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The electronics
contract manufacturing service agreement
is the most important part of the relationship between the electronics manufacturing
services (EMS) provider and the original equipment manufacturer (OEM). It
is not just an agreement between two parties. Outsourcing service agreements outline
what one party will 'give' in exchange for some sort of remittance provided by
the receiving party. The EMS provider is expected to provide goods or services
to the OEM, in exchange for some sort of compensation provided in return by the
OEM. Sprinkled in are rules of engagement that detail who; what, where, when,
and how much. EMS
providers are motivated to pursue formal contracts with their customers because
this re-assigns the risk to the customer (OEM) rather than the provider. Without
a contract, typically the customer is not held liable for its forecast, so all
purchasing or other spending that is done by the EMS provider is at the risk of
the provider, with limited reward. This is the primary reason why the EMS provider
pursues the contract more aggressively than most OEMs - because of the transfer
of risk in the relationship that comes with the contract. Meanwhile, the OEM is
interested in mitigating its supply chain exposure and risk. Most
providers are quick to establish and maintain contractual advantages Well-managed
EMS providers contribute significant internal forethought and discipline, focused
on determining the actual and anticipated 'costs' of doing business with a potential
OEM client program, well in advance of placing a contract service agreement in
front that potential OEM customer for signature. In
addition to factoring the provider's usual cost of doing business into a contract,
providers will also solicit input from various internal cross-functional groups
such as process and test engineering, production, program management, and finance;
to mention a few. Individuals from these departments often have first-hand knowledge
from either working with similar technologies or products within the provider
or, from experiences with positions held previously with other contract manufacturing
or OEM employers. This type of planning and input should not come as a surprise
because once such costs are determined the provider is then able to manage its
profit and margins more effectively. Contrary
to what some OEM executives believe, many OEM organizations that engage with an
electronics contract manufacturer do not invest nearly a sufficient amount of
time or resources when formulating and negotiating their contract service agreements. One
likely reason is that many OEMs do not understand how a sophisticated EMS business
model is run. Regardless
of the OEM's technology or marketplace, one can still hear many OEM board room
conversations referring to full service global contract manufacturing organizations
as 'board stuffers'. This mindset needs to change. When
OEMs are being madly driven toward an outsourcing endpoint against a tightly-managed
timeline or, more importantly, when they do not have enough internal outsourcing
depth and scope, it will always serve the OEM best to take the time and carefully
evaluate all phases associated with developing contract agreements. Every
supply chain director knows this. However, too few have the background or the
time to invest in order to execute successfully. Some might say an outsourcing
contract is typically only as good as the intentions of both parties who formulate
it. This can be taken further by stating the success of the relationship (for
both parties) is directly proportional to the amount of time invested and knowledge
applied before actual negotiations begin. Initial stages of contract negotiations
and the language of the service agreement are critical to the success of both
parties. Some key areas where OEMs typically do not place enough attention during
the contract development process include a common understanding between both parties
on the language of the contractual terms and conditions as well as cost reductions
and how they will be passed to the OEM. Once
a contract is signed, ideally it should be able to remain in a file cabinet with
only periodic reference to it. If either party finds itself frequently pulling
out the contract to review and contest terms and deliverables, it is likely the
relationship is on a slippery slope and the lawyers will soon be involved. This
is because one (or possibly both parties) did not perform due diligence beforehand.
Don't
get lost in the detail Providers
are here to provide services that fill a need in the marketplace. Regardless of
any previous or existing relationships the OEM may have with the provider, the
provider is in business to make money. In
most instances, unfortunately, OEMs feel they are getting a good deal as a contract
reaches the point of a mutual understanding. Except for the medical sector, most
OEMs tend to go for price only as the deciding factor when signing the dotted-line.
This myopic view often ends in a very short-term relationship because in many
instances, the EMS provider's price may be below cost and is not sustainable.
The reality is that the price per unit is important but it usually does not reflect
the cost of a dynamic business model (opportunity costs) and as such poor decisions
to engage are made daily which are in neither party's interest. At
the end of the day, providers will continue to present contracts to OEMs enabling
the provider to make a profit at the expense of the OEM. This is reasonable. The
provider wants to charge as much as possible while also convincing the OEM to
sign the contract. Conversely, the OEM wants to pay the provider as little without
the provider walking out on the deal. In some way, both parties want something
neither can have, simultaneously. What
happens in between determines how good the relationship will be.
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Mark Zetter is a renowned industry consultant and president of Venture
Outsource (San Jose).
For more: http://www.ventureoutsource.com Reprinted
with Permission | 
