The Top 10 Reasons why OEM/EMS relationships fail - Part 2

In part one of this article we discussed the historical development of the EMS industry and how that has contributed to some fairly broad discontentment on the part of both OEMs and EMS providers. All too often the promise of a synergistic, low cost model based on each partner focusing like a laser on its core competencies has failed to materialize. As with all partnerships that fail to live up to great expectations, each partner inevitably turns to the other partner with blame and accusations. The seeds of discontent slowly grow into a forest of resentment - leading many to the ultimate and generally wrong conclusion: "Everything will get better if I just get a new partner."

But getting a new partner only changes half of the equation and is not without its own set of risks... and then there is the cost. A recent analysis conducted by Riverwood Solutions showed the cost of moving a specific $50M/year piece of EMS business from one supplier to another was just over $4.2M or almost 8.5% of the annual program costs. Perhaps an even more interesting statistic here is that of the total cost of switching EMS suppliers, the OEM's cost accounting system recognized less than a fifth of that cost as product cost:

Cost of Switching EMS Provider as Accounted for by OEM

- COGS: $604K
- General & Administrative: $63K
- Overhead: $3,560K

This costly switching of suppliers was never captured as increased product cost as so many of the costs incurred do not directly role up under a product for most outsourced OEMs. So even thought the cost of switching EMS providers is very real, it is rarely capture in a single general ledger account titled "The Cost of Switching EMS providers."

With this example in mind, let us return to where we left off with #6 on our top ten list of why OEM/EMS relationships fail:

#6. Heroes and Scapegoat Herders.
All OEMs have some form of organization directly responsible for managing their EMS provider(s). These organizations range from an army of one, to vast cross-functional organization supporting every possible operations discipline. The main goal of these organizations is to manage and continuously improve the performance of their outsourced manufacturing partners. Except for the very large OEMS such as Dell, HP, Cisco etc., the OEM personnel in these roles generally must accomplish their objectives by wielding influence, persuasion and a bit of charisma rather than having any specific authority to make actual changes at the EMS provider. This situation where responsibility and authority are somewhat disparate often reveals two different behavior categories we refer to as Heroes and Scapegoat Herders. Both of these categories of professionals are on the front line of managing their company's EMS relationships, but tend to have different approaches and different levels of effectiveness.

Heroes. Generally speaking, Heroes like to be recognized. What better way to be recognized then by frequently doing something heroic?? Managing an EMS relationship for a Hero seems to involve developing less than robust processes and information channels that tend to keep the Hero - with his or her broad body of specific knowledge - at the center of the action in managing the EMS relationship. Keeping information tight to the vest, either by design of poor execution, means the performance of the EMS provider is highly dependent on the actions of the Hero. But when the Hero is personally required to marshal through the emergency ECO, to get those last 20 end-of-quarter units shipped, and to pull some parts out of thin air to fill a shortage - maybe the Hero is really part of the problem. All too often we have seen OEM Heroes leave for greener pastures and suddenly a long standing OEM/EMS relationship is on the rocks. If your outsourcing partnership is dependent on a Hero, chances are the tools, processes, data interchange and rules of engagement are inadequate and destined for failure.

Scapegoat Herders. This type of EMS relationship manager typically does not see his or her role as that of making their EMS provider successful, but rather one of ensuring that any and all failures can positively and unequivocally be blamed on the EMS provider's gross incompetence. The Scapegoat Herder rarely positively influences the performance of the EMS provider or the effectiveness of the OEM/EMS relationship, but they are fully equipped with detailed explanations of why performance is terrible and who within the EMS organization is to be blamed for the specific crisis du jour. As with most types of professional herders, the Scapegoat Herder believes that the answer to every problem can be found in greener pastures.

The Heroes and Scapegoat Herders phenomenon however, is not unique to OEMs. This same problem exists in reverse at EMS providers. We have seen many a satisfied OEM customer become almost immediately unhappy following the change of key account personnel at the EMS provider - and many an unhappy EMS customer has become delighted by a personnel change. People are critical to any partnership, but performance that is perfectly correlated to individual players is the sure sign of a weak process.

#5. The Grass is way Greener.
It's just not working out for you!! Your team is frustrated, your supplier quality and delivery metrics have flat-lined, and you hear tell of EMS suppliers that are giving away product for free and promising infinite upside with zero liability. It's time to check the market again. Your quote group sends out an RFQ to the same industry players you did not select the first time around. Your RFP briefly describes the deal highlighting the good and leaving out the bad. These prospective new suppliers, unencumbered by the details of the real situation such as 100% within month forecast volatility, 42 ECO's per week, and your in-house test engineering team led by Rube Goldberg.

The new green grass suppliers, all of whom know full well who your incumbent supplier is, have decided to provide you with a perfect scenario "budgetary quotation." Knowing full well that "budgetary" really means future pricing based on assumption that will never prove true, the new provider knows that best case they will get the business after slowly negotiating the price up, and worst case they get to cause their competitor a great deal of grief by providing a low ball quote based on nothing but rainbows and sunshine.

Before you pull the plug on your existing EMS relationship, make sure you understand the total cost of that decision and what has really motivated you to make it. There are many cases where the grass really is greener and its time to switch pastures. But keep in mind these two very real reasons why the grass may seem greener; (1) its an optical illusion caused by the sunshine and rainbows, or (2) the guy on the other side of the fence is slinging around a lot of "fertilizer".

#4. Baseline Pricing Models in a Non-baseline world.
Contrary to what many have come to believe, over 1/3rd of all OEM/EMS break ups are initiated by the EMS provider. Although there are numerous reasons why an EMS provider may choose to disengage with a particular OEM - 99% of those numerous reasons come down to account profitability in one form or another. Perhaps the most common cause of these EMS instigated divorces is the various types of "baseline pricing models".

These types of models - such as the fixed VAM on declining MCOGs model - serve as more of a perpetual disincentive to the EMS provider then as the strict cost control measure they were designed by the OEM to be. Overtime the EMS provider sees its minuscule 2% margin quickly erode to zero and beyond, the rate of erosion ironically driven by how well they have reduced the OEM's MCOGS over the preceding quarters. Soon a 9% mark-up on a $200 BOM becomes a 9% mark-up on a $160 BOM - but manufacturing improvements have not kept up with declines in purchased material cost leading to substantial losses for the EMS. Even when this type of model does not cause the EMS provider to seek a way out, it may cause the OEM to looks for greener pastures as the EMS starts to skimp on services and provides a "B Team" in an attempt to salvage some profit from the account. I recall vividly the COO of a large OEM bragging about how he had contractually engineered all of the profits out of his EMS contract... which turned out to be about 2 quarters before he was kicked out of his existing supplier on the eve of his company's largest ever new product launch.

If you've created an unprofitable model for your EMS provider, it is just a matter of time before one of the parties looks for the door.

#3. We've outgrown each other.
Although breaking up is hard to do, sometimes it is absolutely the right thing for one or more of the parties. OEMs often outgrow what we refer to as their "starter EMS" when product volumes or complexities reach levels originally only hoped for. On the other side of the table, EMS providers often modify their business models, choosing to focus on different industries, geographies, or average engagement size, requiring necessary customer portfolio adjustments.

These fundamental misalignments over time are a very natural occurrence - sometimes avoidable and sometimes not. But a thoughtful and honest approach to the process of selecting an EMS provider could potentially eliminate many of these unplanned break-ups.

#2. Optimizing the parts rather than the whole.
This problem can be driven by the OEM, the EMS provider, or some faction within both. For example the OEM's key executive says that product cost is the number one goal (sometimes goal number 2, 3 and 4 as well). Individuals within both organizations work aggressively to reduce product costs with a singular focus. EOQs are modified, schedule change flexibility is slowly reduced, ECOs are consolidated and only implemented weekly, low cost (and low capability) accessory/packaging suppliers are engaged. Product costs come down dramatically over three of four quarters, exceeding the aggressive goals set by the team. But product cost is not total cost!! Inventories are rising, E & O charges increasing; customer returns for small issues like accessory pack-out are on the rise. Lack of demand change flexibility causes the loss of a few customer orders for the OEM, reducing revenues, impacting margins and creating further cost pressures. Over time, the OEM forgets that cost was job 1, 2 and 3 and becomes frustrated with the lack of flexibility and responsiveness of the EMS provider. At this point the OEM starts looking for greener pastures and the situation becomes a fate accompli.

In the supply chain every dollar is created equal - whether it appears on the COGS line, in an overhead account, or in a potential OTC associated with switching manufacturing partners. OEMs must have someone in the organization that understands and monitors the supply chain performance holistically and can take responsibility for an end to end view of total supply chain cost.

#1. D-Day Disasters.
Although this is not the most common causes of failure in OEM/EMS relationships, it is one of the more spectacular failure modes to witness. Whether it is a botched quarter-end, a poorly executed new product introduction, a massive quality systems failure, or even the mishandling of key intellectual property - a D-Day event of spectacular enough proportion is rarely a recoverable event. Most of these catastrophic events are the result of some fundamental lack of process, management, systems or some combination thereof within the EMS provider. And although in an industry as big as the EMS industry a Black Swan may occasionally swim by - most D-day events are the painful manifestation of fairly simple and generally broad operational deficiencies.

To avoid a D-day disaster and the often resultant resume update that follows - create a system of Key Operational Indicators with your EMS provider and monitor them religiously. You don't need to wait for a spectacular crash to know that the train is coming off the tracks.

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