The Top 10 Myths About Selecting a Contract Manufacturing Partner

With so much of today’s electronics manufacturing outsourced, my team at Riverwood Solutions ends up spending a lot of time inside various contract manufacturing facilities. Sitting on a plane today heading to yet another contract manufacturing (CM) visit, I started tallying the number of CM factories, and the number of different countries my team has been in over the past year visiting CMs. I was able to quickly rattle off CM factories in 24 different countries on 5 continents that were visited by just the consulting arm of Riverwood Solutions in the past 12 months.

There are a number of different reasons why we spend so much time in outsourced manufacturing facilities. The one that I want to discuss here is the process of selecting an outsourcing partner or contract manufacturer. For an OEM that makes its living selling a physical product, the selection of a contract manufacturer to build that product is a weighty decision. Yet there are so many misconceptions and misplaced notions about what is really important in the selection criteria. The following is a list of some of the most common myths and misconceptions we see held by OEMs about selecting the right contract manufacturer.

10) “If I select the right contract manufacturing partner everything will be perfect.” Contract manufacturing is a difficult, competitive, low-margin business – and it is one that needs to be actively managed. OEMs that get the best results, and that express the highest level of satisfaction with their CMs, are ones that structure their own operations organization to effectively manage outsourced manufacturing.

9) “I just need to find the lowest quote price.” For many products and markets, the X-works per unit manufactured quote price captures just 70% to 80% of the total supply chain cost. I’ve seen many instances where going with a per unit quote price that was 2 points lower ended up costing an extra 5 points in other less visible costs – both internal and external. Additionally, many CMs have well-developed and institutionalized business processes for identifying and capturing additional costs that were not included in the quote that are then passed on to the OEM in the form of various fees and charges.

8) “My board will be impressed if I sign on with a “Tier 1” manufacturing service provider.” The general convention of grouping CM’s into various tiers, generally from one to four, was developed by the financial markets in order to help explain differences in valuation multiples across the industry. If we substitute the words “great big” for the words “tier 1” in the original quote above, the statement tends to sound a bit more consistent with how silly it really is. The only time an OEM truly needs a great big CM is when they have a great big piece of business to place. In most cases we advocate finding the right size fit, in addition to understanding the fit across other dimensions including technology, geography, management style/culture, end market experience and, of course, business model.

7) “I don’t want to be at a CM that is building for my competitor.” Why not? Is it because of the proprietary nature of the manufacturing processes that you are outsourcing to the lowest bidder? Occasionally the view espoused in this quote is correct, but in general it is misplaced and more times than not exactly incorrect. OEMs should find the most broadly capable and compatible CMs for their specific business and often times this means building with the same company as one of your competitors – which is just not the same as running your product down the same line using the same support staff.

6) “I need a partner that is willing to invest in my business.” I’m sure I’ll get a few emails on this one. In my experience, the statement above generally implies that the OEM is looking for someone to lose money building products for them. Rarely is there an actual advantage to having a key supplier lose money on your account – and if you revisit item number 9 above, the fact of the matter is that they rarely do. Expecting a CM with a 6% ROA and a 12% WACC to “invest” in your business is a bit like asking Bernie to manage your accounts.

5) “Vertical integration is critical to getting the best price and lead time.” Are you sure? Have you done the math? Have you really looked at a best of breed, dis-integrated supply chain and compared it holistically to a vertically integrated CM model? Sometimes the statement above is true, but 8 times out of 10 this statement is based on overly simplified logic and not detailed analysis. If vertical integration is universally the right model, why did the vast majority of OEMs abandon it well before the outsourcing model took off?

4) “In an outsourced world, R&D should be able to manage production.” Whether manufacturing is captive or outsourced, managing manufacturing and the upstream supply chain is a profession, and one that requires skilled professionals. Although we see a great many start-ups and small companies that try to simply tuck manufacturing operations under product development, we see very few (approximately zero) that are truly successful with this strategy.

3) “Larger CM companies will produce my product for a lower Valued-Added Margin (VAM).” Although this is true in many instances, in almost as many instances it is not true. For most CMs, the largest cost contributor to VAM is what we refer to as labor influenced costs which include direct labor, indirect labor and even facilities cost. Unlike raw material, the purchasing of local labor is not really impacted by some volume discount.

2) “CM X’s presentation was far superior – they’re the best choice.” At Riverwoodwe have a saying about this – “the time to separate the slide-ware from the shinola is before you engage the CM with a contract.” Never confuse the resources and expertise of the sales and marketing department with what you are actually buying in the way of manufacturing services. Do your homework, do your reference checks and talk to the operations team – not just the sales team.

1) “I need the most technically competent EMS partner.” Clearly technical competence is an important factor in most supplier selections; but an excessive if not singular focus on technical competence is the single biggest, and most consistent mistake we see OEMs make in selecting a CM. This is in part because some OEMs will place undue authority or responsibility on their product development organization in the selection of an outsourced manufacturing partner. Differential technical capability, at least on a PowerPoint presentation, is also one of the easiest factors to grab onto and to hold up as a clear differentiator. But technical competence should be just one of many factors weighed in the decision process as appropriate to the specific situation. Effectively working with contract manufacturing is a fairly complex business relationship that must function well across a number of functional areas. Ultimately the CM relationship is a commercial relationship and excellent technical performance cannot fully overshadow all of the other business level requirements.