Defining a new value proposition for EMS providers and industry

Companies are starting to talk about a post-recession environment and boom opportunity for electronics manufacturing services (EMS) firms. While I feel this is premature, one issue needs immediate attention. In "The Wrong Message: EMS Value Proposition Still Rooted in Cost Reduction", I advocate the fundamental problem with the EMS industry is the inability to effectively communicate its real value to OEMs, the transference of risk.

This inability to communicate such value plus continued focus on cost reduction has bogged EMS firms down with low margins, earning less than their cost of capital over the long-term. In this article, I articulate the value proposition I believe the EMS industry must adopt.

What should this value proposition encompass? Value propositions at most EMS firms focus on cost reduction; manufacturing, design, and customer focus. These elements are wrong. We have already discussed that cost reduction is the wrong message and manufacturing is redundant.

Design is important to OEMs, but the meaning of design varies.

In some cases, design is very limited to optimizing designs for various processes; in other engagements design refers to the entire product development process. Meanwhile, design is just one of many services provided.

Finally, there still remains much to be said about the relationship between OEMs and EMS providers. Focusing on the specific needs of OEM clients is required to move beyond basic contract manufacturing. But EMS firms need the trust of OEMs to be successful.

EMS firms work with the OEM's intellectual property (IP) and often enhance and sometimes even develop IP on behalf of OEMs. IP needs to flow freely between the OEM and the EMS firm if the relationship is going to prosper.

EMS firms also need to know the OEM's business strategy in order to best understand where and how they need to execute the OEM's strategy and also to understand where the EMS firm can possibly enhance this strategy. But OEMs are reluctant to openly discuss their complete product roadmaps with EMS providers and perhaps for good reason, EMS providers often build competing products for other OEM customers, often times in the same EMS factory, during the same shift.

OEM fears that EMS companies might leverage this competitive intelligence inherent in an OEM product's roadmap are not to be taken lightly by EMS firms and, they aren't. Yet, the burden of alleviating such fears in the OEM mind rests primarily with the EMS provider.

Figure 1 shows a sample of the services the industry provides. While EMS companies have had to develop deep expertise and knowledge in these services, many non-EMS service providers also offer competing services to OEMs. So, what is unique to the EMS industry?  The answer is a complete range of specific services provided by EMS firms that combine to form a full solution that simplifies the way OEMs manage their outsourcing partners.

Figure 1

OEMs also benefit from faster time-to-market by working with an EMS firm, leveraging their deep knowledge gained through managing the multiple processes tied to these solutions. Looking across all of these services, EMS firms also provide their complexity management skills to keep all the multi-step processes working seamlessly and successfully, for multiple clients, even with all of the potential pitfalls that can arise.  Therefore, process management expertise is another critical element.

EMS firms' most costly service to deliver to OEMs is variable manufacturing capacity.  EMS firms build, buy, and manage manufacturing capacity for their clients. The challenge comes from specific production lines certified for, and dedicated to, a limited range of products, usually for just one specific client.

One particularly expensive part of this challenge is the timing of variations with demand according to the unique characteristics of specific product segments, regions, and distribution channels for OEMs as utilization of the manufacturing capacity can fluctuate annually, quarterly, weekly, and daily.

Dynamics such as these can lead to inefficiencies and increased costs tied to maintaining the capacity, which cannot be offset by building ahead of demand because no one wants to assume inventory costs. The problem is worsened because the manufacturing capacity dedicated for each OEM program must be in excess of the EMS firm's average peak demand. One of the last things any EMS provider wants to do is limit production for their OEM partners, denying them the opportunity to capitalize on any short-term opportunities.

The end result is that EMS firms maintain this manufacturing capacity whose use varies greatly over time. Yet this is of great value to OEMs because they get the flexibility of highly scalable production levels without the cost associated with maintaining the capacity.

Given these elements, and remembering that I believe the true value of outsourcing is risk transference, I feel the core of the industry's value proposition needs to highlight the shifting of risk from the OEM to the EMS firm.

This new EMS value proposition also needs to focus on the value EMS firms generate for their clients. Doing so shifts the EMS-OEM conversation away from a defensive or reactive message of cost reduction toward a discourse with a more prospective, action-oriented nature of how the EMS firm will generate value for the OEM. Therefore, my model value proposition for the EMS industry runs something like this:

The EMS industry creates value for OEMs by taking on operational responsibilities from the OEM and executing comprehensive solutions, tailored to the unique needs of their OEM partners, that then helps OEMs deliver products to customers.  EMS firms' process management expertise allows OEMs to focus their resources on their core competencies and EMS firms' investments provide OEMs with the flexibility to respond to short-term opportunities. Through collaboration with EMS firms, OEMs reduce their exposure to risks and increase the velocity of their capital, while the knowledge and experience of EMS firms help OEMs thrive and grow to the next level of their success.

While this is not perfect, it hits on key areas where EMS firms do create real value and this should resonate with OEMs. More importantly, this new EMS value proposition changes the nature of the dialog between OEMs and EMS firms and can over time change OEM perceptions, which now are often that EMS firms offer commodity services.

However, executing complex processes, with little margin for error, to the specific criteria of each OEM client needs, fulfilling unique goals, strategies, and requirements is not a commodity. Perhaps this is why relationships between OEMs and EMS firms tend to be sticky. This value proposition should address this misperception and refocus the conversation, recognizing the true environment in how OEMs go-to-market.

Changing the perceptions of the OEM and refocusing the relationship based on this perspective, the balance of value is likely to improve between OEMs and EMS firms.

Figure 2 provides my view on the current balance and what should be the proper balance, along an equilibrium curve. Improving the balance in value each side receives from the relationship means EMS firms will improve their margins while still supporting OEMs' desires to reduce their costs. This will fuel continued investment in process technologies and further development on process expertise.

Figure 2

This process can also forestall emerging EMS market opportunities, where margins are currently higher than in other segments, becoming fixated on lower costs as the only value from engaging with EMS firms.

Adopting this strategy can further stave off competition from emerging EMS players who can offer lower cost offerings. Most importantly, if this transformation can take place, EMS firms may gain the freedom to truly manage their operations to achieve higher performance.

In what I call the Third Generation of Manufacturing Outsourcing, the OEM completely transfers risk to the EMS partner. OEMs will still manage the relationship, but fundamental business / operational responsibilities for the performance of the outsourced processes lie with the EMS partner. This includes the ability to optimize capacity to better meet the needs of clients and the EMS provider's own overall performance.

For OEMs, they're able to shift their purchasing and manufacturing strategies to better focus on the end goal of delivering products to customers at the highest margin possible.  More importantly, if EMS firms can indeed deliver on this next generation of outsourcing, OEMs can reduce their resources expended in managing their EMS partners with such resources refocused on demand management, understanding end-user requirements, technology and sales channel developments.

What's needed to implement this statement of value for the EMS industry? While this will vary as different EMS companies implement this strategy, primary actions by EMS companies should include:

• Adopting a more active perspective in their communications with OEMs, changing their own mindsets, as well as helping to educate, and change, those views commonly held by the OEM.
• Proving the value EMS firms generate with objective data, not only in their performance but also in the value of their operations to OEMs.
• Segment OEM customers within EMS portfolios to help focus efforts on building a new basis for partnership.

I will go into each of these items in more detail in a future article, but the key to this process is building deep trust between the EMS firm and the OEM. To achieve this trust, EMS firms must close the gap between the benefits they promise OEMs and what is actually delivered. This is why the new talking points must be backed up with objective proof. Until trust is achieved, the fundamental situation will not change.

For EMS firms, this means a continuation on their march toward bankruptcy and eventual replacement by emerging service providers.

For OEMs, their ability to fully outsource production and focus on their core competencies will remain limited.

Collectively, stagnancy in the EMS-OEM relationship will remain an impediment to achieving the next level of performance.

VentureOutsource.com, July 2009