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Why U.S. production options may still represent the lowest total cost for some projects.

A data collection equipment manufacturer noticed that a technology shift was poised to dramatically increase demand for a new generation of product. Realizing that Asia would represent the lowest cost volume production source, the company shifted to a Chinese contract manufacturer. During peak demand, it saved money. As volumes dropped off, the firm used its original U.S. EMS provider for end-of-life support.

A large company with internal manufacturing capability in Mexico purchased an industrial manufacturer. The new parent's strategy was to transfer outsourced production to its internal Mexican and U.S. manufacturing operations. However, after the first year it found that some of the product lines previously profitable when outsourced in the U.S. were actually costing more to build internally in Mexico. The solution was to reevaluate which product lines were outsourced vs. built internally.

EMS provider Genesis Electronics Manufacturing has seen a number of its customers choose to keep it as a supplier for niche product lines after situations such as these have developed. Most OEMs have a mixed basket of product, some of which transitions well offshore, and some of which isn't a good fit. That is why it may make sense to keep a small portion of the overall production requirements with a domestic supplier. This potential misalignment with production business isn't always obvious in the initial quoting process. For some OEMs, the understanding of total cost isn't completely evident until a project is moved and the new production scenario revealed to be a bad match, or a project scope change occurs such as a demand drop in the latter stages of a product's lifecycle.

Conceptually, this phenomenon can be categorized as a "priceberg," where 80% of the risk may be hiding below the waterline in startup and ramp-down, where management costs per units sold tend to be the highest. Building a harmonious, minimally disruptive dual-sourcing strategy requires an understanding of priceberg composition. The peak of the priceberg is the visible high volume part, focused on for cost reduction. Some projects have sharp peaks, while others are almost flat sheets of ice. Sharp-peaked projects usually benefit from dual sourcing while the more predictable flat models may support a single source. Ultimately, sourcing strategy is best determined by evaluating what lies below the water line.

Hidden Cost Drivers

In the first example, the OEM recognized that product development and maturation had different support requirements than did the high-volume phase. The combination of falling demand, requirements for frequent engineering support and high product variation found in the development and maturation stages weren't attractive offshore. This OEM recognized that the opportunity cost associated with slow responsiveness combined with internal overhead costs as a result of frequent staff trips to the offshore source was greater than the cost associated with maintaining some level of U.S. production capacity. It hasn't abandoned an offshore outsourcing strategy, but is using a dual-sourcing strategy that mixes an onshore EMS provider for NPI activities and some production, and an offshore EMS provider for product with higher annual quantities. The result is that, while product has high ECO activity or is in a declining production phase, the OEM receives optimum support from an EMS provider whose business model is aligned with that project complexity, while a low-cost region handles products during the highest volume phases.

In the second example, the project was also high mix, low volume. Several assemblies had high PTH content and overall there was little component commonality. Required labor content (versus labor content driven by inability to automate board-level assembly) was low, which meant that the added Customs administration and logistics cost associated with migration to Mexico wasn't completely offset by a lower labor cost. The result: Automated board-level production in a U.S. EMS facility with a strong material procurement arm was less expensive than internal production in Mexico for some product lines.

Likely Cost Drivers

What project characteristics are likely to drive hidden costs great enough to offset the perceived unit cost savings of offshore sourcing?

The most typical causes of misalignment with offshore high-volume production business models are:

• Variable market demand.

• High mix/low volume production.

• Low labor content.

• Specialized inventory issues.

• High ECO activity or need for configuration changes on the fly.

• NPI support near the OEM's engineering team.

• End-of-life support/long product lifecycles.

• Need for repair depot or other end market post-manufacturing support activities.

Evaluating an EMS provider's track record with projects of similar size and scope can be critical to understanding true business model alignment. When the business model is truly aligned, the EMS provider will not only be able to show similar projects on the floor, but will typically have systems in place for addressing these common issues.

Areas of focus include:

Corporate culture/business model. While this is more qualitative than quantitative, it is often the largest driver of unanticipated costs in variable volume, high mix or long lifecycle product lines. Offshore EMS models may have high minimum quantity commitments or require the building of small lots once or twice annually. From a tooling and product development standpoint, offshore ODMs may design in common parts that go obsolete as the ODM changes its internal packaging or subcomponent design. The client may not own tooling and rights to use the design. Low unit price may be offset with ECO or specialized support fees not originally quoted. The most onerous cultural disconnect occurs when an EMS provider decides to motivate bad-fit project attrition by increasing price or dropping service levels.

The optimum way to analyze alignment with business model is to ask the contractor to describe preferred project characteristics. Most EMS providers can articulate the characteristics of an ideal project. If the characteristics described align with only a portion of the outsourced product, dual sourcing may be important. Checking references with accounts of similar complexity, mix and volumes can also be an accurate way to gauge fit.

NPI/engineering support. A challenge for higher complexity or longer lifecycle products isn't necessarily the engineering team's speed or depth of its "leading edge" expertise. Often it is the ability to manage complex or high-mix product transitions, make component lifecycle recommendations, support redesign because of obsolescence, and support a mix of old and new technology during the product's life. The ability to integrate design recommendations for manufacture or test into the internal design process can also be critical as an optimized automation strategy reduces labor cost. Component choices should be aligned with an approved vendor list that enables goals for cost, availability and quality to be met over time. Tooling design and procurement expertise should also be evaluated carefully as they impact tooling cost, part cost and ultimately part quality. Another evaluation factor may be proximity to the design team or the willingness of the contractor to support internal design or redesign effort with onsite engineers at critical project review phases. A final area of focus may be willingness to support strategic initiatives. For example, one of Genesis' clients does not currently require RoHS-compliant product. However, in designing current product, the OEM has the company review each BoM for component choices that will migrate easily in an RoHS conversion.

Material/logistics management expertise. Higher mix, long lifecycle products often have less component commonality and a higher obsolescence risk. If demand is also variable, excess inventory liability risk is high. Key criteria to evaluate include ability to source hard-to-find parts; supplier agreements with liberal return privileges; channels for liquidating excess inventory; willingness to procure and store end-of-life buys, and ability to manage variable demand with a cost-effective finished goods Kanban strategy. This is another area where an EMS provider should be an extension of the OEM's manufacturing organization.

Automation strategy/alignment of production capabilities. High mix, variable demand product drives more frequent line changeovers. Often these product lines also include a mix of SMT and PTH technology. Reducing cost means minimizing changeover time and automating as much of the assembly and test as possible. Key criteria to evaluate include equipment changeover flexibility, availability of automated PTH insertion equipment, competency of test engineering personnel in developing cost-effective test strategies, breadth of automated test equipment, and overall internal production strategy for managing high mix production.

Ramp-down and post-manufacturing support. Long lifecycle, high mix, complex products often require extensive support relative to end-of-life management, warranty and out-of-warranty repair, and refurbishment. A key issue is dealing with declining product demand. This may require lifetime buys, redesign necessitated by part obsolescence, and good support in liquidating excess inventory.

Reverse logistics support can also be important. EMS providers that offer formal repair depot services typically understand the challenges associated with this phase of product support. More important, when this is done as a distinct business focus, a shared infrastructure usually helps offset the costs associated with end-market support, inventory management and higher levels of troubleshooting technical expertise. Access to reliable outsourced repair depot support can also create an additional value stream for OEMs by enabling the sale of service contracts to the end market. In addition, repair depot support can be used in a dual offshore/onshore strategy by providing a safety net for product rework such as ECO implementation for product in transit as a new revision is cut in. Finally, outsourced repair depot and reverse logistics support can help OEMs meet recycling requirements driven either by regulations or market preferences.

As the priceberg analogy demonstrates, lowest unit price is rarely reflective of total project cost. Most EMS business models have preferred classes of projects, and often the total basket of outsourced product is not a perfect fit. OEMs taking the one-size-fits-all approach may find 80% of their management time is spent dealing with issues below the waterline portion of their outsourced product. Taking the time to evaluate varying requirements in your product mix and developing a dual-sourcing strategy that leverages the competencies of EMS providers with varying business models is often the lowest cost approach. Most important, developing this type of optimum sourcing strategy on the front-end of an outsourcing project can save the cost and time of "re-sourcing" product that is out of alignment at an offshore low bidder.

Ed Grimes is business development manager at Genesis Electronics Manufacturing (genesismfg.com); egrimes@genesismfg.com.