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OEM squeeze play: tougher terms for EMS players: how can EMS companies remain flexible in today's economy?

Electronics manufacturing services (EMS) companies are viewed by original equipment manufacturers (OEMs) as an extension of manufacturing capability. In good economic times, this view translates to order increases above expectations and the potential for higher margins to support demand upside on short notice. In times of economic downturn, it translates to sharing the pain of demand reductions. I recently interviewed four EMS providers to discuss how they were dealing with OEM requirements for increased flexibility as a result of fluctuations in demand.

The participants were: Ted Volberding, chief technology officer and founder of Integrex (Bothell, WA); Robert Stoller, president of Genesis Electronics Manufacturing (GEM, Oldsmar, FL); Russ Steiner, manager of marketing and business development at TotalEMS LLC (Logansport, IN); and Mark Naccarella, director of supply chain management at Preco Electronics (Morton, IL).

What changes has your organization made over the last 18 months to support customer requirements for finished goods (FG) stocking or greater schedule flexibility?

Volberding: Realistically, there was a greater probability of upside potential or safety stocking requirements by the OEM before 2001. Insufficient forecasting was overcome by building finished goods (FG) inventory. However, in the past two years, there has been a greater emphasis on supply chain collaboration and minimization of inventory. Also, all parties involved--supply chain, OEM and EMS--have been more cognizant of inventory indemnification. In retrospect, the more agile and flexible EMS companies can respond to upside demand quickly by co-stocking raw material through vendor-managed inventory (VMI) programs. They can also minimize OEM work-in-process (WIP) with predefined core assemblies through design for manufacture (DFM) efforts that can be configured to finished goods at a later date. The ability to quickly turn materials minimizes inventory, which improves the profits and loss (P&L) and balance sheet of our customers. The emphasis is on better communication among the OEM, EMS and the supply chain.

Stoller: There have been limited requests from our customers to hold finished goods. We have responded positively and varied the methodology of recouping expenses. GEM has agreed to time frames, at the end of which the customer agrees to take product, carrying charges which are embedded in the price when a particular quantity of finished goods is agreed upon and no time sunset is indicated. Flexibility is one of the services that an EMS company in our volume niche provides. However, flexibility has gained new meaning in the last 18 months. Lead times are ignored on a routine basis, and backlog, which was once a minimum of three months, is now down to one or two months. My company previously implemented the ability to share material requirement planning (MRP) with suppliers and set up bonds to ensure that components are available. Such steps help to minimize lead times, but unique parts present a challenge. In the latter case, our purchasing team uses older methods of personal contact with the supplier.

Steiner: We are still very reluctant to stock any finished goods, regardless of poor customer forecasting ability. We operate on lean philosophies from order entry to shipping. In an effort to build just-in-time (JIT), as always, we use a daily delivery schedule from our suppliers that is a direct reflection of customer orders. We cannot anticipate needs as well as our customers, who, unfortunately, cannot forecast with a high degree of accuracy either. We have instituted evergreen forecasting, which is updated at worst weekly, in some cases daily. We share this with our suppliers who attempt to support our forecasts without overstocking themselves. We have instituted a take or pay policy that covers our risk on non-cancelable, non-returnable (NCNR) goods.

Nacarella: Preco began taking a harder look at its cycle times in 2002. On the average, we have reduced overall cycle times by approximately 35 percent, with some product times down as much as 65 percent. However, we feel there is still some room for improvement. I feel there are three reasons for our results: 1) we have a dedicated production and inventory control manager who understands how to create a competitive edge for our company; 2) we have adopted a lean manufacturing, continuous improvement philosophy and 3) we purchased and began using a flow manufacturing software tool that enables us to build and ship products in a JIT environment.

In supporting customer requests for finished goods stocking, which of the following business models do you use?

a. agree to finished goods stocking with specific dollar amount and/or unit quantity limits at additional charge

b. agree to finished goods stocking with specific dollar amount and/or unit quantity limits at no additional charge

c. agree to finished goods stocking with no restriction

d. never agree to finished goods stocking

e. other.

Volberding: In the present environment, finished goods stocking can occur at the OEM (like the Dell model) or at the EMS, if there is a periodic pull on the FG Kanban. However, there needs to be an expiration date for this FG. In a perfect world of regular end market consumption, an OEM can modify their Kanban. However, if there is no demand and the FG Kanban becomes stagnant, then the EMS must reserve the right to transfer ownership of the product at an agreed-upon time period, typically less than 45 days. One must be cognizant of the generally accepted accounting principles (GAAP) for recognizing revenue, especially when material ownership changes hands. Integrex has the ability to minimize the FG Kanban by rapid replenishment and, therefore, keeps most inventory in raw material (which can be re-assigned or returned) or in a flexible WIP configuration for the OEM.

Stoller: We agree to finished goods stocking with specific dollar amount or unit quantity limits at an additional charge. We do not agree to finished goods stocking with specific dollar amounts or unit quantity limits at no additional charge, nor do we agree to finished goods stocking with no restriction. However, we believe FG stocking is important to our customers; therefore, we are eager to propose a solution to their forecasting problem. Variations of FG stocking are JIT agreements that ensure that the customer will get product in specified quantities when they need it. Generally, these are rolled into an agreement that includes pricing, which contains a provisional remuneration for inventory holding. We work to help the customer understand that this is a service that it is providing.

Steiner: We only replenish Kanban levels that certain customers pull from, and in these instances the stockpiling costs are born by the customer. In other words, we have higher sell prices on all built-ahead stock unless the program pulls stock every few days. Otherwise, we build to ship items, not build to stock them.

Naccarella: Our customers do not ask us to stock finished goods. I presume they do this so they do not unnecessarily expose themselves to contingent inventory liabilities. What they do ask for (in different ways) is maximum scheduling flexibility with minimum inventory liability. By way of manufacturing service agreements, which we are just beginning to use, we can offer safety stocks of FG. However, the real answer lies in over-lead time reductions. Preco has made good progress in reducing its manufacturing cycle times. We still have a lot more work to do in order to become even more competitive and at the same time set higher expectations with our supplier, so they will reduce lead times.

Do you see requests for finished goods stocking as specific to certain industries, or is it being requested across your customer base?

Volberding: There is no specific industry segment requesting FG stocking, due to the increased emphasis on inventory indemnification and our ability to quickly replenish FG Kanbans.

Stoller: In our experience, this request is industry generic.

Steiner: Most customers understand that they are asking for something that will cost them money. In cases where stocking at some level is the only option, we agree to a specific Kanban size for them to pull from ... whether that is an area at their location, a specific stocking location local to their plant or at our assembly facilities.

How willing has your supply base been to support your required business model changes with specific flexibility changes of their own (Kanban, etc.)?

Volberding: In our efforts to deploy rapid replenishment programs, our lean initiative requires dock to stock inventory capability (distribution, as well as custom material) with supplier report cards for on time delivery and quality. Effectively, the supplier provides a certificate of conformance (C of C) with their delivery, and stocks the work cell where the material is consumed. We eliminate non-value added inventory transactions, and all material is placed at point of use (POU). Work cells monitor their on-hand material and maintain their inventory records, as well as returned materials (RMA). A distributor replenishes consumables as well. Periodic price checks, RMAs and the supplier report cards enable purchasing to award contracts and eliminate purchase orders.

Stoller: In the current business environment, the distribution community is very interested in any proposals that will bring them business. On the other hand, my company is seeking to cement its relationships with these same suppliers, so that we will be able to receive preferential treatment when the market turns. Suppliers of this sort are interested in setting up bonds to support our uneven demand. With the exception of raw board suppliers, most suppliers of unique items are less likely to agree to any arrangements to satisfy sporadic demand. Suppliers act as independent as always, despite having been hurt by the current market climate. In these instances, we lean on our customers to allow us to qualify alternate sources, We even volunteer design capabilities to remedy the single-source syndrome.

Steiner: In our largest supplier's case, they have been very flexible. We have an in-plat store that stocks materials for us to the day we pull goods--on their books--in exchange for the floor space to do it in.

Nacarella: We have mixed success with our supply base on schedule flexibility and lead time reduction. I believe there is a correlation between how successful we are and our control over the approved vendor list (AVL). In other words, we may not be as successful managing our supply base if the OEM controls the AVL.

Susan Mucha is president of Powell-Mucha Consulting, El Paso, TX. E-mail:
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Author:Mucha, Susan
Publication:Circuits Assembly
Geographic Code:1USA
Date:Mar 1, 2003
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