up with five important and immediate steps that you, the OEMs, must take to ensure your risks are properly managed and mitigated:

1. Refresh your forecasts and communicate them to your EMS – now! One of the biggest mistakes made in the prior downturn was that the first signs of decline were seen by OEMs in October of 2000, but not acted upon until January or February of 2001. Contract manufacturers were in the dark during this three to four month communication gap, continuing to drive the supply chain based on forecasts that were obsolete and far from reality. Ironically, it is October again, and operations organizations of OEMs are reacting to uncertain market conditions. We encourage you to resist the temptation of perfecting your forecast before you pass it on to your EMS. Everyone recognizes that the pendulum can swing either way but keep in mind that it is better to error on the side of caution. Your EMS will be more receptive to chasing demand with a positive attitude than canceling orders with a demoralized spirit. Keep your EMS providers regularly updated as demand fluctuates.
2. Validate lead-times and MOQ levels for high dollar components. One of the foundational elements of excess inventory is inflated lead-times and large minimum order quantities (MOQ). Work with your EMS provider and your strategic component suppliers to ensure that lead-times are accurate and that package multiples are reasonable. It might be prudent for you to pay a slight premium on price to receive a lower package multiple. This helps keep your excess inventory under control. You may find yourself in a position where you micromanage the activities of your EMS for a period of time until you are sure that your risks are being actively mitigated. If the decline is protracted as some economists expect, you want to be ahead of the curve in getting your EMS’ attention before the wave of risk mitigation activity begins.
3. Review existing excess inventory against “should be” levels. Most OEMs do not have a good grasp of how much excess inventory they have at their EMS and worse yet, an even larger percentage do not know their “should be” inventory level for components. Ask your EMS to provide you with an excess (and obsolete) report and describe to you the process for arriving at those numbers. Validate them on your own to ensure that your EMS a) ordered components in the right quantity and no sooner than the component lead-time, and b) executed cancellations without delay. You may need to step in and assist them in push-outs and cancellations of components with component suppliers in which you have a stronger relationship.
4. Re-calculate inventory buffers in the supply chain. Buffers are an effective shock absorber when you have unexpected spikes in demand, but they are often neglected when volumes go down. These include finished goods inventory (FGI) buffers at the product level, or subassembly and component buffers at your EMS, component suppliers, or distributors. Regardless of where the buffers are being held in your supply chain, you will need to modify them in response to changing supply and demand risks. For instance, you may have had a buffer in place at the product level because you regularly experienced significant upsides within lead-time. Or you may have created buffers in response to supply risks due to allocations. Today’s market volatility may have a direct impact on your assumptions.
5. Review your contract terms and modify them if needed. Your contracts will drive your EMS’ behavior in times of extreme conditions. We realize there are a lot of skeptics that say “no one looks at contracts after they are signed”. That may be true to some extent under steady state conditions but when an economic storm hits, the contracts come out of the drawers. EMS providers make reference to these contracts to determine not only what to do, but how aggressively to do it. Believe it or not, OEMs that have robust language on liabilities get the attention of the EMS’ resources far ahead of those that don’t. It behooves you to revisit and modify those terms if needed. If you don’t have a contract with your EMS, get one in place now, covering key operational issues for the time being. You can expand the language to include additional terms later as time permits.

The key to mitigating your risks amidst the current economic challenges is to make sure that you take proactive steps before it is too late. Failure to act now forces you into dealing with the aftermath, which will strain your relationship with your EMS providers and strategic component suppliers. Looking back at 2001, most companies knew of demand declines at least three to four months ahead of the time that they notified their EMS providers.

If you feel that we can help assess your risks and help you with mitigation strategies, or help you draft and negotiate robust contracts, please let us know. The OEM-EMS relationship is one of the cornerstones of our consulting practice.