Outsource manufacturing contracts and cost reductions

By Mark Zetter

As the OEM and contract manufacturer relationship develops, both sides understand they need to make money and, more importantly, each party needs to be profitable while doing so.

It’s important the contract manufacturer is properly motivated to accept the OEM business opportunity and is encouraged to perform to commitments while building in quality to the product program being outsourced.

It’s not unreasonable for the contract manufacturer’s cost of doing business to be higher at the beginning of the OEM-contract manufacturer relationship. Afterward, as the contract manufacturer becomes more skilled and knowledgeable at managing the OEM product program, contract manufacturing management efficiency increases. Therefore, it’s not unreasonable to expect the contract manufacturer earns most of the cost savings early-on in the relationship.

How much should you pay for EMS services?

As the outsourcing relationship proceeds, it should be spelled out in the contract the contract manufacturer agrees to seek ways to reduce the cost of manufacturing the OEM’s products by methods such as elimination or replacing of certain components listed on the bill of materials, securing alternate sources for particular product materials based on leverage the contract manufacturer has in the global technology supply chain, and improving product assembly or test methods — among other objectives.

In exchange, it would be reasonable to expect the OEM customer will receive 100% of any cost reductions identified by OEM customer. These would be implemented and distributed at the next quarterly price update meeting between the contract manufacturer and the OEM.

Meanwhile, for cost reductions identified through the contract manufacturer’s internal efforts, these savings could likely be split between the contract manufacturer and the OEM: with 25% of the cost reductions, or savings, retained by the contract manufacturer for a period of, say, six months, and the remaining 75% of cost savings / reductions being applied directly to the OEM customer’s production cost by way of a quarterly price reduction.

Then, following the initial six month period for a ‘specific’ cost reduction, the OEM customer owns 100% of the cost savings.

OEM RFQ Terms & Strategy Clauses Presented to EMS Provider
OEM NRE & Purchase Price Variance Template for EMS Manufacturing
OEM Terms & Strategy for Program Transfer to EMS Factory
Contract Agreement for EMS Electronics Manufacturing Services (10 pages)
Contract Agreement for EMS Electronics Design Services (7 pages)
Contract Agreement for EMS Medical Device Design Services (7 pages)
Contract Agreement for EMS Medical Device Manufacturing Services (14 pages)

It’s also a good idea to get the contract manufacturer to agree to a cost savings or, cost reduction, target or percentage, on a quarter-by-quarter basis.

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