Don’t Outsource to Low Cost Regions of the World
Until Your Product and Company are Ready

The Challenge

Over the last decade, more and more OEMs have converted from an internal manufacturing model to one of outsourcing to take advantage of economies of scale and low cost assembly regions created or obtained by leading EMS Provider/contract manufacturer. In so doing OEMs have been able to reduce their operating overhead and focus their businesses on differentiators like R&D, Marketing and Time to Market. The successes of large OEMs, coupled with the poor business climate during the first part of this century, has meant that management teams of small and medium OEMs are under increased pressures to outsource to low cost regions as a quick fix to improve their competitive position and profitability.

The common perception is that a global contract manufacturer (CM) will convert marginal designs into performance leaders, and they will reduce the cost of high end products to compete with discount products. Then for enhanced customer service, the EMS provider will implement a full demand pull system for free. Remember, CMs are experts in manufacturing (not your products), and they work off cost plus models. So if you have any expectations that are not in the scope of your work/manufacturing agreement, you can count on paying for it.

The Approach

Don’t get me wrong; there are plenty of products that need to be built offshore by global EMS providers, but building offshore needs to be carefully evaluated, planned and resourced before it is launched.

The key issues to be worked through prior to moving to a low cost region (LCR): design stability, supply chain, volume, resources and costs. Design stability is probably the most overlooked aspect of an outsource plan. If a design is marginal and poorly documented, you will have problems with manufacturing yield when the product is built domestically. When you send this design to an LCR to be built by workers whose English is at best a second language and your engineering support is 12 to 16 time zones away, the yields will drop off significantly. Usually when product yields drop below 97%, your low cost EMS partner will shut down the line and product will stop flowing. In this crisis you send a team of engineers over, and they will spend a month straightening out documentation short comings, supplier issues and design flaws. If you are lucky, the yields will improve to an acceptable rate and product flows again. For your troubles, you have weeks of lost production, delayed new product development, more ECO costs than you could ever imagine and probably an increased unit cost. Then after all this effort, you’ll find little or no improvement in field failures, as the core design is still the same.

The supply chain can be one of the shining lights of the transfer if managed properly. When your EMS provider quotes the product offshore, you’d better pay close attention to the non-AML sources included in the bid and the component lead times. International EMS providers will assume (see the quote fine print) the OEM will approve their local suppliers as it contributes a significant portion of the cost reduction. So plan on allocating resources for a major sourcing exercise, or be willing to accept a cost increase (component price delta and international freight). Once you have completed the outsourcing plan, make sure your manufacturing agreement is signed by your EMS provider prior to establishing your transition plan. If you do, you will have full lead time for your transition plan. If you don’t, you will either lose your negotiation leverage to support lead time requirements or jeopardize your transition to retain your negotiation leverage. In either case you are in trouble.

Make sure you have the right volume to go offshore, and this means both unit and dollar volume. There is a direct correlation between low cost areas of the World and education level. If product volume is low or high mix, it will drive frequent line set-ups and/or changeovers, and the human factor will step in and drive yields down and field failures up. A good rule of thumb is a single assembly that has 500,000 placements a month (e.g. 2,000 assemblies with 250 placements each) is a low end candidate. Dollar volume is a tricky thing. You need to ensure your dollar volume is significant to the manufacturing site, and in many cases, to the regional operation managing your business. If you have $10M to $20M of outsource you’d better really have a strong relationship with your EMS provider, as this range can get you into trouble. In this $10M to $20M range the off shore cost benefits are significant, but this range is not large enough to retain factory priority. When the large OEMs ($50M to $100M) get a spike in demand, the EMS partner responds and asks “how high.” When this happens, you’d better hope you are carrying a lot of inventory. It doesn’t do any good to have the lowest cost but not be able to supply parts.

The thought that an EMS provider understands the core business and business drivers of each of their OEM partners is dangerous. A CM provides services for hire, and at best they will have a moderate understanding of your business. OEMs need to remember that EMS providers don’t possess the industry, customer and product knowledge that has been collected over years if not decades that the OEM has been in existence. This knowledge provides advantage in product planning, design performance & capability, supplier qualification, demand trends, test capability, peripherals compatibility, installation environment, tool compatibility, etc. The key is to identify the areas you have strategic or cost advantages and maintain resources to control your partner on the aspects that you outsource. EMS providers are manufacturing experts first, but they will be happy to support logistics (forward and reverse), sourcing and design, if they can do so profitably. Since they are profit motivated, you’d better control the cost drivers you outsource.

When performing your ROI on outsourcing, don’t restrict your analysis to direct costs (purchase price). If you work through the EMS provider’s assumptions you can work out direct costs fairly quickly, but indirect costs can quickly snowball out of control. Offshore manufacturers offer low processing costs to attract customers with robust design and stable demand, and penalize customers with poor designs and volatile demand by passing on indirect cost items at a premium. The indirect costs driven by the OEM and passed on by the supplier (i.e. low yields, ECOs & related inventory exposure, demand changes, sole sourced components, frequency of shipments, special packaging for overseas transit, etc) find their way back to the OEM through product cost increases, expense PO’s or cost reductions held back. Then there are costs the OEMs incur themselves (i.e. travel, freight, duty, disputes between the EMS and key component suppliers, increased lead time, reduced schedule flexibility, reduced responsiveness, more formal communication & data collection procedures, increased sustaining engineering support, non-parallel holiday seasons, relationship commitment, etc…) that never made it into the ROI and into a budget. Indirect costs can easily end up erasing 25 to 50 percent of the offshore cost savings. In addition, there are opportunity costs associated with not fulfilling customer orders timely and not beating your competitors to market. These opportunity costs can be very high and difficult to quantify, but the impact on the business’ future can be lasting. Once all the costs are calculated, you may come to the realization that the savings will not provide a significant benefit.

The Result

To be successful with offshore EMS providers, there are three basic rules to follow. One – The company must be honest with itself about total outsource dollars, design stability, demand stability and ability to manage an overseas supplier. Two – The OEM must determine the capabilities that must be retained to be successful in their market place, and only outsource those that make sense. Ensure that each capability you outsource is negotiated and documented, as you don’t want assumptions to come back and get you later. Resource the project to support the transfer and support/manage the sustaining activity. Three - ensure your ROI is thorough, because careers are cut short when a company spends hundreds of thousands of dollars (in some cases millions) to transfer products offshore only to find out that the realized savings are only a fraction of what was expected.

Offshore manufacturing is the lowest cost solution for companies with the right products and volumes, but if your company doesn’t have the right products and volume, or if your company’s success is defined by its responsiveness and flexibility, look for a high performance regional EMS provider. Culture, time zones, language and product complexity are still important factors to consider on the long road to success in manufacturing.