Know the “whys” behind each clause in the manufacturing agreement.

Partnership is one of the most hackneyed terms in the electronics manufacturing services (EMS) industry. It often gets used to describe business relationships that are anything but partnerships. At the same time, the best EMS relationships actually are partnerships where parties have a symbiotic relationship beneficial for both companies. What drives these different relationships in the same business model? Often the answer is the program manager.

Back when outsourcing was a new concept, the most experienced employees at an original equipment manufacturer (OEM) were assigned the responsibility for the relationship. In many cases, those executives had manufacturing as well as purchasing experience. When demand or allocation surprises occurred, these experienced teams worked together for a good resolution in most cases. Today, contract manufacturing is just one more thing that most OEM purchasing departments source and manage. Buyers may or may not have ample experience managing EMS suppliers, particularly given the volume of turnover in these roles. Less experience translates to a focus on unit price, less ability to understand the impact of errors in forecasting, and difficulty in understanding issues that excess material creates.

When the right expectations are set, partners consider the entire puzzle, not just their piece.

In today’s world, that inexperience may translate to a customer who sees finished goods inventories building as demand softens, and chooses to push out or cancel forecasted production orders in situations where raw material inventory is also high. In the absence of pushback from an experienced program manager on the EMS side, an ugly excess inventory situation often gets uglier and the EMS company’s internal forecasts must be revised downward. This particular situation is happening across the EMS industry right now. Moreover, it illustrates just how fast the concept of partnership can disappear when the parties are acting independently.

When the right expectations are set, partners consider the impact of choices on both sides of the equation. During the period of worst allocation and unpredictable spikes in demand, EMS and OEMs worked together in ensuring adequate stocks of raw materials. This increased the level most EMS companies held beyond what was standard practice for the business model. Cost sharing became part of that equation. As material allocation eases, the normal business model is to rationalize that excess inventory either through production, returns or sale.

Many component manufacturers have classified material noncancellable, nonreturnable (NCNR) across a broader range of parts than usual, so the normal adjustments an EMS purchasing team would make are more challenging. If soft demand drives canceled production orders, then excess inventory either sits or gets sold, likely for less than purchase price since availability has improved. This costs the OEM money, assuming a manufacturing agreement is in place.

Comparatively, working together to build a revised production schedule that continues to consume parts while permitting some of the existing finished goods inventory at the OEM to also be burned off is a better solution because the EMS provider is also able to revise material ordering downward to better adjust inventory levels over time. It also helps smooth the impact on EMS revenue that steep changes in demand otherwise create.

This is just one example of the importance of setting expectations for what the EMS-OEM partnership should look like when business variables change. The best way to start that process is with a manufacturing agreement. Back in the days when I negotiated manufacturing agreements for my EMS employer, I was amazed at how many “surprises” those clauses often drove on the OEM side. That negotiation helped build the partnership framework that governed the relationship, however. As with a prenup, we walked through the potential areas of the relationship that could go wrong and reached agreement on how those issues would be handled at a point where both parties could rationally discuss business concerns and the business case for the agreed-on resolution. Then we had an agreement that could be pulled out anytime the partnership was going through a rough patch.

While it may be more challenging to negotiate manufacturing agreements with an inexperienced outsourcing team, it can be done, provided the EMS representative is willing to educate that team on the “whys” behind each clause.

At the program manager level, this same education process can help less-experienced OEM team members understand the impact of inaccurate forecasts, engineering change orders (ECOs) and order cancellations. Concepts such as minimum-buy quantities and their resulting excess inventory liability should also be explained carefully at the beginning of a program. When OEM actions are causing inefficiencies, taking the time to make suggestions to improve the OEM’s process can be beneficial.

The bottom line is that just as it takes two to have a partnership, it takes two to create an unworkable relationship. If one party is willing to educate the other on the business case for partnership, both parties usually benefit. If that education process doesn’t seem to be working, it is likely a sign that the customer wasn’t a good fit to begin with and the education process speeds the realization that disengagement may be the best option. Either way, setting expectations as early as possible helps both parties figure out the best way forward much faster than relationships where expectations are unstated until difficulties develop.

Susan Mucha is president of Powell-Mucha Consulting Inc. (powell-muchaconsulting.com), a consulting firm providing strategic planning, training and market positioning support to EMS companies and author of Find It. Book It. Grow It. A Robust Process for Account Acquisition in Electronics Manufacturing Services. She can be reached at smucha@powell-muchaconsulting.com.

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