Outsourcing is an important part of the modern manufacturing landscape. In fact, in many cases, your contract manufacturer (“CM”) represents your most important and complex supplier relationship. If you need to switch CMs, the cost, risk, and disruption to your business can be significant. For this reason alone, you should apply significant due diligence before you embark on a business relationship of this type. Your CM should not be viewed as a supplier in which you have a simple buy/sell relationship, but one that is considered as an extension of your manufacturing operations with interdependent processes, tools, and systems that enable you to respond to change orders, ramp-up on short notice, mitigate your liabilities, and ensure shipment of quality products to your customers.
In our practice, we are often surprised by the speed and hastiness with which a CM is selected by OEMs, leading to unintended consequences such as delayed new product introductions, increased costs, increased inventory exposure, and missed shipments. While there are many factors and criteria that go into in selecting the right CM, in this newsletter, we will discuss some of the more critical steps.
Filter the candidates before the RFP/RFQ
In the majority of cases, a pre-existing relationship between some of the personnel at the OEM and the CM, or a simple web search becomes the starting point for communication between the two parties. Driven by an NPI schedule, cost reduction target, or capacity requirement, an RFP/RFQ is submitted along with a BOM (bill-of-materials) and the back and forth cycle begins. Logical as it may seem, we believe this approach to be a false start for several reasons. First, experience shows us that you need to know what you want before you reach out to any CM. This requires collaboration between multiple parts of the organization such as engineering, quality, and manufacturing, not just materials and procurement. Second, it is important to know how interested and committed the CM’s management team is before launching the RFP/RFQ package. This means that you need to have initial discussions to gauge alignment in areas like opportunity size, fit in technology and process capabilities, management style, manufacturing footprint, etc. Finally, you want to be very selective in who receives the RFP/RFQ, knowing that the time you spend analyzing the CM proposals is limited to those that are a strong fit as determined by your initial filters. In nearly all of our CM sourcing engagements, we facilitate internal, cross-functional meetings, the output of which is a requirements document, defining weighted criteria that are unanimously approved by key stakeholders. And prior to submitting any RFP/RFQs, we hold conference calls in which we communicate our high level requirements, ask about the CM’s capabilities, and finally ask the CM contenders: “does our client’s business interest you enough for them to have significant mindshare in your company”? If the answer is anything less than a resounding “yes”, that should serve as a red flag.
Strive for transparency and win/win
The last thing you want in a CM selection process is surprises that either force you into a questionable business relationship due to time pressures, or result in starting the entire project again. This is where your RFP/RFQ process needs to be bulletproof and outline precisely what you are looking for. As an example, what level of transparency do you require in terms of visibility to the costed BOM, mark-ups, rate structures, overhead, and profit? How much data will you want about the internal manufacturing operations like work-in-process yields or lower level inventory levels? What level of transparency are you willing to offer about your product roadmap, current challenges, and existing cost structure (of course without breaching any third party confidentiality requirements)? The key is to approach your sourcing efforts with a win/win mindset where both sides see the upside for being transparent with one another. In one recent CM sourcing project that we completed for a client, we set expectations early with the CMs on the type of relationship we wanted for our OEM client and the level of transparency our client needed and was willing to give. This enabled some productive conversations with two potential CMs and helped us weed out another one that was more guarded and wanted an arms-length relationship.
Set realistic and balanced expectations
A common complaint from CMs is that OEMs often walk in with an overly optimistic forecast and timeline for moving the business. While this may lead to a lot of excitement in the short-term, the moment the CM realizes what the true picture is after the award of business, prices go up, responsiveness goes down, and the relationship sours. The OEM’s supply chain team, now in the uncomfortable position of explaining to management why the projected cost savings have suddenly disappeared, applies even more pressure on the CM causing further strain, and the downward spiral continues. It is also worth noting that responsiveness is a two way street and that as an OEM, you will need to do your part in keeping the communication momentum. If you expect a quick turnaround on quotes, questions, or inquiries, then you must prepare to reciprocate. This means working internally with engineering, quality, component engineering, and purchasing in advance to ensure they are reasonably available to answer your CM’s questions at the same pace as you expect from CMs. Remember that the “I’m the customer and you’re the supplier” paradigm does not serve you well in this type of supplier relationship where collaboration is critical to achieving excellent results.
Establish framework for a contract
One of the mistakes we often see in this type of sourcing project is what we call the dueling red-lines. It starts when some well-intentioned person sends a boilerplate contract for the other side to review and provide feedback. Typically there has been no discussion between the parties on a framework or any discussion about the musts, wants, and priorities. This, combined with the fact that most boilerplate contracts favor the drafter, leads to both sides staking out their positions in red-line contracts that fly back and forth. This is not a productive way to start a relationship. In the RFP phase, you should articulate 5-10 concepts or issues that are important to you without converting them to legalese or staking an extreme position. By asking for feedback on these foundational issues, you then start a productive dialogue about your interests and get a chance to understand the interests and priorities of the CM. Having these discussions early helps avoid surprises later in the process when it does make sense to clarify and formalize the business relationship in some type of agreement.
Summary
As an OEM, you should view your CM relationship as a marriage. It is among the most important relationships for a company. Successful CM relationships depend on system linkages, design collaboration, quality initiatives, and proactive supplier management and governance programs. Most of these connections require months to set-up and maintain, meaning that switching from one CM to another can be very costly and time consuming. That is why we always encourage our clients to spend time upfront on due diligence and resist internal organizational pressures that compromise this process.
Helping clients select the right CM is one of our core practice areas. Please feel to contact us at info@symphonyconsult.com if we can be of any assistance.