IDC on flawed EMS value propositions, OEM low-cost joker cards, spy games

The contract electronics manufacturing services (EMS) industry is crowded. Even as companies merge or are acquired, and some simply fade away, too much industry capacity remains while EMS companies are competing using the wrong message. However, companies can survive, and even do better. How is this so?

There's a disconnect between the way EMS companies market their services (and the manner in which OEM buyers perceive the value of EMS services) but, this is only part of the problem. OEMs must also trust their EMS partners. In taking a closer look at EMS-OEM relations, it seems OEMs don't trust EMS providers. At least not 100%.

VentureOutsource.com talks shop with Michael J. Palma, senior research analyst Electronics Manufacturing Services and Consumer Device Semiconductors for leading industry research and consulting firm IDC.

Michael's responsibilities at IDC include managing IDC's OEM Manufacturing Value Chain program where he closely evaluates strategic supply chain relationships between EMS / ODM providers and their OEM customers, and organization types, across the electronics supply chain...developing supply chain maps and insights.

Michael also manages IDC's Electronics Manufacturing Services (EMS) Forecaster product where his industry forecasting skills and analytical talent can be counted on to keep industry thought leaders up to date with innovative insight and analysis.

We asked Michael some tough questions. After reading his responses, we think you'll agree he offers fresh, and direct but honest and encouraging insight for re-thinking the structure of EMS-OEM relations and the nature of the industry.

Transcripts from that discussion follow ...

Join the discussion. Add your comments below.

VentureOutsource.com: Throughout most EMS-OEM engagements, OEM buyers (e.g., purchasing agents of EMS services and, electronics components) face OEM company mandates to get the lowest price they can find. This price-sensitive OEM decision process is often counter-productive to getting the best suited EMS provider for the OEM. Meanwhile, EMS providers support this OEM low-price / -cost mindset by branding and marketing their low-cost service destinations as being the answer to everything. What are you thoughts about OEMs shifting away from a low-cost mentality and, instead, demanding actual value created by the EMS provider that truly helps improve the OEM's business? What are some ways you feel OEMs can determine whether or not their current EMS provider IS creating value in the outsourcing relationship? What are some things EMS providers can do to explore ways they can improve the effectiveness of their marketing campaigns so such campaigns communicate real value to the OEM?

Palma: This is critical if current EMS firms expect to thrive five years from now because it has been my opinion for some time the value proposition for EMS firms has been a broken.

For most EMS firms, despite all the other language they use, the key message they communicate to customers, and what OEMs value the greatest in their relationship with EMS firms, is "we can reduce your costs."

EMS firms have bought into the OEMs' tactical focus on the lowest possible cost for discrete components and services. But, this perspective is, in the end, harmful for all parties involved.

Michael J. Palma Senior Research Analyst Electronics Manufacturing Services (EMS) & Consumer Device Semiconductor IDC

OEMs following the lowest cost strategy are missing all of the indirect and hidden costs to manage their outsourced processes and they ignore the total cost to produce and deliver a product to their customers. In the end, this near-sighted focus, which simplifies evaluating the purchasing function, can result in higher costs and other poor decisions that negatively impact their products and customers.

For EMS firms, the focus on cost reduction is, in reality, a race to bankruptcy or an invitation to be displaced by a competitor with a lower cost basis.  

Even worse for EMS firms, this focus on commodity pricing often means EMS firms cannot price their services appropriately.

Almost all leading EMS firms cannot achieve the cost of capital needed to invest in and support their operations.

The true nature of outsourcing is the transference of risk in the execution of a process from the client to their outsourcer. For the outsourcer, the proper pricing of EMS services (this assumption of risk) should carry a premium for the assumption of these risks, in addition to ongoing costs driving operations; so that total composition allows significant margins, when the outsourcer executes properly, that the outsourcer can recoup costs, fund continuing investments, and reap an appropriate profit, after repaying the capital outlay to build the service delivery infrastructure.  

However, another problem in the current market environment is that OEMs rarely transfer the full risk for operating their purchasing; logistics, design, manufacturing, and support processes to EMS partners.

This hedging shows either their reluctance to trust their partners or their short sightedness regarding how to engage with outsourcers and to manage their operations.

The result is the market is still too heavily engaged in contract manufacturing and not business process outsourcing.

OEMs' focus should be on how to best design, build, and deliver products. And be smart enough to tap into EMS firms' greatest asset, knowledge and experience in the execution of these functions. For at this stage, much of the knowledge resides in the EMS community as OEMs shed these skills and knowledge base long ago in the IT market.

My recommendation is that EMS firms should focus on their ability to improve their customer's business - essentially, focus on how they create value for the OEM.

Doing so can both provide a way to better price their services but also be a key disruption to EMS competitors who remained focus on low cost.

But this means changing their perspective from a supplier to an outsourcer.

Now, this may not be possible for EMS companies deep in survival mode. But any EMS firm that thinks it has a chance to emerge from this recession needs to consider this transformation in their value proposition.

For on the other side of this recession, if an organization cannot radically change the nature of their relationship with their clients and realign its compensation, they will eventually find it impossible to secure future investment and face bankruptcy or displacement, as mentioned above.

As for OEMs determining if their EMS partner is creating actual value, OEMs must look to peer benchmarks and their own previous performance.

Most importantly, OEMs can look to their success with their end-market customers and their total cost to deliver product to these customers. OEMs can also look at how their organization and processes have evolved and the role their EMS partner has played in this evolution.

OEMs should ask themselves: Has the EMS partner led initiatives to change how I do businesses or have they merely executed on the initiatives I laid out in the beginning of the contract?

Other areas to look at are time-to-market, product quality and return levels. Customer loyalty and satisfaction along with the cost to service customers are some further metrics to examine to see if the OEM's business has improved.

    

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