The OEM-EMS relationship is often characterized as dysfunctional, inequitable, or broken, plus a few other choice terms that cannot be put in print. These characterizations might make for colorful discussions over drinks at an industry conference, but they do not tell us much about what is actually going wrong in the relationship. Fixing a relationship first requires a better understanding of the actual behaviors/dynamics that are causing the problem.
We therefore asked EMS companies a simple, but potentially revealing question: What are the most irritating behaviors exhibited by your OEM customers during either the sales/quoting process or the actual engagement?
Several dozen brave individuals responded after receiving guarantees of confidentiality and promises of retraining and entry into the Witness Protection Program if they were discovered by their OEM customers as having participated. Their responses proved very illuminating yet difficult to categorize due to the varied nature of the responses. Let’s therefore look at the data in the two general phases that were asked about: quoting and the actual engagement.
NOTE: These survey results are not intended to represent all problematic issues in the OEM-EMS relationship, just those reported by our respondents. I am sure others exist.
THE QUOTING PHASE:
The main issues mentioned as occurring during the quoting phase centered on:
• Data
• Money
• The vetting process
• OEM gamesmanship

DATA: In order to produce a quote an EMS actually requires data. This data sits in two related buckets: data about the actual build being requested by the OEM, and data about the business engagement with the specific OEM.

Surprisingly, (or maybe not) the lack of complete information needed to quote was the most frequently mentioned issue in the entire survey (38% of respondents). Respondents reported that incomplete, outdated, poor quality, and/or inaccurate data is often provided by OEM customers… yet the OEM still expects an accurate quote. This is akin to asking someone to quote a price for building you a new home without providing number of bedrooms, style or square footage…and expecting a good price with a perfect outcome. Not gonna happen!

Regarding the actual terms of engagement that the OEM is asking the EMS to enter into with them, 13% of our respondents reported that OEMs often fail to share strategic data such as forecasts or their Terms & Conditions (T’s & C’s) that would allow the EMS to assess whether they even wish to engage with the particular OEM. This consideration is important for the EMS and definitely influences the mark-up they would choose to apply in their quote.

MONEY: Whether you call it cost, pricing, or fee for service, money is always an issue in both the quoting and engagement phases. 29% of respondents reported concerns with OEMs that were most interested in “nickel and diming” them up front, and then insisting on continued “cost downs” or free services throughout the engagement.

THE VETTING PROCESS: Many respondents (33%) cited issues with the engagement process that OEMs force upon EMS. To begin, the vetting process is considered too long, involving multiple and sometimes repeated quoting exercises when the OEM is often only trying to get a benchmark so they can squeeze their existing supplier. Several respondents also reported that after a lengthy vetting process the OEM had actually disqualified them for not having a facility in a low cost region, a fact that was apparent at the outset of the process. Many respondents also reported irritation at the “hurry up and wait” attitude wherein OEMs expect quick responses from the EMS while the OEM themselves are slow to respond to the EMS requests for further data and needed clarifications.

OEM GAMESMANSHIP: Business is all about winning and gaining advantage, but a fair number of respondents (21%) cited OEM behaviors that they found especially irritating. These included:
• Overstating the size of the opportunity or using unrealistic forecasts to get a lower price.
• Expecting certain services (e.g., testing), but leaving them out of the RFQ.
• Quoting only for benchmarking purposes.
• Requesting repeated quotes on the same BOM.

EMS companies have limited resources and would prefer to engage in quoting activities only if they have a real chance of winning the business and being allowed to earn a decent return.

THE ENGAGEMENT PHASE:
The main issues mentioned as occurring during the engagement phase centered on:
• Materials
• Changes
• OEM manufacturing support
MATERIALS: As in any for-profit enterprise, the EMS industry achieves its gross-margin by applying a mark-up to the underlying elements of Cost of Goods Sold which includes Labor, Overhead and Materials. OEMs try to save money and defer liability to their EMS partners in this area. So it is not surprising that this would be a sensitive area for our EMS respondents. A large proportion of our respondents (28%) cited concerns with OEMs in this area. The main issues were: disagreement over component liability, disagreement over lead times, and receiving insufficient and/or bad parts when the OEM is kitting material to the EMS. These issues result in the EMS having to devote more time trying to negotiate and resolve the challenges. And time, as they say, is money.
CHANGES: Electronics manufacturing is often portrayed as a perfectly rational, linear process, but in reality it is always changing based primarily on OEM actions. 15% of respondents cited OEM actions such as: changing their requirements between the quoting and engagement phases; changing or cancelling orders with little notice and with an “oblivious attitude to the impact of the changes on the EMS”; and shortening their delivery expectations once the engagement begins.
OEM MANUFACTURING SUPPORT: 18% of respondents cited issues with the oversight provided by OEMs during the engagement that caused them problems. The majority of these related to the perceived lack of manufacturing knowledge that their OEM customers possess. The other respondents commented on issues of OEM internal disconnects that made satisfying their requirements more challenging. This included different objectives between manufacturing and quality, and between purchasing and engineering especially in regards to changes in specifications.

WHAT DOES IT MEAN?
Based on these results, some OEMs do not need a manufacturing partner…they need a magician.
Good relationships require two basic ingredients: good communications and honesty. Consistency in these areas allows trust to develop. If an OEM is interested in having their EMS perform optimally, then they must acknowledge and address the behaviors that are hindering performance.
After decades of over-capacity in the contract manufacturing services industry, and companies like Foxconn stealing market share through questionable business practices, it isn’t surprising that OEMs have gotten used to a master-slave type relationship with their EMS. However, the times are changing. With the continuing consolidation and shrinkage in the industry, and a substantial number of EMS and ODM companies exiting the services business model altogether, it might be worthwhile for OEMs to consider taking a closer look at this relationship. A good place to start might be asking your EMS suppliers the same question that we posed in our survey.

In the closing paragraph of article number 6 of this Risk Series I mentioned that “Risk is not always a noun (i.e. a probability) as it can also be a transitive verb (an actual exposure) and in the world of business its many underlying elements tend to pile one on top of another.” When I wrote these words, in my mind’s eye, I saw a stack of irregularly shaped blocks struggling to remain vertical. The vision of a Jenga game where no one wins as each bock is so interdependently connected that if even one was removed the entire pile would topple.

Not a pretty picture but here’s what it looked like…

At the top of the stack was the destabilizing influence of price reductions during periods of increasing cost being wobbled by the reduction of internal resources at OEMS just below it, then in the middle a shrinking demand cycle struggling to counterbalance the ever increasing velocity of change in business, and on the bottom, the process of geographic concentration slowing crushing the principle of institutional continuity out of shape.

But it wasn’t this image that worried me the most, as we spend a great deal of time at CBA thinking about how these individual pieces interact AND how their shapes evolve over time.

What worried me was the platform they were sitting on, a three legged stool of:

• Unpredictable capital markets
• Geopolitical unrest and instability
• Overtaxed infrastructure in low cost regions

Why are these three elements so worrisome? Because, in spite of what you might see or hear from your favorite news source, geopolitical and geo-economics outcomes are simply beyond anyone’s ability to forecast.

Meteorological analysis is a good comparable, as even after centuries of study and the development of very sophisticated modeling software running on the world’s best supercomputers the farther you go out in time with weather forecasts the broader the range of error becomes. Same-day forecasts are usually pretty good, five to seven day projections are a crap-shoot and beyond that it literally becomes a “guess”.  The reason is simple; there are just too many variables. A butterfly flaps its wings in Singapore and three weeks later a hurricane begins to form over the Atlantic Ocean.

So given this reality how do you deal with unmanageable risks?

Our recommendation is “change the game.”  Playing Jenga in business is a bad idea to start with but then doing it on an unstable, unpredictable platform makes it even worst. A better game would be one that eliminates the “vertical stacking” of risk variables so that when the platform does begin to shake (which it inevitably will even if we can’t predict when) the blocks might move around a bit but hopefully won’t all fall off the stool.

What’s better than Jenga?

How about going back to the basics, like the fundamental tenets of business that we all learned and have practiced for many years? I know you know them…

• Create innovative products
• Produce them to high standards
• Sell them at competitive prices
• Enrich the customer experience
• Build lasting value for your stakeholders
• Be a good corporate citizen

Obviously each of these objectives can be fulfilled in countless ways, which is exactly as it should be. Business is all about creativity and competition; no one deserves or is given a free-pass. Success is only granted to those who are the most creative and diligent and then only until they are replaced by someone who can play the game even better.

This means that winning isn’t easy and unfortunately, perhaps because of human nature – perhaps because we’ve lost our moral compass, it has become far too easy to drift off the highroad into a swampland composed of…

• Me too solutions
• Marginal quality
• Pricing gamesmanship
• Enriching yourself at your customers’ expense
• Short term thinking
• Exploitation

Which I believe is the poisoned well from which excessive risk springs.

In this series we have reviewed each of the nine elements of risk that have more than doubled our Composite Business Index over the past four years.

Including:

1. Prices are down but costs are up
2. Fewer resources at OEMs worldwide
3. The demand cycle has shortened
4. Businesses are operating at higher velocities
5. Supply chain concentration in Asia
6. Loss of institutional continuity
7. Unpredictable capital markets
8. Geopolitical unrest and instability
9. Overtaxed infrastructure in low cost regions

Wherever possible we have offered suggestions and alternatives. Where options were few we have provided insights gained from watching this situation develop.  We have tried to be direct and unambiguous in our presentation of the facts.

We have already notified our Outsourcing Navigator Council membership that we have raised our risk advice to “LIKELY” meaning that on an industry average basis it is now likely that an OEM will experience a serious disruption in their supply-solution in CY2012.

Yes, the current situation is that bad.

Bottom-line, do yourself and your stakeholders a favor and do something – TODAY – to start mitigating risk. Looking over your shoulder is a waste time you can’t afford; the risk is directly in front of you!

Jobs seems to have attended the Joseph Stalin Charm School: his world was one of clear good and evil; he was a constant liar, in what came to be known among his underlings as his “reality distortion field”; he was “anti-loyal,” abandoning people he was close to; he used silences and unblinking stares to shame people; he held show trials, bringing employees of a failed project into an auditorium, telling them they should hate each other, and firing the leader on the spot. Thus, when I read about Jobs’s praising China to President Obama, I suspected that Jobs liked outsourcing, not just as a profitable business decision but also on a deeper level. Contemporary China has found a way to combine, for outcomes positive and devastating, some of the most abysmal features of 19th century laissez-faire capitalism and 20th century totalitarian dictatorships. This is a combination that would seem to have felt very comfortable for Steve Jobs, as long as he was in charge. Apple has long been infamous for opposing open access and more collaborative computing cultures. Its hardware and software have always been untouchable, unmodifiable, and manufactured for each other alone. Apple tells consumers what they want and what they will get. Its design aesthetic is stark, minimalist, white. Apple’s massive growth in the last eight years to becoming the single most valuable publicly traded company in the world is not entirely explained by the thesis that Apple products are great, or that the company was early to take advantage of wireless broadband, or that Apple’s time had come when we all began to see computers as lifestyle accessories. For every era gets the companies it deserves. A brand of cleanness and simplicity, of chipperly trading control for efficiency, seems particularly well suited for a time when people have lost faith in an incompetent, messy, gridlocked, shallow democracy and in our fragilely recovering economy. Better an iPhone than Il Duce, of course, to make the trains run on time—or at least to tell you how to get to Penn Station—but totalitarian shadows probably should not fall over the products we crave, in how they are made or why we love them. Nor should the manufacture and the appeal of our most desired products reach the same conclusion: that people are much less than our machines.

So what should we do? Mike Daisey’s printed-out suggestions distributed after the show—talk to Apple, be aware, spread the word—conclude with a limp suggestion that is slightly less than storm-the-barricades: upgrade less often. Yet there aren’t a lot of other obvious answers. For there is a paradox of virtue, a cousin to Keynes’s paradox of thrift (where spending less and saving more is individually a good thing but bad for general economic health). Refusing to spend money on any product unless it is ethically manufactured is indisputably right. However, refusing to spend money—or feeling guilty for doing so—traps us both backward and forward. The backward trap comes from wishing that the Foxconn factories did not exist. In 1980, China’s GDP per capita was near the bottom of any country in the world—half the level of Sudan, for instance. By 2010, China’s GDP per capita had increased thirteen times and is now three times higher than Sudan’s. The teenagers coming to Foxconn factories to be dehumanized into machine parts often started their lives in rural villages where life is arguably worse. China’s suicide rate is the highest in the world, 287,000 people each year. But the rate in rural areas is three times higher than in urban ones. However ugly and unforgivable the conditions of factories in China, however frightening and potentially fatal China’s environmental and foreign policies, basic economic development there—and the increased human happiness—is hard to wish away.

The other trap comes when we think about the future. If we stop buying Chinese products unless workers there are immediately treated and paid better, Chinese exports will fall, Chinese people will lose their quality of life gains, and the US government spending (paid for by debt bought by the Chinese) will have to be drastically cut. Is there any way out of the trap of wanting to buy ethically? One solution, at least to the specific issues of the conditions in Chinese factories, will be time. Eventually, the surplus of Chinese workers willing to work under brutal conditions will dry up. Chinese wages will rise, workers will organize, conditions will improve, or the Chinese currency will inflate, and Chinese exports will lose some of their price competitiveness. This is starting to happen now. However, the likely result of is only that outsourced factories will move to other countries and find other workers for whom factory life is better than, well, subsistence rural life. A solution that we can participate in is to be willing to pay more for products that are manufactured or sold ethically. This happens all the time, at farmer’s markets and independent bookstores. But most people don’t have the luxury of paying more for everything.

Certain corporate leaders, who’ve been making 40 percent gross margins, do have that luxury. We are back to Mike Daisey’s fantasy. Had Steve Jobs never lived, there would probably be the same number of workers in Foxconn factories and their treatment would likely have been no better or worse. But Daisey is right that Jobs was in a unique position to make a difference had he decided that it was OK to be slightly less profitable by being significantly more humane. Jobs’s legacy as the lovably jerky Edison of our time ignores that he wanted us to believe that there is an escape from life into cleanly designed and efficient technology, and that only a ruthless dictator could show it to us. It ignores that many of his products were manufactured with child labor in brutally efficient factories. “Out of the crooked timber of humanity,” Kant wrote, “no straight thing was ever made.” Not even an iPad.

The issues surrounding this risk factor are subtle and difficult because they pertain to the fabric of the outsourcing rationale, and theoretically have been resolved ages ago. What we mean by institutional continuity could be confused with the concept of ‘core competency’. As most will recall, companies were advised to outsource all but those activities that were considered ‘core.’

I want to be crystal clear about this: institutional continuity is not related to the ‘core competency’ of an organization. I have always felt that the latter was a very misleading concept. Why is it useful to consider activities in this manner? Does it mean that a company has ‘core incompetencies’? Outsourcing something you can’t do very well is obviously very risky; and the current state of many of the outsourcing relationships we observe in our consulting practice proves how risky it is. Most OEMs are not satisfied with their EMS supply solution, in spite of the ‘master-slave’ power imbalance that exists.

The loss I am talking about is deeper than the core competency discussion indicates.

Institutional continuity is what is elemental in an organization. It  relates to the way business is conducted, the company’s history and purpose; and how and why it exists. Does outsourcing in itself break institutional continuity? Not necessarily. But when you outsource everything – not just manufacturing, but design, logistics, customer service, accounting, IS/IT, and human resources – the system does break down, and I see that happening in some OEMs, especially in the past few years. So many pieces have been removed from the flow of the organization’s value stream that the value begins to leak out the holes.

To illustrate: in the US we have a Constitution, which has been the law of our land for nearly 230 years. Its power comes from the fact that it hasn’t changed much, so a body of law can be developed based on the expectation of continuity. Some people think certain parts are too flexible in fact, e.g. the Commerce Clause, originally meant to limit Federal power over the states, has been interpreted to allow most anything.

But what if we did change the Bill of Rights and other parts of actual Constitution itself every decade or so? What if, like at the state level, it was easier to amend? What if during some difficult times we threw out altogether the First Amendment guaranteeing freedom of speech, or the Fourth Amendment prohibiting unreasonable search and seizure. There would be far less stability in the courts, and among lawmakers and eventually the country would no doubt devolve into chaos.

This is the risk we are talking about related to loss of institutional continuity. It is why businesses fail — they lose their sense of purpose and some central competitive advantage slips away. This can happen at any size company, in any industry, and outsourcing too much, too often, can be a symptom, but it isn’t the disease itself.

In electronics companies, where innovative products are part of the institution’s DNA, outsourcing the manufacturing of those products can lead to a loss of the ability to find the competitive advantage in this skillset. I can’t tell you how many times we hear OEM outsourcing managers saying that all EMS companies are the same. Granted, the marketing departments in the EMS industry sometimes fail to communicate their company’s unique value. But the OEM has often lost the insights required to identify, understand, evaluate and, most importantly, leverage the unique and varied capabilities that exist in the EMS industry. CBA will be talking more about this in future blogs.

Look at Hewlett Packard. This company began when two EE’s, Bill Hewlett and David Packard, started building test equipment. The company’s history with these two men has always been part of the institutional continuity of HP. I remember visiting the company and seeing the two partners’ desks left intact since their retirement. Now, I wonder how potent that history is for HP — and if this isn’t a good example of the risks associated with loss of continuity as the company has considered abandoning hardware altogether. Certainly HP has faltered in the past 18 months.

In chasing “low cost” at any price, many electronics companies have taken their eye off the ball of their own businesses. And continue the sports analogy, it is similar to what happened to the San Francisco 49ers football team.  In the 1980’s the 49ers developed the most replicated model in professional football, the aptly named “West Coast Offense.”  This was the brainchild of legendary coach Bill Walsh, facilitated by owner Eddie DeBartolo, and executed by Hall of Fame quarterback Joe Montana.  Deploying this model, the 49ers won five Super Bowls and were named the “Team of the 80’s.”  Then in the late 1990’s things started to go wrong.  A new owner, a series of new coaches, and various quarterbacks thought they could easily continue the success of the franchise while also changing the underlying factors that had allowed the team to be successful.  The team was losing its institutional continuity. One coach, Hall of Fame linebacker Mike Singletary, even stated that the position of quarterback was not the most important position on the team.  How wrong he was!  The result was that the 49ers have been a sub-par team for over a decade and have not made the playoffs.  They are only now reclaiming some of their past glory,  by many accounts by going back to the principles and style that initially made them great.

Risk is not always a noun (i.e. a probability), it can also be a transitive verb (an actual exposure) and in the world of business its many underlying elements – including loss of institutional continuity – tend to pile one on top of another. Until ultimately, we see them show up as the 40% increase we’ve recorded over the past four year in the Composite Business Risk Index.

I think it’s time to say “enough is enough” and start thinking about how to recover what we have lost versus focusing on what else we can change.

http://charliebarnhart.com/gpm-webinar/

http://charliebarnhart.com/oems-internal-spend/

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McDonald’s drops egg supplier after animal cruelty footage
McDonald’s will be looking for a new egg supplier after Mercy For Animals released footage from an undercover investigation of animal cruelty at Sparboe Egg Farms, a supplier.

What if these stories were in today’s news?

Widespread Destruction
The morning after China was struck by the most powerful earthquake to hit the nation in recorded history the disaster’s massive impact is only beginning to be revealed. Rescue efforts began with first light as military helicopters plucked survivors from roofs and carried them to safety. The 8.9-magnitude temblor, centered near the east coast of China, killed hundreds of thousands of people, caused the formation of 30-foot walls of water that swept across rice fields, engulfed entire towns, dragged houses onto highways, and tossed cars like toys.

“There are a huge number of little bits of the high-tech food chain which are done nowhere but in China,” Jane Doe, senior investment manager of MMM Equity said. “Nobody else has the capacity, and in some cases the technology, to do it.”

Hopefully by this point you’ve realized that these news articles were actually from the horrible catastrophe that struck Tohoku, Japan on March the 11th, 2011. The only thing we’ve changed in the copy was the geographic location, the scale of impact (i.e. increased the numbers in these stories to reflect the differences in the populations in these two areas) and the names of the entities cited.

But what if it really had happened in China instead of Japan? What would the impact have been on the global electronic industry?

We are not going to argue the proportional concentration of electronics related resources in Japan versus China or quote endless statistics on what percentage of this type of material or that type part are controlled in which geography. Everyone has their favorite source for this data and we encourage the reader to select whichever they feel most comfortable using; we all know what the reality of the situation is.

Over the past decade the global electronics supply-chain has migrated to Asia with the majority of it concentrated in the river delta, industrial hubs of China.

Bottom-line: if a Tohoku type of event occurred in one of these regions of China today it wouldn’t be weeks or months for the industry to recover, it would be years. Global businesses would lose billions if not tens of billions of dollars in revenue, lay-offs would be in epidemic proportions, even enterprises with rock-solid balance-sheet would immediately switch to a survival mode of operation (i.e. meaning there would be widespread failure of any supplier/service provider whose business was related to either discretionary or B to B spend) and some significant percentage of OEMs reliant on a commodity-based business model would simply go out of business.

It’s harder to think of things that wouldn’t be impacted, than to think of those that would.

We have a model for what happens when a critical resource is concentrated in just a few areas, like oil. Supply and demand is artificially managed (to control prices), geopolitics vs. the market dynamic becomes the basis of distribution and strategic interests are protected (read: wars are fought). Not a pretty picture.

Are we overstating the probable outcome? Perhaps, but to be honest we don’t think so. What we do know for certain is that a gentleman named Edward Aloysius Murphy, Jr. once said “Anything that can go wrong will go wrong.” I just hope the term “China Syndrome” doesn’t end-up taking on a whole new meaning.

Closing note: We apologize to anyone we may have offended by using the consequences of the Tohoku tragedy in this article to make a literary point. Our hearts go out to the people of Japan and those around the world who were impacted by this cataclysmic event. We recognize that it was not only a natural disaster but a human one as well.

NEXT ARTICLE: Risk Factor #6: Loss of institutional continuity

(Part four of a nine part series on why risk in the global electronics industry has increased over 45% in the past four years)

In the first three article of this series we talked about…

1.) OEMs demanding continual, on-going price reductions even during times when costs are clearly going up, not down. Article link>>

2) How this disintegration of respect for the supply-chain has resulted in some OEMs now targeting employees managing outsourcing programs for elimination. Article link>>

3.) When the demand-cycle shortens the supply-solution needs to be shortened. Article link>>

These are three issues deeply rooted in cost-cutting. Pay less for what you buy, buy it with fewer people and (heaven forbid) never hold any inventory. Sounds like Wal-Mart. I suspect you never thought you would be working for ‘Wal-Mart’ when you spent all that time preparing for a career in high-tech, huh? Bummer; get over it.

Anyway, now we are going to shift (in this and the next two articles) away from cost cutting and look at how a company’s business processes can result in added risk. In other words, what I call systemic migration to core-incompetency.

Let’s start by agreeing that Business is an inherently risky proposition and today’s maximum velocity business models based on complex, highly leveraged solutions make the situation even worse. Nevertheless, the trend is clear, electronic branding companies (or OEMs) continue to outsource more functions, more often, to more geographically remote locations than ever before.

Why do they do this?

Some might say they do it to coldheartedly bolster corporate profits by chasing low-cost labor around the world, and given the often negative human impact resulting from laissez-faire globalization the argument seems… well, compelling. But to gain competitive advantage in today’s highly commoditized marketplace, where every competitor exploits every other competitor’s slightest weakness (perceived or actual), velocity (versus innovation) seems to be the name of the game.

So what is a conscientious manager to do?

1. Acknowledge that high velocity means higher risk
2. Accept accountability for any issues resulting from this risk and (at least try to) do something about it.

While this may seem an unreasonable burden to place on the already hard-working folks who manage outsourcing solutions, consider who loses the most when your company’s customers’ orders go unfulfilled, or when your company fails to meet its financial commitments, or when your CEO can’t report an ever increasing level of profitability to Wall Street. Like it or not, the bottom-line is that the bottom line dictates whether your job will ultimately be at risk. Hey, someone has to be held responsible and you can bet your severance pay it won’t be anyone on Mahogany Row!

A good example of what we are talking about would be when an OEM decides to use an Original Design Manufacturer (or ODM) for a new product, as this decision is typically made to provide both a lower design cost and increased velocity in product introduction.

So what are the risks?

Starting with lower design costs the most applicable pitfall is unintentional creation of enterprise momentum as performing product design outside the company can result in the elimination of a capability or resource core to a business’ success (i.e. thus making it a core-incompetency!)

So how does a manager mitigate the risk of this happening?

The first step is to understand and estimate the impact related to the potential risks. In our ODM example a typical risk element could be:

That a key engineer decides to ‘jump ship’ as a result of seeing his or her co-workers being laid-off or passed over for additional training as a result of designs being outsourced.

And should this key engineer leave the organization, what would it cost to replace him or her? Or even worse, what are the potential costs of losing a key person to a competitor?

One way to estimate this would be to ask, does the probability of this happening, multiplied times the cost of replacing him or her and the lost revenue resulting from the exit of this key person produce a number larger than the potential saving from outsourcing the design?

If the answer is yes, then using an ODM is simply too risky.

Relative to the advantage of reduced time-to-market, the question is will the advantage gained by using an ODM really produce a benefit that exceeds the inherent risk associated with a higher velocity solution? A more difficult but not impossible question to answer as one of the potential pitfalls with the ODM model is what CBA has labeled “The theoretical kinetic energy risk to business (i.e., the v² factor).”

Let me explain. Physics tells us that kinetic energy, or the energy of motion, is calculated as one-half the mass of an object, times the objects velocity squared.

Kinetic energy = ½ mass _X velocity²

In other words, the larger something is or the faster it moves the more kinetic energy it possesses. But there is an interesting consequence in the final element of the equation: velocity squared. As whenever you multiply a number by itself, the product increases geometrically not linearly.

Let’s take a look at an example to see what this means.

If you square the number 2, the answer is 4. But if you square the number 3, the answer is 9, an increase of 225% for only a 50% increase in the original number. Throw a stone just a little faster and it impacts its target with considerably more force. Or reduce the time-to-market by increasing the velocity of the process and risk grows dramatically. Even as a theory, it is a very scary thought.

If you attended a business school you probably remember learning about the “potential energy” effect, which is the force accumulated within an enterprise as it grows larger. You were probably taught that if left unmanaged this force will eventually bring an organization tumbling down. The analogy in nature from which this effect is derived is that whenever you lift an object the process instills into it potential energy and this energy remains within the object until it falls back to its original height. In the case of nature this energy is derivative of gravity, in the case of business it is a function of chaos theory.

So the kinetic energy risk has a well-documented parallel in business and a strong basis in common sense. There is little doubt; using an ODM solution to reduce time-to-market will increase risk and it will increase it exponentially as the time element is reduced.

Bottom-line, perhaps a little paranoia about increasing the velocity of business processes would be wise. Remember, paranoia is only a disease when they aren’t out to get you! Given what’s going on today in the electronics industry, the economy, the US, and the world – a little paranoia seems more than justified.

NEXT ARTICLE: Risk Factor #5: Supply Chain concentration in Asia

(Part three of a nine part series on why risk in the global electronics industry has increased over 45% in the past four years)

In the first article of this series we wrote about OEMs demanding continual, on-going price reductions even during times when costs are clearly going up (not down) and why this practice damages everyone involved with the transaction. Then in the second article we reported on how the dramatic drop in respect for the value of the supply chain has resulted in OEMs targeting their own employees (especially those who manage outsourcing programs) for elimination. What we called the pink slip approach to a better bottom line.

On the surface all of the above seems irrational — the extreme of foot-shooting. But maybe something in the demand cycle has changed in some profound way that would justify these actions? Let’s take a deeper look.

• Have product volumes increased so dramatically that economies-of-scale are offsetting escalating costs? Ah, sadly, no… volume and batch sizes are down across most sectors.
• Have OEMs moved their supply solution geographically closer to their enterprise thus requiring less administrative support? Ah, again, no…  OEMs are outsourcing more tasks, more often, to locations that are more geographically remote.
• Has the demand cycle lengthened, which would add flexibility to enable these actions? Ah, definitely no to that!

In fact the demand cycle, or the time span between when a consumer orders a product and when they expect to receive it, has shortened — dramatically. And this is true in virtually every market the industry serves. No one wants to wait, for anything. It doesn’t matter if it’s a consumer, commercial or industrial product, the buyer wants the purchase delivered immediately. Therefore most OEMs simply don’t know what they need until something is sold and then they need it right away.

Hasn’t this always been the case?

Yes but not to the extreme it is today. Back in the day when business was practiced as an art form by well-seasoned professionals, OEMs maintained finished goods inventories and operated in-house manufacturing capabilities (in addition to outsourcing) which dramatically improved their response times. Did this increase their inventory levels? Of course it did.

Yet, it worked.

It was a cost of doing business and as with any cost it needed to be carefully managed and controlled but successful companies learned to use it as a competitive advantage. Then we decided it was an outdated approach that needed to be replaced.

For a few years Lean looked like the answer but Western industry simply couldn’t bring itself to fully embrace the approach with its many operational disciplines. And a half-hearted Lean implementation is a bit like what they say about being half pregnant. It’s impossible.

So we ended up with today’s dysfunctional pathology where OEMs refuse to place firm commitments, the outsourcing industry is afraid to order anything until the last possible minute, the downstream supply chain routinely labels everything as non-cancelable/non-returnable, and the “overnight delivery” service industry reaps the rewards of everyone else being behind the demand curve.

A geographically remote, highly fragmented, sequential solution driven by a forecast based model intended to provide a strategic just-in-time-requirement via a tactical solution called Outsourcing. Does anyone believe this is working?

If not, what is the answer?

Maybe it is time to rethink where we’ve been. If we can’t bring ourselves to fully embrace Lean then maybe it is time to try something we know will work. If the demand cycle has shortened then the supply solution needs to be shortened to facilitate the requirement. We know that building in the region for the region (be it internal or external) speeds things up and is easier to administer than a cross-hemispheric solution spread over a dozen time zones and we know that a carefully managed finished-goods inventory speeds-up a company’s ability to respond. These are known quantities.

Will this transition be easy? No but who ever said business was supposed to be easy?

Will it cost more than today’s solution? Yes, especially in the short-term.

Will it work? Yes.

Bottom-line, successful long-term businesses are not built by leveraging short-term advantages out of the supply chain or padding margins via reductions in staffing levels. Nor do they ignore the realities of the market dynamic; when the demand cycle shortens, it’s time to shorten the supply-solution. The alternative is a continually escalating level of RISK!

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