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© igor-stevanovic-dreamstime.com Analysis | June 19, 2013

Outsourcing's Next Evolution, how we got here - Part 1

The landscape for the EMS industry is changing - politics, economy and the business climate are all to blame. OEMs are demanding more for less as they re-evaluate their relationships.
The global outsourcing phenomenon is entering a new phase. EMS prices are rising; geopolitical risk and uncertainty are increasing, and many OEMs are reconsidering their global solution, including abandoning outsourcing altogether for certain segments of the product lifecycle. The relationship between OEMs and their EMS providers is worse than it has ever been. The level of mistrust is very high. EMS are disengaging with unprofitable customers at the same time that OEMs are demanding increasingly draconic cost reductions and onerous terms and conditions.

Something has got to give.

And when it does, global capacity shifts will impact all end markets and sizes of companies, from the Goliath fringe to the most regional.

Charlie Barnhart & Associates have launched a series of articles to discuss the key findings from the Beyond Outsourcing Report. There will be five articles, released on the first of the month:

1. Introduction and Background: How We Got Here

2. 10 Macro Trends Driving Outsourcing

3. OEM Risk Ranking of EMS Service Offerings

4. Outsourcing Alternatives

5. Buy or Build?

This article will start the series by briefly describing how we got to this point. Originally, OEMs designed, developed, and manufactured most —if not everything—that went into their products, hence the name ‘Original Equipment Manufacturer’. Then as technology evolved and became more pre-packaged and ubiquitous (e.g. integrated replaced discrete logic and modular construction supplanted elemental designs) product differentiation shifted from a matter of functionality to an issue of cost-versus-performance.

This created a high-degree of ‘product churn’ in the market place and life-cycles began to shrink. As a result, sales forecasts became increasingly unreliable due to demand fluidity brought about by shifting user preference. In reaction, OEMs looked for methods to shift their fixed-costs to a variable basis, as utilization rates in their internal factories became progressively more difficult to predict and control.

The outsourcing industry, initially on a consigned basis, began as a means by which to ‘buffer’ these peaks and valleys in the OEM’s manufacturing requirement, but these companies soon gained greater responsibility as their service offerings expanded. OEMs continued to shrink investment in internal capabilities and outsourced more functions, more often. Eventually they began to dismantle their internal operations and launch large scale divestiture programs.

These actions, coupled with the impact of globalization, and an unprecedented economic downturn post Y2K, created a supply-demand imbalance in the EMS industry (favoring the OEM) and prices for manufacturing services dropped precipitously.

This advantage was embraced broadly by OEMs who quickly came to rely upon this recurring windfall to prop up their eroding margins. So when EMS pricing ultimately hit the bottom of the pricing curve, they saw little choice but to abandon their existing supply-base and transfer their outsourcing requirements to lower-cost solutions such as China.

This left many midmarket OEMs without a supportive, low-cost, local alternative for the early and late stage elements of their product life-cycle, and many simply resigned themselves to off-shoring these requirement to suppliers whose value-proposition was little more than a high-volume producer of low-cost goods in some regionally remote geography.

In many if not most cases, this provenance resulted in a cumbersome, expensive, and ineffectual solution that still plagues many of these OEMs, who continue to struggle with a cascading set of requirements that remain inadequately or totally unfulfilled. In short, the “baby was thrown out with the bathwater” a consequence certainly not intended but very real indeed. And while a sea-level change in outsourcing now appears inevitable, the question remains – will these shifting tides ultimately solve the issues that have resulted?

Clearly, in-sourcing much of the product life-cycle including; prototyping, NPI, EOL and on-going support (if not the full production requirement) would not be free, but neither would it be as expensive as many people believe. High quality, well maintained equipment of all types is in surplus throughout North America and Western Europe, as are the human resources necessary to perform these tasks. And for a midmarket OEM with an outsourcing spend of as little as $50-100 million per year, a persuasive financial argument can easily be made for in-sourcing.

As each OEM’s situation is different, each OEM’s solution will be unique. This series of articles is intended to stimulate a discussion of how OEMs can re-think outsourcing starting with a clean slate. So use these suggestions only as a starting-point and aggressively seek out or craft a wholly custom solution that complements and harmonizes with your requirements. What is most important is not which option you choose, but rather that you choose an option that integrates a life-cycle based solution into your manufacturing strategy.

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