OEM Supply chain and contractual strategies to reduce EMS provider pricing and sourcing costs

By Mark Zetter

OEM Supply chain and contractual strategies to reduce EMS provider pricing and sourcing costsIs investing in supplier development key to OEM success in the market and increasing supply chain performance? (Apple invested billions of dollars in the production of its LCD panel suppliers: LG, Sharp, and Toshiba) Or, can greater OEM reward be achieved through supply chain cost reductions with EMS providers and suppliers?

 

Can electronics OEMs lower outsource design and manufacturing costs through better EMS provider management? This question among others were explored during a number of conversations with Cuihong Li, Ph.D., assistant professor of operations and information management at the University of Connecticut’s school of business.

Dr. Li is actively involved in researching whether (and to what degree) dividing an OEM’s sourcing strategy into two discreet approaches (supplier development strategy and supplier contractual strategy) can considerably lower supply chain costs for OEMs.

Looking at these two approaches in more detail, Dr. Li considers cost reductions given to the OEM by ODMs and EMS providers / suppliers and, then she also evaluates in what ways OEMs can leverage known competition among EMS providers / suppliers competing for a particular OEM’s customer contracts with those outsourcing / supplier partners.

Supplier development v. cost reductions (contractual development)
The supplier development strategy platform determines the amount of resources (e.g., equipment) the OEM invests in each EMS provider’s / supplier’s operation to enhance delivery capabilities to / for the OEM.

The contracting strategy platform determines how the OEM should sequence over the time the price and investment decisions against the supplier’s cost reduction activities (e.g., guaranteeing the price and/or investment before the supplier engages in cost reduction effort, or vice versa).

Supplier development
Dr. Li cites Apple in an example of an OEM investing resources in its suppliers is Apple. Apple invested billions of dollars in the production of its LCD panel suppliers (LG, Sharp, and Toshiba) to help ensure ample supply for Apple’s end market /customers.

Our discussion thus turned to potential investments an OEM might make to enhance or improve the delivery capability of its suppliers.

For example, the OEM may investment in machines / equipment / tools for a supplier; investment in facilities for a supplier or investment in a supplier’s human resources (e.g., supplier worker training).

Cost reduction activities
In looking at opportunities for supplier cost reductions, we discussed production process improvement opportunities; improvement opportunities for manufacturing throughput yields, material cost reductions, logistics and so on.

Some of the potentially rewarding areas we discussed for OEMs to engage their EMS providers to then encourage them to locate internally for cost reductions and to then, hopefully, pass on EMS-internal cost reductions with the OEM (see, OEM Outsourcing Calculator to uncover savings) include:

  • Process technology (e.g., equipment, automation, production process, testing)
  • Sourcing (e.g., contract management, supplier relationship, logistics)
  • Production management (planning and control of material flows, quality management)
  • Facility (e.g., location, size, types)
  • Organization (e.g., decision making process, performance measures, incentives)
  • Human resources (e.g., skill levels, training, recruiting)

 

We then discussed some of the risks and concerns any supplier might face in taking on such cost reduction activities, plus whether such cost reduction activities internal the supply might (should?) rely on an OEM’s investment in enhancing a supplier’s deliver capabilities.

For instance, the supplier might engage in the determined cost reduction activities only after receiving the investment from the OEM. (For example, the supplier can work to improve the yield rate on a production line only after the production line, invested by the OEM, is set up.)

Or, perhaps the supplier implements the cost reduction activities before receiving the investment from the OEM. (For example, the supplier can search for lower-cost material sources before a production line or work cell invested in by the OEM is actually set up.)

We also discussed strategic moves (and related risks) by some OEMs that may motivate such cost reduction activities internal suppliers such as single-sourcing by the OEM where the OEM agrees to source all of its market demand from one supplier. Other strategic moves we discussed include pricing, quantity and investment, where:

  • Price commitment involves the OEM committing not to [re]negotiate the procurement price with a supplier based on the cost reduction outcome
  • Quantity commitment where the OEM commits to a minimum demand volume sourced from that supplier, and
  • Investment in the supplier where the OEM invests (or, commits to) a certain amount of resources in the supplier before the supplier engages in cost reduction activities


Contracting strategy (contract agreements)
Cost reductions derived from outsourcing contract negotiations can be achieved in a number of ways. They can be realized by commitment to pricing by the OEM (v. contingent pricing) where the OEM commits to a price (read: sets a target price) before the supplier cost reduction efforts is realized. Or, does the OEM negotiate the price contingent on the supplier cost reduction being achieved beforehand?

Where OEM investment in the supplier is agreed on, does the OEM first invest in the supplier, who subsequently engages in cost reduction activities? Or, does an OEM want to first observe the outcome of supplier cost reductions (perhaps based on pre-determined metrics) and then invest in the supplier?

 

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  1. Hong Kong
    Posted at 9:58 pm on September 5, 2011

    OEMs can lower costs in many different way, the problem is to analyze if the cost reduction is worth the effort, or indirect repercussions that such a cost reduction process initiated by the OEM might cause on the EMS’s cost structure.

    Some OEMs force the EMS to purchase material from specified suppliers, at a lower cost for the OEM, but doing so, might increase operational costs, and risks that the EMS might not have without such cost savings attempts.

    Depending on the industry and product type of the OEM, the cost reduction initiative will prove itself worthwhile or not. Just my 2 cetns

  2. Mark Zetter

    Mark Zetter    
    Silicon Valley | North America
    Posted at 12:08 pm on September 6, 2011

    Hello Hong Kong,

    You bring up a few good points.

    In many instances, with more of the supply chain being outsourced to the EMS provider than being in control by the OEM, the EMS provider tends to have more leverage across the extended supply chain and thus has the opportunity to push back on vendors for pricing concessions which translate to reduced ‘costs’ for the OEM (but, only if the EMS provider notifies the OEM and then decides to share his (EMS-internal) savings with the OEM (as lower pricing).

    You’re also correct about varying approaches for varying industry markets as some have greater supply chain costs built in (think: military, medical vs computing or server)

    All good considerations for OEMs. (And EMS/ODM companies)

    We’ve since added this discussion/article to our ‘OEM Outsourcing 101′ section (bottom of LEFT column) on the site, which contains other helpful/relative best practices and content for OEMs engaged in, or considering, outsourcing of their manufacturing supply chain operations.

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