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What is Price Masking?
By Mark L. Casey | November 13, 2007
What is price masking and who benefits from it? To answer these questions, let’s start by exploring the contract manufacturer’s (CM’s) supply chain practices.
Because of their size, volumes, and component spends, large CMs wield considerable power in negotiations with their component suppliers. This power is often translated into special pricing for the CM. When a CM gets low Bill of Materials (BOM) pricing, it gives them an opportunity to mark up the BOM to the customer’s expectation and thereby increase their margins. In a relatively low margin business like contract manufacturing, any practices that increase margins are welcomed.
However, the OEM that uses a Tier One CM is usually also a large company with power of its own. As OEM sourcing groups have gotten more sophisticated, they have realized that the CMs are making additional margin on the components that have been specified by the OEM. Not content to leave that margin “on the table,” OEMs have developed practices that have been termed “price masking” in order to hide component pricing from CMs and to wrest that material price savings to their benefit instead of the CM’s. How does it work?
Given that most large OEM’s do not want to buy components and consign them to the CM (which would be one way to accomplish this), there are two primary methods of price masking. One is the buy/sell agreement and the other is rebates. How do these work?
Buy/Sell Agreement
The Buy/Sell agreement allows the OEM to negotiate their own prices with the suppliers and to buy the components directly at this special price. They then sell the components to the CM at the CM’s “market price.” This allows the OEM to pocket the difference. The OEM does not have to take physical possession of the components. The components are shipped directly to the CM.
Rebates
The rebate approach requires that the component supplier sell the components to the CM at market prices, which is likely to prohibit a significant mark-up by the CM. The OEM then receives a rebate from the component supplier for each component purchased for that particular assembly. This all takes place, ostensibly, without the CM’s knowledge. Again, the rebate amount ends up in the OEM’s pocket instead of the CM’s. There is obviously additional accounting required in this system to properly tie the rebates in to the true manufactured cost of the product.
Conclusion
Since this is really a power struggle, it appears to mainly be large OEMs that have been able to effectively use price masking. Smaller OEM’s do not possess the clout with their supply base required to negotiate significant component savings to implement these practices. In fact, CMs that are larger than the OEM may be able to provide better component pricing, even with the mark-up, than the OEM can get on their own.
If you have experience with price masking from either side of the fence or wish to comment on the practice, please use the comment function below.
Topics: Contract Manufacturing, Electronic Components, Electronics Manufacturing, Services | No Comments »
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