The following is excerpted from a paper written for Technology Forecasters’ Quarterly Forum:
As the name implies, Original Design Manufacturers (or ODMs) are companies who provide not only manufacturing services but also product designs or design services and may (or may not) sell their own branded products. While this definition does not fit every ODM, as some do not provide manufacturing service but only designed products, it does describe the vast majority of the companies involved in this activity and is a reasonable starting point from which to launch our analysis and discussion. Additionally, while it’s generally held that the ODM industry is an Asian based activity there are in fact ODMs located in all the major industrial geographies; including North America, Europe, the near East and other Asian locations.
With that said, it’s undeniably true that the vast majority of this activity (certainly over 80%) takes place in Asia and primarily from within very few key geography; including Taiwan, Hong Kong and to a lesser degree Korea. Further, while the use of ODMs has dramatically increased over the past five years, and the trend is expected to continue, less than a majority of OEMs have either incorporated or yet gained significant experience in this approach.
Therefore, in this writing we will use a “comparative methodology” leveraging the high level of experience most OEMs have with EMS (or Contract Manufacturing) in identifying and reviewing the distinct business practices of ODMs.
Approach:
To highlight the primary differences between ODMs and EMS companies we will focus on these five key issues:
- Business Form
- Value Proposition
- Cost Structure
- Pricing Practices
- Operating Characteristics
A review the potential windfalls and pitfalls of the ODM option will also be included.
MIXING BUSINESS MODELS
In response to the high growth rate of the ODM industry, a mixing of models is occurring with EMS companies acquiring (or developing) product design capabilities and ODMs competing for contract manufacturing business.
Complicating matters however is the uncertainty created by OEMs shifting their manufacturing to China and embracing less than innovative products from ODMs. It is no secret that the electronics industry has a long and checkered history of chasing low-cost labor around the world and that many leading OEMs are already searching-out the next ‘hot spot’ be it in India, Russia, Viet Nam or somewhere else. Relative to ODMs, one cannot help but question the plausibility of an OEM marketing strategy who’s only branding point is the familiarity of the logo that gets pasted to the product.
This ‘convergence’ could reasonably be expected to continue until the two alternatives effectively merge into a melded composite that combines the advantages contained in each. In the meantime, and not unexpectedly, the EMS and ODMs continue to expand and fine-tune their value propositions and jockey for position in this shifting landscape.
As a sideline to this activity, the industries have also begun using convergence to ‘balance’ their account portfolios to better position themselves to take advantage of potential margin variations between sectors and mitigate risk (or over dependency) on any individual market segment.
EMS/ODM COMPARISONS
1. Business Form
The ODM industry is like the EMS industry in these ways:
A highly fragmented environment that is made up of dozens of players, none of whom control the overall market.
Dominated by ‘several’ large publicly traded players who dominate the industry, but who individually hold far less than a majority of the market share. The largest ODM in CY2003 was Quanta with a 20% share.
CAPEX intensive (especially in the areas of Plant, Property, and Equipment) and has high ROIC goals.
Only ‘lightly’ differentiated by its manufacturing investment.
The ODM industry is unlike the EMS industry in these ways:
Concentrated in low-cost geographies, principally Taiwan and Hong Kong for design and Mainland China for manufacturing.
Segmented by “product” based intellectual property (IP) or product-specific expertise.
Operates (to some extent) in the OEM space, especially in the areas of consumer, low-end computing, telecommunications, and network products.
Invests in product-based Research and Development versus manufacturing technology.
Has developed either a captive or subordinate supply chain for a broad range of both active and passive materials, primarily but not exclusively in China.
2. Value Proposition
Like the EMS industry, the ODM industry offers its customers:
Access to a well-developed manufacturing capacity that is capable of matching the Tier I Contract Manufacturing service offering.
A fairly robust manufacturing capability that is typically multi-facility based and posses sufficient redundancy (except for the element of geographic concentration) to be considered a workable alternative.
A ‘fixed’ price relationship with reasonable flexibility.
The ability to access the supply chain with a greater degree of leverage and influence than the typical OEM might be able to achieve on its own, especially in the area of industry standard components and fabricated material.
Unlike the EMS industry (with some exceptions), the ODM industry offers its customers:
Product-specific IP at a very low cost, as measured against what the OEMs typically spend for their equivalent developed internally.
A means to accelerate their time-to-market by virtue of elimination of most of the product development and validation process.
Line-card expansion with minimal investment as compared to internal development.
Access to Product Roadmaps and Life-cycle Management alternatives.
Access to new Geographic Markets principally within the Asian region.
A way to minimize off-balance-sheet Material liability.
3. Cost Structure
Like the EMS industry, the ODM industry incurs:
All four of the major cost elements of any for-profit enterprise, including: Material, Labor and Overhead costs (COGS), Sales, General and Administrative costs (SG&A), Cost-of-Money related expenses (CoM) and Tax and regulatory expenses.
In the area of Taxes and Taxation, however, the rules both inside and outside of Mainland China are considerably different than those encountered in most other major manufacturing geographies, and generally they create a competitive advantage for Chinese producers.
Non-recurring and Extraordinary Expenses that ultimately must be recovered as they are expensed versus depreciable items.
Risk liability (both on and off balance sheet) such as warranty exposure.
Unlike the EMS industry (again with some exceptions) the ODM industry enjoys:
- Access to capital markets that are less regulated, more flexible, and less expectant, including both governmental and non-governmental sources.
- A lower cost of capital (by virtue of above.)
- A means to (legally) avoid paying most taxes.
- Less exposure from regulatory/judicial functions particularly in the areas of product liability, occupational health and safety, employee relations, and environmental compliance and administration.
- A lower administrative burden in their customer relationship due to lower expectation levels. Noteworthy however is that this situation may be rapidly unraveling as OEMs that have met their lower pricing objects are now pushing for enhanced levels of service, support, and organizational development in “reward” for their business.
- A lower cost of both direct and indirect labor by a factor of 5 to 6 times.
4. Pricing Practices
Like the EMS industry, the ODM industry generally:
Uses a cost-plus mark-up formulation.
Integrates volume discounting into their prices.
Uses a system of standards and variances to measure operational results and define profits.
Applies ‘significant’ judgment, based on both market positioning and strategic business issues in establishing prices.
Is expected to be profitable by its investors on both an operating and net basis.
Unlike the EMS industry, the ODM industry generally:
Uses IP vs. Cost (or Service) as their primary sales differentiator, especially in relation to its experience in particular market segments.
Will ‘give away’ design IP to secure manufacturing opportunities of sufficient size and value.
Are willing to execute business at break-even to acquire market-share and/or to penetrate selected market segments. This difference seems to be related to a “perspective variation” between the Asian and Western investment community.
Doesn’t use pricing as a means to avoid business, which is a typical strategy deployed by EMS companies who are “reluctant” to tell either current or potential customer they do not wish to quote a particular piece of business.
Is far less open about pricing practices and far less likely to disclose information publicly or privately.
5. Operating Characteristics
Like the EMS industry, the ODM industry generally:
Uses a business model that recognizes the value of top-line growth as the driver of economies of scale and is willing to incur debt to accomplish this growth if a reasonable return on investment can be achieved.
Is focused on asset management and uses ROIC-based goals to measure success at approximately the same level of expectation as Tier 1 EMS companies.
Has a relatively long sales cycle as compared to its product life cycle.
Services a highly “mobile” customer base that has minimal capital investment in the relationship and often seeks out new suppliers as a means to drive cost reductions on new products.
Operates in an environment of rapidly shifting and continually escalating expectations.
Unlike the EMS industry, the ODM industry generally:
Is provided more “insight” into their customer’s objectives, product strategies, and market situations and can leverage this information to formulate its business and strategic planning.
Benefits from a broader-base of participation in the sub-tier supplier selection process and wields much more influence in that relationship.
Is (generally) believed to provide more value to the relationship than is provided by the EMS industry so is better positioned to avoid “incremental costs” related to new customer expectations, demands, and desires.
Has far more flexibility in managing the supply-chain and in retaining the benefit that may be derived from these activities.
While there are clearly differences between EMS and ODM companies there are also many similarities and common approaches practiced by these industries. Not surprisingly, as they are both for-profit enterprises, they are most alike in areas related to their financial management, methodologies, and objectives.
What may surprise the reader is the area of greatest difference between the EMS and ODM industries is found in their Operating Characteristics — not their Value Propositions! Further, as these industries draw closer together in both service offering and overall cost structure (i.e., on a macro basis ODMs are getting more expensive and EMS is getting cheaper) one could reasonably expect Operating Characteristics to ultimate become the only major differentiator between the industries.
WINDFALLS AND PITFALLS WITH ODMs
The ODM option offers OEMs these potential benefits:
Can provide speed, cost, and access advantages in those areas that an OEM determines to be non-core to their primary business.
Simplest strategy for growth and brand expansion, especially in product arenas that be new or unfamiliar to an OEM.
Development of strategic market inter-dependencies as exampled by an OEM that otherwise would not have the engineering expertise to independently develop a complementary product that could be “bundled” with an existing product to enhance sales. Such as a printer company that ODMs a digital camera.
Provides a means of addressing competitive weaknesses or attacking a competitor’s weaknesses, such as filling in a line-card void or being able to offer customers complete systems solutions when competitors are not.
Expanded integration of the “virtual” business model especially in the areas of product development, support, and test engineering.
Leveragability of the resource due to fragmentation within the ODM industry and the convergence that is taking place with EMS adding ODM service.
Means of mitigation for off-balance-sheet liabilities especially for Materials.
Ease of disposability by virtue of the ODMs non-core contribution and the minimum level of investment made by the OEM.
However, ODMs can also pose the following problems for OEMs:
Loss of internal expertise and competencies in design. The PWB fabrication and PCB assembly and test analogy may be a good one in projecting the probability of this risk.
Unrecoverable loss of IP and/or market opportunity. Unfortunately, this issue should probably be stated as a “certainty” versus a “potentiality” as more examples of this already occur than could possibly be quoted.
Diminishes institutional understanding of IP value with employees of the OEM as they begin to see IP as something you “buy” versus something that you “create.”
Dilution of Brand and/or differentiation, which is “inherent” in the ODM business model.
May shift organizational focus from bottom-line to top-line as more “filler” products are introduced and more heavily relied upon for revenue generation.
Unintentional creation of enterprise momentum in elimination of a capability or resource that spills over into an element core to a businesses’ success. (For example, how do you maintain an environment that assures the retention of engineers you want to keep when laying-off/eliminating their associates in wholesale numbers?)
Simultaneously increases supply and geographic exposure, i.e., not only are your ODM, but all of your ODMs’ suppliers, and all of their suppliers’ suppliers are located in China, and this entire structure is subject to the same infrastructural, monetary, and geopolitical risk factors.
Cost/complexity of maintaining adequate surveillance is many times more expensive than in other geographies and with alternative Outsourcing strategies.
The “kinetic energy risk” to the business (i.e., v2 factor, meaning that when an object, or process, is accelerated to twice its velocity it strikes with not twice but four-times the impact force.)
SUMMARY
In conclusion, the ODM alternative represents a viable methodology to address many of today’s electronic industry challenges by providing OEMs with a low-cost, high velocity means of expanding product offerings, fulfilling market opportunities and further leveraging their business models. Yet, the use of ODMs is not without risk as like in all industrial segments they operate with a distinct group of business practice. And while many of these practices may appear to be similar to those of EMS companies they are not identical and therefore require an investment in understanding, consideration and planning for the approach to be fully utilized and ultimately successful.
Tags: Global trends, Leading indicators by Charlie
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