Understanding cost reductions for OEM outsourcing and the value EMS providers offer

Outsourcing cost reductions and benefits can be achieved with greater savings when OEM companies outsource manufacturing and other functions of their supply chain to contract manufacturers or, electronics manufacturing services (EMS) providers or original design manufacturers (ODM) offering a wider array of supply chain services. (See also, 'Defining a new value proposition for EMS providers and industry')

The figure below breaks down the outsourcing cost and savings analysis for an OEM outsource contract manufacturing program while also presenting the contract manufacturer’s cost of performing contract manufacturing and other supply chain management services for the OEM customer’s business.

Keep in mind, there are many criteria, or factors, executives evaluate when making their outsourcing decisions while evaluating and selecting contract manufacturing partners. (Cost reductions and cost savings are not the only criteria, nor are either of these two criteria always the most important)

The dotted-line, blue box (at left) surrounds primary cost components, or line-itemed costs of doing business, for an OEM manufacturing program being performed in-house. (This example is simplified although there are typically numerous more cost components)

To the right of each cost component is the cost of that pricing component as a value ($) relative to an equal percentage value for the total cost (value) of an OEM’s in-house manufacturing program. For example: materials account for $76 (or 76%) of a manufacturing product’s cost – where total cost per product unit is $100/unit (or, 100% of the product’s total cost).

Moving farther to the right are columns numbered one through seven with each column related to current costs or, where/how the OEM executive lowers his cost of doing business by taking advantage of various degrees of value-add associated with increased levels of outsourcing the OEM’s supply chain functions to contract manufacturers that are completely vertically integrated (based on identified value-add criteria and capabilities)

Contract manufacturing value add criteria and capabilities

Column 1
The contract manufacturer can pass on outsourcing cost reductions to the OEM because the contract manufacturer serves multiple OEM customers. This is true for most contract manufacturers. By serving multiple OEM customer and product programs, the contract manufacturer lowers his cost of doing business while, hopefully, increasing his capacity utilization rates across his facilities.

The contract manufacturer, in return, can pass along part of this savings to the OEM customer. In this example, the OEM’s product used to require a cost of $100 for the OEM to build each unit, internally. Here, the OEM now only pays $98 – for an incremental cost savings of 2%.

Column 2
The contract manufacturer can pass along additional outsourcing cost reductions to the OEM because the contract manufacturer provides services in less expensive geographies.

Labor and overhead drop in regions such as China, India and, many other areas across the globe (as compared to North America and part of Europe). However, freight is likely to increase because of shipping and supply chain distribution costs to get the completed product to the end-markets can be located away from the manufacturing destination

Column 3
Contract manufacturer can pass along additional outsourcing cost reductions to the OEM because the contract manufacturer offers design for manufacturing (DFM) services.

Design for manufacturing (DFM) services, more often than not, involve the contract manufacturer designing lower-costing components into the OEM’s product. In such instances, we see cost of material and overhead dropping. In some instances, designed-for-manufacturing product may also require fewer line employees to build a more efficiently engineered and manufactured product

Column 4
Contract manufacturer can pass along additional outsourcing cost reductions to the OEM because the contract manufacturer has optimized his logistics supply chain. Contract manufacturers with relations with local vendors providing quality materials are able to source from these vendors in the region and reduce costs for inbound materials (i.e., freight)

Column 5
Contract manufacturer can pass along additional outsourcing cost reductions to the OEM because the contract manufacturer has industrial parks.

Although an expensive proposition when initially building infrastructure -- contract manufacturers with industrial parks located across in certain regions of the globe have their vendors and suppliers ‘on-site’, within close proximity to the actual manufacturing facility.

This arrangement affords a host of benefits when suppliers are close together…such as walking across the street to talk with a sheet metal enclosure supplier instead of a long-distance call across time zones. Some of the regions across the globe attracting large industrial parks include China, Mexico, Brazil, Scotland, and India.

Column 6
Contract manufacturer can pass along additional outsourcing cost reductions to the OEM because the contract manufacturer is vertically integrated.

Vertical integration refers to the contract manufacturer dedicating (owning) its own sheet metal stamping or plastics mold injection facilities to provide for OEM customer product program needs. This allows the contract to also better-manage the flow of the materials supply.

Column 7
Contract manufacturer can pass along additional outsourcing cost reductions to the OEM because the contract manufacturer has achieved purchasing economies of scale.

As the contract manufacturer’s business and revenue grows and his customer base expands…contract manufacturer achieve greater ‘purchasing economies of scale’. (The idea with this and, with each of the above, is – as the contract manufacturer saves money and reduces costs running and managing his business, he can pass along some of the savings to his OEM customers).