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Nine key points help OEMs negotiate better contract service agreements with EMS providers

By Steven Linahan

Inside of EMS factory.There is an old saying, you win business on price and lose it on service.

However, service is more often than not an amalgam of several focus areas used to describe anything that does not have clear expectations and deliverables which should be stated in the EMS provider services agreement.

I strongly recommend that when OEM executives are evaluating and searching for EMS providers, a simple statement of contractual business T&C’s be included in the request for quote (RFQ) package.

These should be agreed to at the beginning stages before anyone signs anything – and everyone is still keenly motivated.

See, also:
Search EMS Resources Directory
Checklist for evaluating EMS providers
59 Questions for OEMs to ask ODMs

 

Price rates
Surprisingly, this basic element from any customer’s agreements is often omitted or left as TBD. Service providers aren’t going to fill this in later.

Many OEMs believe that they establish a price based on a quote and assume subsequent quotes will follow in the same manner. Wrong. State your cost formula and fill in the rates.

The following is a typical formula:

[(Material + Mark up) + (Labor rate + Mark up)] x SG&A x Profit % rate

An even simpler version:

X% over BOM

See, also:
Outsourcing Calculator for OEMs
Ways OEMs can reduce EMS pricing

 

Quite often, EMS providers will tell you about their elaborate systems, and EMS cost v. OEM price methods or activity-based costing… I’ve heard them all.

Just fill in a simple table and spell out the simple rates that you will be charged for labor by function, over head rates, SG&A and profit and know what is rolled into each. The only variables should be time and quality yield rates, which should be stated by you.

Quality yields should be managed with metrics and actions holding EMS providers accountable for meeting goals. (Specify rework and prototype rates)

Out of scope charges
List any out of scope charges you will pay for. Clearly state that any other charges and fees that are not specifically allowed for in the OEM-EMS provider service agreement are not allowed. OT should be stated as being the responsibility of the supplier to meet delivery dates.

 

‘EMS providers live and die by purchase price variances (PPV). There is great visibility in managing their top 70% of spend to generate PPV.’

 

Cost reduction expectations
No buyer should ever omit this. Doing so leaves the objective completely open ended. Depending on your business this is a reduction in BOM and MVA stated in monthly, quarterly or yearly rates. This is obviously for the controllable portion of the BOM. Don’t fall for the blah, blah, blah corporate buying leverage and commodity management story.

EMS providers live and die by purchase price variances (PPV). As a company, there is great visibility in managing their top 70% of spend to generate PPV.

 

Nine Key point help OEMs negotiate better contract services agreements with EMS Providers

 

This is [actually] good if you are in that top spend as it creates opportunity to get some of this PPV back. But, odds are you may only have one or two parts in their company PPV wheelhouse.

This leaves you with a little bit of nothing, or perhaps the annual EMS providers’ supplier commodity re-negotiation.

Without a specific reduction goal committed, your EMS provider is not going to work to generate those reductions (except annually).

Material liability
How are materials purchased? Are materials purchased against the PO? By forecast? If by forecast, what is the extent of the purchasing window?

This looms larger than you think considering the counterintuitive effort on inventory turns by EMS providers.

EMS providers buy common and unique parts to MRP windows but unless you state you have a right to review and challenge their item master data for lot size and lead times, and unless you insist on controlling A class and super A class parts purchase windows, and signing off on all non-cancellable and non-returnable (NCNR) and customs that are not returnable, don’t be alarmed when find yourself with a big liability in play without a lot of recourse. (See, also: 80 Metrics to focus EMS provider materials management and increase EMS profits)

Insist that all items not signed off and accepted as NCNR are 100% returnable with no penalty.

Sometimes there is a tradeoff in supplier selection for flexibility. You do have a say in sourcing because it is your liability they are deciding for you.

 

‘The fastest way to get a delivery is to cancel an order.’

 

Warranty terms
Its important to note that most EMS providers offer a pass though component warranty of the supplier’s and warrant only the manufacturing labor. However, my opinion is this isn’t always the practice as it is intended more for catastrophic component failures and in cases where the customer is high maintenance.

Mostly, though, it is important to know where your product will be serviced: US, Asia, Europe? Is the factory facility funded by the supplier? Do you have to ship products internationally for service?

State that you need a factory repair facility located where you do business.

Allowable scheduling changes
The fastest way to get a delivery is to cancel an order. This is closer to truth than what we think at times.

Articulate what you need in both upside and downside flexibility and what level of premium or penalty you will absorb.

Normally, I discourage any change inside factory shop windows, and transit. Outside of this it varies by your business type and your business objectives.

I have seen everything, and anything, go since this is completely open to negotiation but this should be in logical and large-sized windows — through the component buying window — such as:

  • 1 to 2 weeks = zero change
  • 3 to 6 weeks = 50% change
  • > 6 weeks = unlimited change with no premium or penalties

 

On time delivery
This seems logical. But, it is surprising how many EMS providers behave seemingly without a sense of urgency at times and what is acceptable to one person is a miserable failure to others.

Suppliers should be held accountable for commercially reasonable investment in overtime and premiums associated with expediting to meet scheduled deliveries, and to expedite those materials to meet those deliveries. Insist on commercially reasonable efforts by your EMS provider to meet delivery dates.

Quality expectations
Same as above, this would seem logical in that EMS providers want to drive toward perfect factory yields as doing so makes them more efficient. With little resources to spare, most of the time you get what you ask for.

If you expect low field failures and high factory yields, clearly state these in your supplier service agreement. State exactly what detail yield and corrective action data is to be reported, and when. (See, also: Manufacturing alerts)

All EMS suppliers have the ability to track this data but it is a project to do so at your interest level. EMS providers work at a high-level pareto basis and many times you aren’t in their top 5. At all.

Some examples include field failure rate; return rate, re-repair rate, final QA, final Test, in-process test…

Have stated goals and manage these at your quarterly business review (QBR) meetings. Data should be only for your products (and by each of your assemblies), at each major process point.

Don’t get sucked into generic factory ‘peanut butter’ yield rates or generic rates across all your products. This does precious little to help you dig into defects, root cause and solve issues. Request corrective actions on each yield outside of your target yield range.

Management execution
‘How’ one manages these points after being included in your supply agreement is through QBR – not by pulling out the supply agreement. This is a professional, key management tool. Keep it accurate, factual and without surprises or emotion. Present all of your metrics on cost, quality, delivery, service and new products / technology in clear, concise terms as you have each these points now articulated in your supply agreement.

This should be measured against stated goals and presented by the supplier, with your summary and comments.

This is an executive-level meeting inviting the most senior level participants in both companies to participate.

The story goes that if you aren’t getting the proper level of attention, you just have to call a meeting where everyone’s boss attends.

Most teams will do everything they can to do well in these meetings plus, many suppliers will use your scorecard as the basis for customer service ratings which is then used to determine a portion of their compensation, so be careful how you wield this power.

Setting clear expectations grounds your expectation and commits the EMS provider to clear expectations internally with their functional groups. Measuring everyone by those commitments, allow both your company and the EMS provider the opportunity to be successful. (See, also: Top 5 mistakes OEMs make with EMS providers and How OEMs can build better EMS relationships)

Have experience with electronics providers you want to share? Add your review.
 

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  1. Ian
    Posted at 9:35 pm on February 14, 2014

    Steve – You indicate ‘Many OEMs believe that they establish a price based on a quote and assume subsequent quotes will follow in the same manner. Wrong. State your cost formula and fill in the rates.’ You then write:

    ‘The following is a typical formula:

    [(Material + Mark up) + (Labor rate + Mark up)] x SG&A x Profit % rate

    An even simpler version: X% over BOM’

    My question is should: X% over BOM really be:

    % Profit / BOM

  2. Steven Linahan

    Steven Linahan    
    Senior Consultant at Providence Partners
    Posted at 5:57 am on February 15, 2014

    Hello Ian,
    The BOM is simply the cost of materials. Labor and Overhead is not a part of BOM costs. Material margin maybe which depends upon the EMS providers formula. Profit does not include the labor and overhead thus a formula of % Profit/BOM would not include labor and overheads and possible SG&A…to be absolutely clear definition on terms used is probably required to determine where all the significant cost elements are captured…there are no free lunches as everyone knows, it is still a matter of understanding that all elements are capture so that there are no future surprises.

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