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Manufacturing Cost Tug-of-War – Part 3
By Mark L. Casey | June 3, 2008
In this third and final installment in our series on the tug-of-war between OEMs and contract manufacturers, we will explore a variety of additional criteria OEMs must consider before making a final decision. These are listed in no particular order:
Quality Systems / Certifications
It is not enough to normalize the quotes and determine who offers the best price. What if the low priced supplier has shoddy quality and a lot of unhappy customers? Suppliers typically have a person or a department responsible for quality. Quality departments and personnel should be experts in all aspects of the testing and quality systems they employ. They should be able to provide not only an overview of their quality systems, but they should also be able to go into as much detail as the customer wants to see. Testing departments should have formal procedures in place for product testing and verification. Again, test experts should be obsessed with test issues and should be ready to discuss these issues with the customer in detail.
The various certifications that manufacturers can earn are varied. Certain certifications are industry-specific and some are more general. One of the most common certifications is the ISO certification. ISO is the International Organization for Standardization, an international non-profit organization that sets industry standards. In the area of quality systems, the ISO 9000 is the family of standards for quality management systems. It is very common for contract manufacturers to hold a certification in one or more ISO 9000 standards. Independent verification and audit companies (like Det Norske Veritas) audit and certify that suppliers comply with one or more of the ISO standards. Suppliers that are ISO certified should be able to provide a certificate demonstrating that they are ISO certified or ISO registered and to which ISO standard.
As for some of the industry-specific certifications, suppliers that serve the automotive industry may be required to hold the QS9000 (or ISO/TS16949 ) certification. Suppliers to the US military may be required to hold military standards certifications. Telecommunications suppliers may also be required to hold special Telcordia (formerly Bellcore) certifications.
Remember that the contract manufacturer is your outsourced factory. Ultimately you have to determine what certifications you want your factory to hold and what quality systems they need to have.
Customer References
A current customer will be able to share both the good and bad experiences with the CM. A happy customer is a strong testimony for a supplier, while an unhappy customer can reveal the warts. A supplier that is unable or unwilling to provide a customer reference may have something to hide or may not have any customers. OEMs should not be shy about asking for customer references. As a sales rep for CMs, I try not to wait until a prospective customer asks about references. My suppliers have happy customers that are willing to vouch for them, so it is to our advantage to encourage such conversations.
Labor Quality & Stability
Is the CM located in an area with a lot of qualified labor available? Is there a local technical school or community college? Are there plenty of engineers being produced in the region? What is the stability of the firm’s labor? Is there high turnover relative to its own area and relative to other areas? This can all have a direct impact not only on cost but, more importantly, on quality.
Infrastructure
Is the CM in a country or region where utilities are a problem? If the electrical supply is unreliable and can be lost for days at a time, how does that impact your production? If there is not easy access to rail, or quality roads, or air transport, how will your products get to your distribution system in the event of monsoon rains or an earthquake? With the rise of terrorism, OEMs need to also look into the security aspects of the region, country, and specific supplier. Stratfor is a good source of information on these issues. There are all “risk factors” that must be considered.
Procurement Expertise
Most CMs are going to be procuring the raw materials and components for your product builds directly. This is known as a turnkey approach (as opposed to a consignment of materials approach). The CM’s procurement expertise and relationships are very important in being able to do this cost-effectively and well. As with the quality department, there should be someone in charge of procurement. In large CMs there is typically a VP of Procurement with a staff reporting to him/her. In smaller CMs there may be a key person with purchasing and procurement expertise and responsibilities. Good procurement groups can be vital when a component or raw material becomes scarce and hard to find or when the price is skyrocketing.
Contract Terms Negotiation
A manufacturing relationship is typically cemented in a Manufacturing Agreement. This is the contract that puts the “contract” in contract manufacturer. This is the legal document that spells out the terms and conditions of the relationship between the OEM and the CM. What does the CM’s contract typically look like? Early in the process many OEMs ask for an overview of the CM’s terms and conditions, warranties on products manufactured, repairs and returns, etc. Sometimes the OEM, not the CM, provides the Manufacturing Agreement as the base document from which to begin negotiations. There is usually no way to avoid getting legal counsel involved at this stage, and it wouldn’t be a good idea anyway. How open is the CM to working with you and your legal counsel to arrive at a satisfactory agreement?
Factory Visit / Audit
Large OEMs have formal audit procedures and send a dedicated audit team. Smaller OEMs may send the owner or other executive to look the place over and to meet the key people. Many mistakes have been made by OEMs who just believed the slick brochures and that never actually made a trip to the factory. It is very important to actually be in the factory and to observe products being manufactured. Be sure the quality systems being trumpeted are actually being used. Find out what metrics they are using to measure the quality being produced on their lines. A visit to two factories from which you have received quotes may reveal that the cheaper of the two suppliers is no bargain at all. Can they really produce your product with the quality you require? Can you visualize your product in their factory? Do they have capacity to add your line or to produce your product on an existing line?
Openness / Transparency / Relationship
There is a little bit of feel to this one, but how open and transparent is the supplier during the RFQ and quote phase? Does it take weeks to get a non-disclosure agreement (NDA) signed? Will a company that makes this part of the process difficult somehow change stripes when you lock in with them for a multi-year manufacturing relationship? Doubtful. You are going to be establishing a business relationship with the supplier, so it is important that you are comfortable with them as a potential partner. The CM is a separate company, so there will be certain details that they will not want to share, but they should be willing to share as much as an OEM needs to know to make an informed decision.
Financial Stability
With publicly traded companies access to financial information is rarely an problem. Required SEC filings such as quarterly and annual reports put a lot of information at the fingertips of anyone with a web browser. The OEM is looking to make sure that the CM is financially stable and is a going concern. The process of selecting a CM is a costly one in terms of both time and money. Changing from a supplier that is failing financially is a perilous process that contains lots of risk and that induces lots of stress. It is a bit more difficult to determine if a privately owned CM is financially strong. CFO to CFO conversations seem to iron these issues out. It is also helpful to know the CM’s history. How long have they been in business? Are they growing? What do their customers say about them?
Conclusion
These three articles have provided an overview of the process of selecting a contract manufacturer. Each OEM organization is unique and will weight certain of these criteria as more important than others, but even those deemed not as important are ignored with some degree of peril. When the objectives and expectations of OEMs are well aligned with the capabilities and quality systems of CMs, long and mutually beneficial relationships are often built.
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