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The Challenge of Outsourced Purchasing

One of the classic conflicts in outsourcing is how much control an OEM cedes to its subcontracting partners. In a narrow relationship, an OEM may outsource only its manufacturing and keep design, purchasing, and other decisions in-house. In a more encompassing relationship, an OEM may outsource everything, including design.

This original design manufacturing (ODM) model gives a lot of latitude to the subcontractor, which provides services ranging from design to after-sales support. But situations arise in which an OEM steps back in. According to today's DigiTimes, {complink 1544|Dell Inc.} is facing such a situation:

    Dell reportedly will gradually retrieve its component purchasing rights from upstream ODMs in the second half of 2011 as the company is not satisfied with its ODMs for not providing clear quotes due to the ODMs receiving most of their component supplies from their own subsidiaries, according to a Chinese-language Apple Daily report.

As Dell spokesman notes that the company does not comment on speculation.

OEMs have been struggling with the outsourcing of purchasing for awhile. Companies such as {complink 3538|Motorola Inc.} and {complink 2376|Hewlett-Packard Co.}, have, in the past, kept their component pricing confidential from their contract manufacturers. OEMs derive a competitive edge from negotiating preferential pricing relationships directly with suppliers. OEMs could lose that edge if contract manufacturers negotiate their own preferential pricing and share those benefits across their customer bases.

Another wrinkle has been added as EMS companies have become more vertically integrated. Companies like Foxconn parent Hon Hai manufacture components as well as provide manufacturing services. There's a huge cost advantage here, but there are also problems. For the OEM, these include:

  1. The ODM controls component pricing. OEMs pit suppliers against one another for the best price. In this case, the ODM is the supplier.
  2. An OEM may spec in a different component than what is used on the manufacturing line. In many cases, commodity components may be interchangeable, but a subcontractor may use what's handy versus what's specified in the design.
  3. An OEM has little visibility into actual component prices. If an ODM negotiates prices with its subsidiary, it's up to the ODM to pass that price on to the OEM. That rarely happens.

These problems are not limited to ODM relationships — component pricing is a hot button no matter who is in charge.

Apple, Dell, Cisco, HP, and Motorola have each, in their turn, set the standard for supply chain management. It's unclear if the in-house procurement trend is shifting. The issue is control and how much or how little an OEM wants to have. The right balance in an outsourced purchasing relationship continues to be a moving target.

3 comments on “The Challenge of Outsourced Purchasing

  1. pjoygordon
    April 7, 2011

    Barbara Jorgensen is correct that OEMs' lack of certainty about the parts purchased by ODMs for their products leaves OEMs vulnerable to “games” regarding pricing and switching of components.  Our OEM clients are concerned also about three other risks from not having full visibility into the bill of materials (BOM) data:

    (1) No full-disclosure of the substances within the components and rest of the product.  This leaves the OEM vulnerable in the face of global regulations restricting more and more substances in products, as well as trying to keep up with competitors who proactively remove hazardous substances ahead of regulations to gain advantage with customers.  It's vital also for the OEM to know what substances in their products are subject to shortages or dramatic price hikes owing to being rare-earth minerals–restricted because of shrinking quantities and/or political strong-arming.

     

    (2) Lack of data about the origin of the parts.  With the USA SEC requiring dislosure of minerals extracted from “conflict mines” and other pressures to source substances responsibly, it's increasingly important for OEMs to know the actual countries from which materials and components are sourced.  Plus, the recent catastrophe in Japan reminds us of the critical importance of swiftly identifying geographic sources of components to prevent supply-chain disruption.

     

    (3) Counterfeit components are always a concern to OEMs, and having less and less visibility to the BOM only exacerbates that concern, with fear about product failures owing to inadvertently having counterfeit parts in the product.

     

    More thoughts on this topic are on our recent TFI blog post: http://www.techforecasters.com/weblog/archives/when-is-supply-chain-knowledge-sufficient.

  2. Barbara Jorgensen
    April 7, 2011

    Hi Pamela–thank you for the additional information and helping out our readers. There are so many pitfalls these days and it looks to me like OEMs have to be more diligent than ever. One would think that outsourcing could alleviate some of that burden; on the other hand, the OEM's name is on the label so ultimately they are responsible for everything that goes into their brand.

     

  3. itguyphil
    April 9, 2011

    As I've learned, Outsourcing only alleviates the direct costs of resources (mostly time). But it does add some indirect pains down the road. Especially if there are defects and/or issues with the end product.

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