OEM Strategy: Buy, Build, or Partner?

The term “Original Equipment Manufacturer” (OEM) was coined when most companies in the electronics industry designed, developed, and manufactured nearly everything in their end products. With OEMs facing lower manufacturing utilization rates and a wide variety of technical and operational competencies needed to support production, financial realities forced them to translate many of their fixed costs into variable costs. The outsourcing industry’s initial purpose was to handle the production demand peaks and troughs of OEMs.

As the outsourcing industry expanded, OEMs downsized internal capabilities and contracted out these functions. The post-millennium downturn further accelerated outsourcing to include key aspects of the entire product life cycle, such as prototyping, process development, new product introduction (NPI), end of product life management, field support of products, and volume production. Transfer of these functions left many OEMs without supportive, low-cost, proximate alternatives for nascent and late stage aspects of their product life cycle.

Today’s high-velocity electronics businesses continue to outsource more functions, even closely related to their intellectual property (IP). Globalization of the electronics manufacturing services (EMS) industry is accelerating. For example, by 2010, China is expected to provide more than 35% of all electronics hardware manufactured in the world. This development in China is taking place in an environment where protection of foreign IP is highly suspect. Until the Chinese government develops credible and reliable enforcement procedures for IP, this is more than a legal problem. IP protection requires a company-wide strategy that takes into account the supply chain, the location of manufacturing sites, and features of product design. Irreversible loss of critical IP, dilution of brand equity and the ability to competitively differentiate, and over-reliance on a remote geographic supply chain are significant risks to a business that follows the outsourcing trend to its logical conclusion.

Despite the changes in electronics OEM manufacturing over the last 20 years, the fundamental raison d’être for a for-profit business is to provide the best possible long-term rate of return for stockholders. What has changed during this time is the number of potential suppliers available, including regional, domestic, continental, and off-shore alternatives. It is wise to re-evaluate buy vs. build on an annual basis, including all aspects of the product life cycle.

Buy: OEMs in the process of outsourcing manufacturing to low-cost geographies need to consider their entire product life cycles in their outsourcing strategy, while factoring in the size of the OEM and relative leverage with the largest EMS providers. Many large EMS providers are selective of incoming jobs, as they operate on thin margins at near-operational capacity. Outsourcing off-shore has lost some of its glow in recent months, as freight fuel surcharges have increased dramatically.

Build: Performing early and late product life-cycle tasks internally remains an efficient and cost-effective solution for many OEMs, whether large or small.Unfortunately, in-sourcing was abandoned because of the production stage of the life cycle rather than early and late stages of the process. In-sourcing should be evaluated as a credible alternative on the basis of strategic advantage, potential risk, and total cost-of-ownership.

Local Partner: In some cases, OEMs can partner with a local or regional contract electronic manufacturer (CEM) or competent equipment supplier for prototyping, process development, and NPI to facilitate transfer of new products to a high-volume EMS provider. At the end of the product life cycle, the local EMS can assist in winding down volumes and providing on-going support.

Obviously, no one answer fits all. Product pricing considered singularly has lost much of its strategic advantage due to commoditizing, while responsiveness and innovative differentiation through products or services has become more influential. Consequently, any strategic assessment weighted primarily on cost-of-goods-sold does not reflect current market realities and should be re-evaluated. From a risk standpoint, the potential downside exposure from manufacturing externally can exceed that of manufacturing internally or locally. This is especially true in early and late life-cycle stages for most products, or when there are IP issues.

Buy vs. build is a decision executives need to make each time an inflection point in the business is forecast or encountered. The only way to choose the optimal path is to constantly re-evaluate which manufacturing alternative provides the greatest strategic advantage with lowest potential risk and lowest cost-of-ownership across the entire product life cycle.

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BRUCE W. HUENERS, COO, may be contacted at Palomar Technologies Inc., 2728 Loker Ave. West, Carlsbad, CA 92010-6603; 760/931-3600; E-mail: [email protected].


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