By Quentin Samelson, Sr. Managing Consultant, IBM Consulting
A few months ago I was asked what “good” looks like for an OEM using EMS providers to manufacture its products. What are the best policies and practices that that customer should put in place to ensure not only that their supply chain was efficient and effective, but that the relationship with their outside manufacturers was successful?
I have some knowledge of my own in this area: I’ve worked on both sides of the relationship – both at companies that manufactured products for OEM customers, and at OEMs that utilized outside manufacturers. But I discovered that while it is relatively easy to find recommendations on how to select an EMS provider; there isn’t much information available on how to be an effective consumer of EMS services.
To some extent, that’s understandable. Once an OEM has engaged with an EMS, it can be hard to disentangle the relationship, so the initial selection process is highly important. The OEM should not only look at the EMS company, but also at the specific facility that will be manufacturing their product. A friend of mine in the EMS business pointed out that “if a medical OEM has FDA Class 2 products to outsource, they need an EMS supplier that is expert in Class 2 medical products. They shouldn’t even consider a Class 1 Medical EMS.” Similarly, you don’t want to build computer servers (low volume, physically large, usually requiring extensive configuration and burn-in after assembly) in a cell phone factory (high volume, small, quickly configured and tested, packed and shipped) – or vice versa. OEMs should generally choose manufacturing partners whose business profile aligns well with their product mix, volume, and industry requirements.
Additionally, OEMs should consider more than just the quoted price when evaluating EMS providers – delivery times and flexibility, technical capabilities and quality performance all will have an impact on total cost of their products, and the success of this critically important relationship.
Assuming that an OEM has made a good initial selection of a manufacturing partner, what can it do to ensure that its use of an EMS provider will be successful over the long run?
Probably the most important requirement for the OEM is to “know yourself” – understand your own company’s strengths, weaknesses, policies, and attitudes. Not only do you need to consider those in your relationship with an EMS provider, but some of them need to be disclosed to the EMS as well. Beyond that bit of foundational advice, though, I would like to propose a set of principles and capabilities that are essential to the OEM using a contract manufacturer.
Basic Principles of Outsourcing
- Understand that your EMS partner needs to make a profit. It may feel like a ‘win’ to work the contract manufacturer’s profit down to zero, but ultimately that won’t benefit the OEM.
- You and your EMS view and understand risk differently. Some of that risk can be managed contractually, but sometimes it is more effective to find a way for the OEM to take on risk that the EMS is unwilling and unable to shoulder. (A frequent example is with long-term component supplier commitments.)
- The OEM-EMS relationship relies on, and should consider, the component suppliers as well. This especially applies to those suppliers with a strong strategic relationship to the OEM; but the most prominent issues are often tactical – when the OEM expects flexibility from the EMS but the commitments from the component supplier(s) won’t support that.
- Although the EMS is focused on manufacturing, as well as building and maintaining the supply chain to support the manufacturing process, that doesn’t mean that they do everything better than the OEM. Continue to monitor actual production at the EMS and stay alert to any difficulties or disruptions.
Overall, the best performance will result from leveraging the Supply Chain knowledge, experience and talent that exists in both companies. Don’t abdicate responsibility; rather, assign responsibilities and tasks where they are most likely to succeed.
Remember that adding a contract manufacturer introduces delay into the supply chain and a certain level of additional noise into the demand data that the component suppliers receive. The bullwhip effect is real; visibility to total system inventory versus demand, and the ability to take action when things get out of balance, can be critical to avoid surprises and big issues.
Managing Disconnects Between Forecast and Demand
Perhaps the most critical for the overall success of the relationship is finding a solution to the (frequent) disconnect between the OEM’s product forecast and the demand that they pass along to the EMS provider, and the EMS’s parts requirements passed on to component suppliers.
This involves the OEM’s expectations for flexibility and the amount of inventory exposure that the EMS can take. If the OEM’s product forecast is in the range of 10,000 to 15,000 per month but they only pass demand for 10,000/month on to the EMS, the two parties need to consider the likelihood of a sudden increase in demand and develop a strategy to obtain enough materials (as well as the additional production capacity at the EMS) to achieve a significantly higher throughput. Solutions like back-up inventory held at a distributor (or at the OEM), and strong relationships with component suppliers can greatly mitigate these issues when they occur – but they need to be put in place early. (I’ve seen the opposite as well – where the OEM provides a steady forecast of 1000 per week but only accepts 500 to 800, and inventory begins to stack up.)
A Joint Sales & Operations Planning process between the OEM and the EMS can go a long way.
Automated, regular and frequent communication of Demand/ Requirements data from the OEM to the EMS provider is crucial; and the OEM’s demand statement should be incorporated in the EMS’s ERP system quickly and automatically. The OEM’s demand statement should be incorporated in the EMS’s ERP system quickly and automatically. Also important: the OEM should define what their demand data means. Quantities and dates can mean anything from un-committed forecast to hard demand expected by that date, and everything in between.
Timely updates from the EMS to the component suppliers are also necessary (so that the OEM’s demand changes are reflected quickly in the demand forecasts that the EMS provides to the component suppliers). The more the EMS can eliminate the lag between the OEM’s demand updates, and the EMS’s updated demand forecasts, the less the two parties will have to worry about the bullwhip effect.
Avoiding the Bullwhip Effect
If the bullwhip effect can’t be eliminated by keeping the demand planning lag to a minimum, the OEM may need to take action to short-circuit it altogether. I’ve experienced situations where a minor (10-15%) reduction in demand resulted in a three-month gap in requirements for critical components – which disrupted the operations at a key supplier. The OEM can either “monitor, analyze & act” on an as-required basis; or take over procurement of critical components. In the first case, the OEM can build analytics to verify that the EMS’s current inventory and supplier forecasts are in sync with the OEM’s own demand. If they are significantly out of sync, the OEM can intervene between the EMS and the component suppliers to bring them back into alignment. On the other hand, some OEMs have taken over the procurement of key items so that the OEM’s forecast directly drives component demand. This process requires a way to transfer the components to the EMS.
The focus should generally only be on critical components – usually the most expensive 1 to 5% of the components in the product. Most assembled products, but especially electronic products, tend to be ‘top-heavy’ – meaning that the top 1 to 5% of parts represent 80 to 95% of the cost. The bottom 95% of the parts also tend to be lower lead time and easier to procure, so less attention (usually) needs to be paid to them.
What “Good” Looks Like
- Have a process to detect and resolve inventory anomalies – both component shortages and ‘aged excess.’ The best solution, of course, is to prevent these situations from occurring, but early detection is nearly as good. When surprises occur, they can consume much more time, and a robust process for managing them is essential.
- Put in place agreed standards for Quality Control and Certifications expected from the EMS, as well as the methods used to achieve high quality.
- Monitor actual production, including utilization of allocated capacity. Many EMS providers are willing to transmit a daily data file to their customers, with current inventory levels as well as production plans and other key data. But that data isn’t of much use if the OEM can’t use it. The data received from the EMS provider needs to have a home – often in the OEM’s own ERP system or in an advanced planning system.
- A defined and agreed problem identification & resolution methodology is essential. The US automobile industry has been using the 8D methodology for decades now. That, or a similar approach, will ensure that issues are documented and resolved.
- You should have a mechanism to sell components to the EMS provider, either from stock or via drop-ship; and the corresponding financial and legal treatment of those sales. Even though EMS providers are often able to source all or almost all components directly, sometimes the OEM has parts that it controls directly. Building some simple guidelines and even some automation to handle this process will save both parties a lot of unnecessary time and labor.
These capabilities aren’t always installed at the beginning of an OEM – EMS relationship, but they should be; and I would argue that in the long run, they have to be in place for the relationship to succeed. In addition, there are three other areas that are often required, but the degree to which they are needed may vary according to the OEM’s business, the products themselves, and the size of the relationship (in terms of value, number of products, volume of production, etc.). Smaller relationships can sometimes be successful with less formality.
Three More Requirements
- Well-documented policies and procedures. Formalize agreements with detailed specifications, timelines, and cost breakdowns to avoid misunderstandings and ensure both parties are on the same page.
- The means to keep the EMS’ Bills of Materials in sync with the OEM’s changes – and if needed, to keep the OEM advised when those changes will actually be implemented in production at the EMS.
- A mechanism to coordinate serial number data, batch IDs, and as-built information, usually from the EMS’s MES system, back to the OEM. In many cases, that information should be integrated back into the OEM’s ERP system.
Of course, others may describe these principles and needed capabilities somewhat differently, but I hope this provides a relatively complete and robust summary of what practices an OEM should put in place when dealing with outside/ contract manufacturers.
