Inside ODM contract service agreements
Shorter product lifecycles creating more losses for OEMs. Engineering change orders can define IP ownership. ODM vendor selection transparency is vital. IT integration can offer significant savings for OEMs.
Following a successful original design manufacturer on-site visit and the decision to engage an ODM, the next step executives must think about is drafting the legal agreement(s). Typically, when working with an electronics manufacturing services (EMS) provider, OEMs only need to put in place a manufacturing service level agreement. (See, also: “Choosing providers: EMS or ODM” and “Manufacturing service level agreement“)
The process of drafting and reviewing contracts with an ODM is no different than the process with an EMS provider. However, extra time should be allotted to cover negotiations for ODM design and customization plus, other related matters. (See, also: 59 Questions for OEMs to ask ODMs)
For OEM executives choosing to take an ODM-designed product (to, essentially, customize it under the OEM’s own brand) ODM contract service agreements need to include some key points of interest and terminology that cover OEM product design changes; IP ownership, manufacturing rights…
For large ODM programs, it would be wise to also allocate additional time for decisions requiring executives from both ODM and OEM companies to personally meet and finalize arrangements agreed upon.
It is vital to have these executive relationships in place for when OEM programs deviate from standard practice (e.g., requesting overtime during Chinese New Year whereas many ODMs factories are located in China and observe a week-long holiday) having access to / relationships with the most senior ODM executives can make a big difference.
“Whether working with an EMS provider or ODM organization, the convergence for these two types of service providers over the last couple of years – with both expanding their core disciplines and capabilities, reveal several similar characteristics to aid OEMs to achieve total landed cost objectives”, says Larry Schiro, vice president of supply base management with McAfee (www.mcafee.com), a Silicon Valley-based provider of antivirus software and intrusion prevention system solutions.
However, it is still imperative OEMs have the proper indemnification when working with an ODM since the final product will take on a substantial amount of original design by the ODM. Furthermore, IP laws differ from country to country and OEMs need to be aware of the laws in specific countries where its products will be sold to ensure the ODM has the proper IP protection in place for such countries. (See, also: “Liability and indemnity – contractual language” and “Foreign IP strategy for manufacturing executives“)
There are primarily four main segments included in either a single contractual agreement (or separate agreements) with an ODM:
- Design and development
- Final product
- Logistics and services
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ODM contractual terms in primary contract service agreements should be detailed but not product specific so that once agreement(s) are signed no further review will be required when product changes do occur over time. (Include product-specific details as attachments which can be reviewed separately.)
Contracting ODM design and development
Since the OEM’s product (finished goods inventory) will be based on the ODM’s design (and, most likely as each OEM will have his own modifications) OEMs need to pay extra attention to the development / engineering change process inside ODMs plus the IP assignment of finished products to avoid potential legal issues later on. Despite such challenges and risks, partnering with an ODM can expedite OEM supply chains and help drive costs down.
“OEMs must architect a supply chain design with their partners with full understating of all parties’ different, multi-polar strengths and always be adaptive to evolving changes”, adds Schiro. With this in mind, below are some key top-level items, or concerns, that should be on the minds of OEM executives and should be written into ODM contract agreements from a design and development perspective. Addressing each of these, and others listed in the paragraphs that follow, can be further emphasized in terms of emphasis within ODM contract agreement clauses and may include details such as frequency, actionable items, functional group stakeholders…
DM roadmap update transparency: This helps the ODM obtain and better understand the OEM’s future product requirements so the ODM’s roadmap can help minimize NRE (non-recurring engineering) charges to the OEM as time goes on.
Engineering design and review: This will help prevent any confusion or discrepancies that may arise between OEM and ODM engineering teams (or, at the least having something of this nature in place in contracts can help minimize the level of frequency of such occurrences).
Engineering change notifications (ECN) and engineering change orders (ECO): These two processes are put in place to clearly define ownership of the functions and between the ODM and OEM. (See, also: “Contract manufacturing risk mitigation and risk management“)
ODM ECO lead time: Cleary defining this process helps ensure the ODM implements OEM ECOs without delay while also meeting line-itemed OEM requirements when doing so. (See, also: “Product and component long lead time management reports“)
ODM supplier qualification process: For obvious concerns, OEMs have good reason to be interested in what takes place when the ODM qualifies a new component supplier or vendor. Transparency in this area will benefit all parties and help insure component or final product features; reliability, performance are not compromised. (See, also: “Electronics contract manufacturer supplier evaluation“)
Manufacturing and the ODM contractual agreement
Manufacturing with an ODM is very similar to working with an EMS provider. The following are some topic areas that require additional thought and clarification in ODM contract service agreements since components for the OEM product are often shared across a vast array of different customers served by the ODM, thus enabling the ODM to have flexibility in material planning and cost reductions. (See, also: “Supply chain management liability indicators and metrics“)
Explanations or additional reasoning is shared following each contract topic area, below:
Shared manufacturing information: The types of manufacturing information identified as available to be shared will influence the type of IT integration required. The right choices in this area will aid in better forecasting and manufacturing lead times.
Ownership of manufacturing rights of final products: OEMs need to ask for this in case the ODM decides to cancel its own roadmap, or should the OEM need to bring in another supplier to expand capacity to meet growing market demand.
Sharing cost reductions: Cost reductions can result from initiatives proposed by either the ODM or OEM. However, it’s not unreasonable for OEMs to expect continual cost reductions from their ODM partners. OEMs taking an active role in helping ODMs reduce product cost should expect the related savings to be shared by both parties. (Also, see: “Outsourcing cost reductions and benefits” and “Cost reductions“)
ECO phase-in / cut-in process: Make sure the ODM understands that you (OEM) want to take part in the decision-making process for ECO phase-ins or cut-ins. These are crucial periods for any supply chain segment and mistakes or errors can happen. You can never have too many eyes involved to make sure nothing is left to chance.
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Define epidemic failure: A clear definition is absolutely necessary. Epidemic failure definitions can vary from product to product. The process of handling epidemic failure should be clearly defined in the primary contract agreement.
Internationally recognized regulation compliance for environmental, material, labor…: Be specific. Avoid leaving any room for wide interpretation in these areas. Doing so is often the root cause of many product quality, reliability, compliance issues. (See, also: “Environmental compliance complicates electronics manufacturing configuration management“)
Material liability and inventory management: Shorter and shorter product lifecycles are creating more frequent instances for potential losses which can be monumental if not managed properly by both the ODM and OEM.
Holiday, overtime schedules: OEMs need to rest assured knowing the ODM has processes and procedures in place to handle work during holidays, and overtime in compliance with local labor laws, and in some instances, union laws. Contrary to what many believe, unions are gaining prominence in some geographies such as China where they did not even exist just a few years ago. (See, also: “The effects of China’s growing labor unions on your company“)
ODM final product contractual concerns
The portion of the ODM contract covering final product should, in most instance, only cover the generic terms that apply to the different products that might be designed and manufactured by the ODM.
Any product-specific terms should be listed separately as an attachment, thus, only the attachment can be easily updated from time-to-time without the need to change the language in the main agreement. Some critical topics for discussion to be included in the product section of ODM contract include:
- Intellectual property rights assignment detailing clear definitions of ownership of IP jointly developed (Also, see: “Lowering intellectual property (IP) risk when outsourcing manufacturing” and “Chinese intellectual property protection – interview with Hong Kong-based legal counsel Vivien Chan“)
- Product pricing and review which also should include any expectations of price reductions and how often such reductions are reviewed
- Finished goods or sub-assembly product which will be dependent on OEM business requirement combined with ODM capability
ODM contracts and logistics and services
Larger ODMs (see: Top 10 EMS / ODM) typically exhibit efficiencies and cost advantages that allow them to provide repair and reverse logistic services in addition to OEM product shipment. Depending on the ODM’s service and logistic capabilities, an OEM may leverage ODM’s services to gain additional cost saving. “OEMs can leverage capabilities for innovation and new product introduction while also developing value chains for reverse logistics”, says Schiro. Some OEM questions for considerations when drafting this portion of the ODM agreement may include:
- Does the final product requirement allow the ODM to provide such as a ‘finished’ good?
- What are the major geographical distribution channels for the product?
- Where are the ODM’s manufacturing sites located? What are product costs for each of these sites? (Knowing this information helps OEMs better understand the total landed cost as well as shipment time of the product per manufacturing major location)
- Does the ODM have the capabilities to support a virtual distribution / logistics hub nearby (or on-site) a chosen OEM’s hub?
- What are the price variances for ODM shipment costs compared to the OEM’s negotiated costs with major shipping companies?
- What is the ODM’s quality level for field service and support infrastructure and how is this quality level determined? Does the ODM offer reverse logistics and, if so, what are some of the requirements to obtain these services?
Total landed costs and the ODM
OEMs used to focus on BOM (bill of material) costs as a benefit to outsource, however, with recent advances in the capabilities of both ODM and EMS provider, some OEMs have started looking at product ‘landed cost’ as a true measurement of the real cost of their products.
In larger OEM organizations where engineering, manufacturing and services organizations have their own distinct cost centers, it would require special effort to integrate and analyze all of the numerous separate costs to develop the understanding of the true cost savings, and benefits, to the OEM’s bottom line.
IT integration is another area gaining more efficiency and noteworthy cost savings when OEMs work with an ODM.
Many larger ODMs have support for SAP and / or Oracle ERP systems, however, OEMs also need to find out whether there are other front-end and factory floor applications that may provide an OEM real-time data.
With short lifecycles and the fast pace of electronic product design and manufacture, having access to factory floor real-time data allows OEMs to react faster to the ups and downs of end-markets and ebbs and flows of customer demands.
Contractual legal agreements are a means to ensure both the OEM and the ODM have a common understanding and expectation of the processes that governs the business relationship.
Keep in mind it is difficult to put supply chain contracts agreement in place that cover every possible scenario. For product-specific program items, it is best to employ the use of separate contractual attachments / exhibits. Furthermore, drafting and reviewing these types of agreements takes time and resources, however, it is possible to streamline the process when OEMs assign experienced executives to help drive the process.
OEM and ODM program managers play key roles in the success of OEM product and on-going relationships.