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Models to understand the true cost of building product.

Is it cheaper to build products headed for the North America market in China ... or in North America? An audacious question, many would think, based on all we know (or think we know) about China's low labor cost structure. But it is one Charlie Barnhart has spent the past several years asking.

Barnhart is a senior consultant with Technology Forecasters (techforecasters.com), a former vice president at Sanmina-SCI, and cofounder of Westronix Inc., said to be one of the first full-service EMS companies. He has developed several models on pricing and outsourcing, and his research has uncovered some eye-opening and myth-busting aspects to what most felt is a mature and commoditized industry.

Using case studies, Barnhart lays out mistakes many OEMs make when it comes to subcontracting. One such study, typical of North American manufacturers, involves a medium volume, high mix assembly and box-build program. In this case, the OEM customer preferred the product to be built in China. The OEM had a supply base of five EMS companies and two ODMs. The product was a large commercial board assembly used for datacom applications, and the estimated volume was 15,000 units per year.

At the time of the bid, the OEM had about $50 million of product annually built by its largest contract assembler. However, the OEM had a history of overdue payments: 30 or more days late on a 30-day term contract. Moreover, it wanted to push out those terms to 45 days for the new contract. But even at $50 million a year of sales, the EMS company was only breaking even on that customer's programs. And the EMS firm was holding $7 million worth of the customer's excess or obsolete inventory. Based on the EMS firm's estimates, the BoM cost would be roughly $990 if procured in the U.S., $930 in Mexico and $874 in China. The total labor time for the assembly and box would be about 105 minutes, including testing. The EMS company has plants in all three places.

So where should the product be built? Understanding the answer first means knowing how it is derived. Barnhart's models take into account all the standard factors of material costs, labor, technology level, SG&A and other markups. But it's his advice that helps reveal the secrets to proper pricing. And once all the factors are properly accounted for, the true price is often far different than initially perceived.

The example OEM has a large number of suppliers, based on its annual outsource spend of about $215 million. Its warts are obvious: it doesn't pay and it doesn't buy back inventory. "It's not a good customer," as Barnhart says. His advice: Don't go low. Use a markup rate of about 17%.

In workshops, Barnhart prods his audience to debate how optimistic they feel about the business, and to set the markup accordingly. Regarding the extended terms, Barnhart recommends against it, asserting, "If you extend someone's terms, they will take advantage of it." And while some line items will change based on region (the technology factor is higher in Mexico - where it is on par with the U.S. and Canada, Barnhart asserts - than in China), others remain flat regardless of geography (e.g., SG&A is a standard 5%). Advice is aimed at both sides. Many OEMs, he notes, use their suppliers as banks, and those suppliers in turn charge interest (1% per month is standard) for the service. Compared to the prime rate, OEMs are paying near the loan-shark rate, a practice they should stop, he says.

For this case, Barnhart advised the participants to assume a competitive bidding situation, based on the number of other suppliers and the fact that the OEM would not disclose whether the new program would replace another product. Yet the actual quote, he said, doesn't have to look like the actual costs.

An OEM would typically look at the BoM costs and markups before even deciding on which EMS company to use. But Barnhart finds that few OEMs know the market cost of their BoMs, even though the BoM comprises 80% or more of the product cost. "Focus on that," he instructs, "instead of beating up suppliers over labor rates and geography, because the BoM is where most of the OEMs' costs are.

"OEMs are spending a lot of money on outsourcing activities and the trend is to spend even more," he says. Supplier engineers can cost an OEM as much as $500,000 a year in fully burdened and travel costs, all to save relative pennies in product costs. He adds that his research of more than 340 electronics companies reveals that those who outsource less than $100 million a year should perform their own NPI and end-of-life work, and those who spend more than $1.5 billion a year on contract work should bring it back in-house.

And where will the case study program be built? Despite the customer's bias toward China, the winning bid was for an EMS factory in Mexico. Reason: The cost, relative to the "U.S. price" and after everything was accounted for, was about two percentage points less than China. As Barnhart's research proves, the obvious solution isn't always China. And if it's low labor cost we're really after, then the region to produce in is obvious: sub-Saharan Africa averages an hourly wage of about 1.5 cents. Habari!

Mike Buetow is editor in chief of Circuits Assembly; mbuetow@upmediagroup.com.