The rising role of electronics manufacturing services (EMS) providers and original design manufacturers (ODMs) in the electronics industry has spurred a power shift in electronics supply chain management. In supply chains where EMS providers or ODMs play a role, OEMs and their purchasing departments no longer hold dictatorial authority over decisions regarding which component suppliers to work with and which parts to buy. Instead, EMS and ODM companies have achieved parity with many OEMs when it comes to power over such purchasing decisions.
This separation of purchasing power often has created chaos in the supply chain. In some cases, unclear delegation of supply chain authority has made it difficult for electronic component suppliers to identify the right company or group to work with. Long-term, mutually beneficial relationships between certain suppliers and OEMs have suffered, as EMS/ODM providers with their own supplier strategies have entered the equation.
With decision-making authority for purchasing split between OEMs and EMS/ODM companies, the most successful suppliers, OEMs and EMS/ODMs will be those that understand how decentralized decision-making coalitions work, and that can create the supply chain coalitions that best achieve their goals. Because of the inclusion of a third-party contract manufacturer, both the supplier and the EMS companies become more powerful relative to the OEM. All three participants--the OEM, EMS and supplier--have much to lose if they do not wield their combined supply chain power intelligently.
Thus, the winners in the electronics supply chain will be those that are the best supply chain "politicians," adept at influencing others and building coalitions.
Production by the EMS/ODM industry, collectively called the contract manufacturing business, amounted to $127.9 billion in 2003, placing 33 percent of total electronic component purchase orders (POs) or material cost for the year. Contract manufacturing revenue is projected to rise to $229.6 billion in 2007 and the industry will account for 48 percent of total electronics material cost, as seen in the figure at the bottom of page 20.
The electronics supply chain has been fundamentally altered by the rise of contract manufacturing purchasing. In the past, OEMs worked directly with their component suppliers and assembled subsystems and built boxes in-house. OEMs had complete visibility of all their component suppliers and exercised total control. Of course, running electronics supply chains has never been easy, and even under the control of one company, issues such as centralized or decentralized supply chain decision making have always been controversial. However, with today's contract manufacturing model, the supply chain is now more complicated, as illustrated in the figure on page 19.
The added complexity contract manufacturing has brought to the supply chain has led to new areas of uncertainty regarding supply chain decisions. These include:
Which company--OEM or contract manufacturer--selects components?
Which company chooses component suppliers?
Which company negotiates with the component suppliers?
Who controls the supply chain?
The answers to these questions are unclear. These and other uncertainties have caused significant supply chain disruptions, inefficiencies and added cost.
Conflicts between OEMs and contract manufacturers over buying practices have become common nowadays. Meanwhile, many suppliers simply don't know who to sell to--or even how to sell--anymore.
In the new electronics supply chain, authority over purchasing decisions increasingly is distributed among OEMs and their contract manufacturers.
To understand how this divided authority works, we can use Shapely values, a tool from game theory (see "Game Theory in Supply Chain Management," on page 22). Shapely values are calculable and objective representations of power distribution among independent groups. These values are represented as fractions of 1, where any coalition achieving a value greater than 0.5 can dictate terms to everyone else.
The chart at the top of the page shows Shapely values applied to electronics purchasing decision-making power when dealing with multisourced parts. The OEM purchasing column shows, on the left, how power is distributed when there is no contract manufacturing involvement--the status quo for most supply chains before the major outsourcing trend began. The column on the right illustrates how the situation changes when contract manufacturing is involved.
With no contract manufacturing involvement, the OEM purchasing department holds enough power to dictate terms to everyone else. With a Shapely value of 0.5, purchasing can unilaterally decide which approved supplier gets an order. The next most powerful group is OEM engineering, which can change specifications to make it harder or easier for them. OEM engineering's Shapely value is typically around 0.3. The supplier, at most, had the remaining 0.2, which represents the least amount of power.
In this arrangement, the system was somewhat akin to a dictatorship, with OEM purchasing departments holding almost absolute power over buying decisions. Suppliers represent the downtrodden underclass, with little say in decision making--unless they can forge covert alliances with OEM engineering to change specifications to make them a sole source. If they accomplish this, the supplier/OEM engineering coalition could gain equal power. However, well-managed OEMs have specific processes in place to ensure such coalitions cannot develop.
When EMS companies get involved, buying decisions become a more egalitarian affair. As the figure at the top of page 20 indicates, when dealing with multisourced components, and with contract manufacturing involved, vague contract terms and strong personalities often create situations in which all five parties can have equal Shapely values of 0.2.
In effect, when OEMs work with EMS/ODM companies, they must give away some of their supply chain power to contract manufacturers. The result is that all parties often have close to equal power--and no single player can hold sway on its own.
The best politician
In this new, more egalitarian environment, the best supply chain politician holds the real power. Today, few companies are aware of how the system works, so it's no wonder there's so much suspicion and chaos. Short of eliminating contract manufacturers, all supply chain participants must learn how to influence the supply chain portions controlled by others.
OEMs have much to win or lose by managing their supply chains properly. Because the top 20 electronic component buyers control more than 50 percent of all the components used, the interests and the strategies of the largest OEMs differ from those of the rest of the players. The biggest OEMs will gain the greatest competitive advantage by giving the least amount of power to their EMS prociders. Most midtier OEMs will have more to gain by structuring their EMS/ODM contracts so that the power inherent in managing the different critical supply chain processes is shared.
Suppliers face a critical choice: Take advantage of those of their OEM and EMS customers that are unversed in supply chain politics, or choose sides and help either the OEM or the EMS take the most profit out of the supply chain. If they help the winning side, then they will reap long-term rewards; if they help the losing side, they will be exiled. This is a dangerous game to play for those who don't know the rules.
Ultimately, the OEM, EMS provider and supplier can greatly improve supply chain performance and cost by managing the relationships to produce mutually beneficial and desired goals.
In many cases, the real-world relationships between OEMs and their EMS providers do not engender much trust from either side. But it is possible for EMS companies to change that equation by departing from tradition and offering informal incentives to OEMs to engage in more cooperative relationships.
Such incentives can take the form of additional free services whose value is just great enough to exceed any benefit an OEM can reap from maintaining a closed relationship with an EMS provider. Examples include testing, or removing some of the inventory burden from the OEM. By moving away from the traditional profit-split arrangement used in manufacturing outsourcing agreements, the OEM/EMS relationship can adopt a structure built on cooperation, trust and mutual benefit.
Contact Derek Lidow at email@example.com.