In the complex and often lopsided engagement between OEMs and electronics manufacturing services (EMS) providers, it's easy to forget that the relationship is not unidirectional and heavily tilted towards the equipment vendor. While OEMs may seem to have the upper hand in the transaction and initial negotiations, EMS companies are also constantly evaluating their customers to ensure adequate fit and success in the low margin business.
The symbiotic nature of the relationship forces EMS providers to constantly and critically assess customers and sometimes turn down contracts just as OEMs keep a close eye on contactors to assure their own success.
I was reminded of this while reading Michael Allen's article in which he discussed the factors an OEM should consider while selecting the EMS partner. In the two-part series, Allen identified six criteria and talked about how these are critical issues to be carefully assessed before engaging with a supplier. The six factors he considered essential for the OEM to review are: price, location, production volume, technical capabilities, in-house design capability, and culture. (See: 6 Criteria for Choosing an EMS Provider, Part 1 and 6 Criteria for Choosing an EMS Provider, Part 2.)
Only the most arrogant OEM executives would assume their companies are not being equally evaluated as potential partners, just as they too review the credentials of the supply chain partners, whether these are component suppliers, contract manufacturers, or third-party logistics services providers. I believe EMS providers are also constantly poking around for information about the OEM customer because the loss of a single contract can be devastating to contractors in the wafer-thin margin business.
While there are areas of similarities, it's clear that what OEMs and EMS providers look for in their supply chain partners can vary widely. Two words sum up the dichotomy: capabilities and pedigree. I believe -- as Allen effectively points out in his blog -- that OEMs are more concerned about the capabilities and strengths of their EMS partners, while contract manufacturers typically focus on factors associated with the "pedigree" of the contractor. The EMS provider is hugely concerned with the history, design competence, sales and marketing strengths, and financial resources of the OEM partner.
There are good reasons for this. Most contracts won by EMS providers have low initial value; the contractor may actually get a haircut on its profits in the early years due to high startup costs and other production investments. Companies in this group aim for the larger chunk of their gains on such contracts as volume shipment ramps up. The EMS provider could be badly hurt if the anticipated demand and production volume failed to materialize because the OEM misjudged the market, due to insufficient or inefficient sales and marketing support, design flaws, or other reasons.
As a result, EMS providers put a lot of weight on the history of the OEM before agreeing to sign up with the manufacturer. Examples in this regard include companies like Apple Inc. and BlackBerry, both of them major players in the mobile handset business but with starkly differing projections about their futures. Any contract manufacturer would be thrilled to get a call from Apple, although the excitement may, ironically, be tempered by the realization that very few EMS providers can handle the flood of product demand from the consumer electronics and PC vendor. In the case of BlackBerry, while demand for its products is nothing to sniff at, its EMS providers today know they are assuming a great amount of risks and could suffer significant financial damage if its latest products don't catch fire in the market.
EMS providers aren't always hung up on large order volumes, though. Sometimes a small-volume contract with higher margins from a specialized industrial equipment or medical OEM could be highly lucrative and less capital-intensive than in the higher volume consumer electronics and PC markets. This is one of the reasons behind the decision in recent years by many leading EMS providers to diversify operations into lower-volume but higher-margin businesses and away from the low-volume PC segment.
So, what are the critical factors that an EMS provider would consider in accepting a contract from an OEM? Interestingly, these would tend to include volume (possible minimal volume guarantees), financial strength of the OEM, end-market (to ensure a fit in capabilities), pricing and other terms of the transaction, the OEM's relative strength and competitive position in the market, and, crucially, the supply chain conditions governing the agreement.
In a recent report, IHS Corp. analyst Thomas Dinges addressed this simmering conflict between what OEMs want and what the EMS provider can agree to, noting that while the two are partners, they still jostle constantly for advantages related to their individual corporate objectives. Dinges said further in the report:
This year will also see the industry attempt to balance two key trends, each likely to pull in the opposite direction: OEM customers wishing to lower their costs on one hand, versus outsourced manufacturing suppliers hoping to see improved cash flow on the other.
From their end, customers will want to know what price is considered fair to pay an outsourced supplier in order to make their product -- forming part of the client’s effort to reduce overall manufacturing costs. For suppliers, on the other hand, concerns will revolve around how to reduce inventory in order to achieve a stronger balance sheet; how to do more with less, especially in the area of capital expenditures; and how to bring down operating costs as a whole.
In essence, how both themes play out -- an intricate interplay between hard-nosed customer wanting lower prices but faster supply chain responsiveness and cash-generation focused manufacturing partner -- will prove of great interest this year to observers and participants alike, IHS believes.