Cost is the bottom line
By James Carbone -- Purchasing, 5/21/1998
It's no secret that original equipment manufacturers (OEMs) are outsourcing more of their electronics manufacturing to contract manufacturers (CMs). Electronics contract manufacturing is already an $89-billion industry and will grow to $140 billion by the year 2000, according to market researcher Technology Forecasters.A new Purchasing Magazine survey finds that 54% of computer, peripheral, communications, automotive, medical, and industrial control equipment OEMs outsource the manufacture of some of their equipment. In fact, the survey reveals that 47% of an OEM's electronics manufacturing is outsourced, and OEMs are spending on average $5.24-million per year on contract manufacturers. Eighty-two percent of survey respondents say they will be spending more on CMs in the next year.
The survey shows that CMs are not only building printed circuit boards for OEMs, but also cable harness assemblies, power supplies, and subsystems. In a growing number of cases, contract manufacturers are building entire systems for OEMs. In addition, OEMs are tapping into CMs' design expertise and involving the manufacturers in new-product development. On average, OEMs use four or five contract manufacturers for electronics manufacturing, according to the survey.
All this is having a profound effect on OEMs and their purchasing departments. As more OEMs turn to CMs to build part or all of their product, the OEM's success will be linked to how well their external manufacturer performs. That means that choosing the right contract manufacturers and managing them effectively is critical for OEMs.
Buyers must choose wisely
The responsibility for matching an OEM's manufacturing needs and CM's capabilities is falling on the shoulders of purchasers, according to the survey. Fifty-five percent of buyers say they must develop a list of contract manufacturers when their companies decide to outsource. Seventy-nine percent report it is their job to evaluate proposed contract manufacturers, and 71% visit CMs to either check out their capabilities or monitor the CM's performance. Thirty-five percent make the final decision as to which CM their company uses and 65% are part of a team that makes the decision.
The task of finding the appropriate CM for an OEM can be daunting because there are over 700 contract manufacturers in the U.S. with varying capabilities. Some contract manufacturers handle just wire and cable harnesses or printed circuit boards. A small but growing number of contract manufacturers will just do box builds for customers and leave the printed circuit board manufacturing to other CMs or to the OEM.
"Some contract manufacturers are good at labor-intensive work," says Cliff Davis, a senior buyer at Adtran, a networking equipment company in Huntsville, Ala. "Others have better surface-mount technology capabilities so we give them precision work to do."
Other contract manufacturers are highly proficient in prototype builds, but they may not have the equipment, personnel, or skill sets to handle volume production. Some may be good at high-volume production, but not prototypes. OEM buyers whose companies use contract manufacturers caution that purchasers should beware of CMs who boast of both production and prototype capabilities. They often use the same equipment for both kinds of work. If a quick prototype run comes in, the production run needs to be broken down and set up for the prototype. Then the equipment will be re-set for the production run. This can be disruptive to both the prototype and production customers because it results in delays.
Wanted: A good match
When evaluating a CM, it's important for buyers to look at the manufacturer's business model to determine if it matches the OEM's, says Chris McComb, director, commodity management for Bay Networks, San Jose, Calif. "Some manufacturers are outstanding at building PC motherboards and can really crank them out at a great cost," he says. Those CMs which cater to the PC industry have a low-mix, high-volume model. "But we need external manufacturers who are medium mix and medium volume. The manufacturers we deal with have to be able to switch direction very quickly," he says.
But finding the CM with the right business model is just the beginning, according to purchasers who have evaluated and now use contract manufacturers for their companies. McComb says buyers need to look at what resources the CMs have in-house and get answers to a litany of questions. "Does the manufacturer have the ability to develop test programs? Does it have a clear relationship established with a key component supplier? How does it manage its supply chain? Does the external manufacturer use project buyers for everything or does it have a supply base management model? Does it have a commodity management model? Does the manufacturer leverage its business? That's why we would do business with them," he says.
Other buyers offered a wide variety of tips when evaluating CMs:
* Site Visits. Buyers should visit the CM's plants and check to see how equipment is used. Is it used for volume production or for prototype builds? That will give an indication of what's most important to the manufacturer. Is the equipment well maintained and can it support current and future designs?
* Go local. Use local contract manufacturers because when problems arise, it's often necessary to visit the site right away.
* Technical support. How many engineers are on staff?
* Quality. Is the contract manufacturer quality conscious? Does the CM have a quality manual and how does the manual compare to your company's. Also check the manufacturers scrap. Excess scrap could mean the CM has a process problem.
* JIT. Can the CM support JIT? Check with the manufacturer's other customers about JIT performance.
* Sourcing strategy. Talk to the purchasing manager about the CM's sourcing strategy and compare it to your company's.
Problems will arise
After a CM is chosen, purchasers need to stay involved with the manufacturer. For one thing, OEM buyers often purchase the components used by the CM. The survey finds that 45% of OEM buyers purchase parts for their CMs. Thirty-one percent turn over purchasing to the contract manufacturers, and 24% say it depends on what product the CM is building for the OEM and the ability of the CM. Eight-two percent say they provide CMs with an approved vendor list (AVL).
Some buyers visit CMs to prevent small problems from becoming big ones. "I spend a fair amount of my time at external manufacturers," says McComb. "I want to be there in case there is a quality or delivery issue."
Other buyers report they have problems keeping CMs focused on their companies requirements if production volumes are low. Contract manufacturers have dozens of customers with various volume requirements. Many CMs prioritize customers based on volume, says Dirk Sweitzer, senior buyer Syn-Tech Systems Inc., Tallahassee, Fla. Syn-Tech uses three cable-harness contract manufacturers and three printed-circuit-board manufacturers for the fuel management systems it builds. "A challenge is keeping contract manufacturers focused on my account and preventing it from becoming less important because another customer comes in with more dollars," he says.
Problems also may occur when an OEM's requirements involve a high mix of parts but low volumes. That's the case for Kodak Motion Analysis Systems Division, which designs and manufactures high-speed cameras. Kodak outsources boards used in the cameras but may need only several dozen per month. Kodak buys the component and ships them in kits to the contract manufacturer. The problem is that parts in the kits are used on different boards and therefore get misplaced by the CM.
"The contract manufacturer will call us and say 'we have 500 pieces, but we think we should have 1,500 pieces,'" says Phyllis Merino, a buyer at the Motion Analysis Systems Division. "That's a big discrepancy, and it takes up a lot of my time. We have three people who deal strictly with tracking [parts] at contract manufacturers," she says.
CMs will do more
But despite problems, contract manufacturing will grow in importance because OEMs see it as an ideal way to reduce their manufacturing costs, lower inventory, and avoid purchasing or leasing capital equipment. The survey finds, on average, that OEMs save about 26% in manufacturing costs by using contract manufacturers.
It also finds that of the companies who outsource manufacturing, 33% plan to increase their number of contract manufacturers in the next year. "We are going to be expanding and adding one or two more [CMs] as our sales increase," says Davis of Adtran. "The more they can do, the more we will offload to them."
And CMs plan to do more for OEMs. Many want to become one-stop shops and build entire systems, not just part of the systems, for OEMs. Somewhat ironically, some CMs are becoming vertically integrated. "Some CMs will have plastic injection-molding equipment or their own metal-fabrication equipment so they can build cases in house for customers," says Charles Mullen, senior industry consultant for Technology Forecasters.
Many CMs are beefing up their engineering staffs. In the past, OEMs used a CM's engineers to help resolve design for manufacturability issues with a new product design. Now CMs report they are using engineering expertise earlier in the process and using engineers to help to design new products.
Electronic commerce is a major thrust for many large- and medium-size contract manufacturers. CMs say the World Wide Web and electronic data interchange (EDI) can be used as tools to reduce cost, which is the chief reason that OEMs use contract manufacturers.
CMs say that by automating the purchasing process, a contract manufacturer can reduce cost by up to 35% for OEMs. Purchase orders, acknowledgments, and forecasts require a lot of administrative effort. In addition, inventory can be reduced with EDI.
For the most part, purchasers whose companies have decided to outsource electronics manufacturing have little chance of bringing it back in-house. "About a year and a half ago, we made a decision as a company to really embrace the external manufacturing model," says McComb of Bay. "We've done that and it's gradually become the way we do business. It's here to stay."
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