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Accenture

Successful manufacturing outsourcing focuses on strategic outcomes that leverage thestrengths of each partner to achieve adaptability, product capability and cost performance.

In the last century, vertical manufacturing strategies were still the rule for manufacturers of high-technology electronics. In 1990, the global market was worth nearly $100 billion, while less than 5 percent of all manufacturing was outsourced. A tremendous surge in manufacturing outsourcing began in the mid-1990s and continued into the 2000s. During this time, a large number of high-technology OEMs (original equipment manufacturers) were revising their manufacturing strategies to take advantage of the wave of outsourcing alternatives available to them, to both improve performance and reduce asset and operations costs. OEM trends toward outsourcing continue to grow today.

In the economic downturn, high-technology companies were especially hard hit, which translated into a serious challenge for supply chain partners that had assumed greater responsibility for manufacturing. In many cases, these providers had acquired costly assets from the OEMs as part of the deal – assets that ended up underutilized in the softer economic environment. And while demand was slowing for end-item electronics, EMSs (electronic manufacturing services) and (ODMs) original design manufacturers were hard at work tailoring operations to improve performance, investing in infrastructure and building out services offerings to provide the OEMs with broader business solutions. In short, their attention was split between eroding endmarkets and managing in-house matters.

Today’s business climate marks an inflection point for both the OEM and EMS/ODM industries and their respective manufacturing strategies. For many OEMs, there’s no turning back from outsourcing decisions – the assets are gone and the core competencies are no longer in-house. While future success is determined more by the business strategy (products and services delivered, markets served), the manufacturing strategy is a key enabler of the business strategy. It should be focused on giving the OEM greater flexibility, improved cost-effectiveness, reduced cycle time, reduced time to market and sustained or higher quality. Achieving these objectives is incumbent upon both the OEM and its manufacturing outsourcing providers.

The Evolution of Outsourcing: From Transactional to Collaborative Partnerships

Outsourcing in the electronics industry has evolved dramatically since 1990. In its earliest and most basic form, the OEM’s make-versus-buy decisions were based largely on opportunities to reduce costs or meet specialized manufacturing needs. The outsource provider would take on manufacturing for specific products on a contract-bycontract basis. Through economies of scale across many such contracts, contract manufacturers were able to leverage operational expertise, lower-cost labor and buying power or some combination of these to lower the costs to the OEM.

More recently, OEMs have used outsourcing to quickly and costeffectively enter new markets. By teaming with an experienced partner, an OEM could significantly cut the time and cost involved in developing new products, such as Microsoft did in its launch of the Xbox.

Some OEMs found that a move toward more collaborative outsourcing arrangements could improve their planning accuracy and ability to respond more quickly to changing market conditions. By outsourcing manufacturing and some of their upstream supply chain activities, OEMs could free themselves to focus on their core competencies, tighten planning processes and be more responsive to customer demand. Instead of having to ramp up or down the workforce, or start and shut down operations, the OEM could simply adjust the fee structure of the outsourcing agreement.

Today’s partnerships reflect shared strategic risk. Partners now must work together to achieve strategic outcomes. Another is measurement. Performance is measured not just by cost savings, but also by revenue, earnings per share and market share. Finally, today’s outsourcing arrangements are highly dependent upon tight linkage between partners. The ability of the outsourcing relationship to become a logical enterprise in which all trading partners in the supply chain are virtually synchronized is critical to success.

Profile of a Changed Marketplace

Indeed, high-technology OEMs have benefited from their outsourcing relationships. However, the evolution from simple contract manufacturing to synchronized supply chains has substantially changed the structure, nature and purpose of the players in the industry. Working together, players on both sides of the relationship stand to benefit in the future by improving the way the supply chain operates today.

New Breed of Supply Chain Trading Partners

Over the past decade, the most visible changes have been the rise of the EMS and ODM industries (see Figure 1). As OEMs broadened the scope of activities they outsourced, contract manufacturers responded by complementing manufacturing with value-added services such as direct order fulfillment to the OEM’s customers and return and repair operations, thus transforming the industry from contract manufacturing to EMS. Also new breeds of outsourcing providers emerged – the original design manufacturers – to meet OEMs’ desire for products that leveraged the ODMs’ unique design capabilities, meaning that the OEM no longer had to maintain those specialized design capabilities in-house.

Disaggregated Supply Chain

Along with these developments, arguably because of them, the role of many OEMs has shrunk to providing four key elements – a recognized brand, product innovation, end-customer relationships and a sales channel. While this diminishing role has helped OEMs with their balance sheets, the cultural change also has made them nervous.

The lines between EMSs and ODMs will continue to blur for certain market segments (generally higher-volume products) as the providers expand both vertically and horizontally. But there are still key differences in what each has to offer. EMSs are unlikely to invest too heavily in design capabilities without either a contract or other agreement with their OEM customers. And while expanding into more market segments, ODMs will remain focused on a core set of products, thus allowing them to specialize in manufacturing for those segments. That being said, both are adding new capabilities and moving into new business markets, and each group has acted in its own way on aspirations of moving beyond low-cost supplier status to become major industry players.

This is seen in private-label products from ODMs that are making their way into Russia, China and Southeast Asia, where global brands have relatively little marketing clout. Acer, an ODM of notebook computers for several OEMs, also manufactures computers under its own brand name and has established brand presence in several markets. Such action will put ODMs in a position of virtual competition with their OEM customers. In some cases, the OEM either accepts or willingly relinquishes the market to the ODM as a way to keep the ODM/OEM relationship on stable footing. In other cases, the OEM has knowingly left low-margin markets to the ODM, realizing that some ODM competition is inevitable, and that such markets offer little potential for the OEM.

Ultimately, there are and will continue to be inevitable conflicts over customers and channels. Today, OEMs generally feel that they own both the channel and the customer relationships. But the EMSs and ODMs could argue that they might be better equipped to meet customers’ needs if the OEM would give them unfettered access to customer input, something that an OEM is unlikely to do, as it would relinquish control and increase the risk of becoming obsolete.

Interestingly, the maturation of EMSs and ODMs risks the erosion of one of the principal characteristics that made them attractive to OEMs in the first place: operational efficiencies. EMSs and ODMs risk losing leanness by adding capabilities and services, and their resulting economics would come to resemble those of OEMs, but without brand identity, blurring the lines between them and their customers even further.

Making the Most of Your Outsourcing Arrangement

As outsourcing arrangements have grown more complex, OEMs, EMSs and ODMs alike must work harder to promote the success of the arrangement. The following should be addressed by partners on both sides of the deal to increase individual performance:

1. Make dealing with inefficiencies your problem, not someone else’s. Efficiency is the core objective of outsourcing and requires collaboration. Therefore, all parties must be vigilant about rooting out and eliminating inefficient practices that could limit the benefits of the arrangement.
2. Clarify the division of responsibility between the OEM and the EMS early and play to each other’s strengths. Don’t assume that the other party will know what you’re thinking, or that your partner will be handling a specific activity. Explicitly spell out roles and responsibilities, in writing, at the beginning of the agreement and update the working arrangement periodically by sharing responsibility for continuous improvement.
3. During negotiations, make sure all parties stand to be profitable. Think win-win, not we win. While outsourcers earn their living by building products better, faster and less expensively, they still need margins to survive. OEMs must not squeeze their partner to the point at which they’re making it too difficult for the arrangement to be a solid business proposition. On the other side, EMSs and ODMs must remember that cost is a principal driver of the arrangement, and therefore must ensure that in their drive to make a profit, they don’t negate one of their most significant value propositions.
4. Create objectives for continuous improvement and remember to monitor them over time. In today’s dynamic environment, conditions can change at a moment’s notice. By working together to continually monitor the operation and identify ways to improve it, all parties can help ensure that the relationship is still meeting the market’s needs while optimizing the relationship’s overall performance.
5. Manage results – don’t just monitor them. Bake continuous improvement incentives into outsourcing arrangements. Waiting for the manufacturing outsourcer to deliver results to key metrics without active participation from the OEM leads to suboptimal results when measured across the overall supply chain. Make their metrics your business, and vice versa.
6. Avoid micromanaging the supply chain ecosystem. Instead, leverage your business partners’ strengths and economies. Many OEMs are reluctant to give up control that they have had for decades, for reasons generally involving mistrust, corporate culture or company pride. Embrace the fact that manufacturing outsourcing entails giving up some control, ensure that your provider understands your company’s key concerns and implement processes that allow them flexibility to leverage their scale while operating within a framework that supports your key objectives.
7. Ensure agreement on internal and external performance metrics. The collaborative nature of today’s outsourcing arrangements requires concurrence on how the relationship’s performance will be measured and evaluated. One simple example could be the metric of on-time delivery. If the OEM defines on-time delivery as the shipment arriving at its dock when promised, but the EMS defines it as when the delivery was shipped from its facility, the performance of the arrangement may be compromised.

OEMs

Aside from addressing the issues of mutual concern, there are a number of important considerations for OEMs individually, as well as several crucial steps that they must take on their own to maximize the benefits of their outsourcing arrangement.

For starters, OEMs must understand the strategic implications of outsourcing. It’s critical for an OEM to confirm how outsourcing fits within the context of its various strategies and amend them to accommodate tighter working relationships with partners. Two strategies of particular concern are product and manufacturing. The product strategy comes first. It defines three elements: the items a company manufactures to promote its market identity; how these products support the company’s overall value proposition to customers; and most importantly, order-winning characteristics of these products. Next is the manufacturing strategy that defines how the product strategy will be achieved.

OEMs should also use outsourcing as an opportunity to divest themselves of any assets and functions that are not core to their value delivery. Working with manufacturing providers, OEMs should focus on the efficiencies enabled by the new arrangement, ensuring that they don’t create more work and bureaucracy (and, therefore, headcount), and that each one will be positioned for success from organization, technology and process standpoints.

Bargaining power is shifting, and EMS asset acquisitions will be less prevalent in the future than they were in the past. When they do occur, they’ll be based as much on the EMS’s strategic interest in acquiring capabilities as on the OEM’s desire to unload the assets. In the past, large outsourcing contracts often included the transfer of a vast number of assets from the OEM to the EMS. Going forward, EMSs will be far more particular about acquiring assets from OEMs as a requirement of doing business, positioning instead for moving product to lower-cost areas of the world where they have specific manufacturing capabilities. EMSs are better able, and much more likely, to offer better terms to OEM customers when products move into existing infrastructure, or when they’re able to move products throughout their own organization.

OEMs must recognize that the sum of all manufacturingsourcing decisions is greater than each individual part. When considering outsourcing, an OEM shouldn’t be content with achieving only manufacturing efficiencies. In fact, cost reduction is just a starting point. Before outsourcing, an OEM must consider how it will scale effective outsourcing arrangements into larger, more collaborative processes that can maximize total economic yield, as measured in terms of shareholder value. Strategic, operational and financial views of the deal should be integrated together into a common business case that also includes unique scenarios for changing business conditions.

Furthermore, the OEM should also identify how the business will collaborate with a broader range of partners to integrate new, innovative capabilities into the business. Such a hybrid model can boost margins by enabling OEMs to bundle strong products with service offerings that increases the value proposition to the customer. The goal is for each party to focus on and exploit core competencies, avoid cannibalizing the other and seek to eliminate redundancy. Such relationships provide huge competitive advantages because they effectively squeeze out smaller, niche companies that can’t match their scale. Ultimately, possessing and exploiting a few exceptional (differentiating) capabilities will be far more advantageous than having many standard ones.

Finally, OEMs should address head on the organizational ramifications of moving to an outsourced manufacturing strategy by considering creating the position of vice president of extended supply chain. Many OEMs have already seen the benefits of such a shift internally, including not only standardizing business processes, but also having a change agent at the executive level who can promote a common interface with manufacturing outsourcers and negotiate tough but fair contracts with supply chain partners. In migrating from internal to extended supply chains, an OEM will take on considerable complexity that it never had to deal with before, and, as a result, will have to become even better at supply chain management.

EMSs/ODMs

There are also considerations for the EMSs and ODMs, as well as key issues that should be addressed to help ensure they are providing the most value to their clients while maximizing their own profits.

Clearly, collaboration is not a one-size-fits-all proposition. Appropriate degrees of collaboration will vary depending on a number of factors including product complexity, demand variability, degree of engineering change, complementary service offerings provided by the outsourcing partner, order-fulfillment requirements and cycle times. There’s a huge difference in collaboration requirements between simple outsourcing of PCBs and the outsourcing of manufacturing and systems integration with a direct fulfillment model for configure-to-order systems.

They must exploit capabilities beyond manufacturing for higher margins and increased use of capacity. EMSs and ODMs can no longer get by as low-cost labor shops. New product introduction and product life cycle management offerings are vital to OEMs. In fact, their use directly correlates with success in the marketplace. Such offerings also help the manufacturer, whether EMS or ODM, to increase existing asset utilization rather than take on the additional cost and risk of acquiring new assets. For complex products, EMSs and ODMs should provide direct-order fulfillment, assembly, test and systems integration.

EMSs and ODMs must manufacture globally and integrate locally. This is especially true for the largest EMSs. Those that optimize globally to take advantage of the lowest-cost manufacturing markets, assert stronger buying power and increase localized integration with OEM customers will outperform their competition.

Manufacturing outsourcing is not about handing off manufacturing responsibility and underperforming assets to reap cost improvement gains. More than ever, such outsourcing relationships should be focused on strategic outcomes that will enhance the supply chain and promote the business objectives of the OEM. It’s incumbent upon both parties to forge relationships leveraging the strengths of each, striving toward process and technology integration and shared perceptions of success. Such collaborative relationships, when focused on adaptability, product capability and, of course, cost performance have a much better chance at succeeding in changing business conditions throughout the product life cycle than the more typical outsourcing arrangements have been able to deliver.