Posted on 11 Jun, 2015 by John Mayes
When decisions need to be made regarding outsourcing one or more of your products to an electronics manufacturing services (EMS) provider, do you fully consider the wider financial implications?
According to "The UK EMS Industry Report 2013 - 2018", carried out by Reed Electronics Research, original equipment manufacturers (OEMs) should, rationally, consider the "full cost over the lifetime of the product" when creating their cost analysis.
However, this is often not the case as many OEM buyers are focusing almost exclusively on the "visible" unit cost and disregarding the other, very real, cost elements.
While calculating the cost of an outsourcing project based on the unit cost would appear to identify the cheapest option, in reality other unforeseen factors can ultimately drive the price far higher.
EMS companies are, as a result, increasingly encouraging their OEM partners to outsource their projects on a total cost basis and, as the Reed Electronics report states, “attempting to persuade their customers that viewing only the unit cost is in fact short-sighted or indeed misleading”.
A good EMS partner will be able to offer you value-added services that actually help you to save money over the lifetime of a product.
Let’s take a deeper look at the unit cost versus total cost debate and consider why it’s better to take a longer-term view.
"Unit cost" is a traditional way of costing out contract electronics manufacturing projects. It is calculated by working out both variable and fixed production costs and then dividing that sum by the number of units produced. It takes into account tangible costs such as material, overheads, labour fees and margins, making it easy for OEMs to identify their break-even point.
With this simplistic approach, establishing the differences in unit cost between suppliers makes selection easy. It stands to reason that the supplier with the lowest figure will win.
Yet industry experts claim it can be "hazardous" to base outsourcing decisions on unit cost alone and point out its limitations. There is so much more to working out an accurate financial picture than simply adding up the material costs and the price of assembly.
Reed Electronics Research advises OEMs to consider the total cost of the project, including hidden and indirect costs, such as the amount of time you end up dedicating to the venture.
It says: “[The total cost] would include some measure of budgeting for things that go wrong, and the amount of supervisory time that they have to allow on the project. In reality, the unit price becomes the focus because it is visible.”
Some of the less visible costs such as flights, hotels and the time taken by engineers are typically allocated to departmental budgets and may not be included in the P&L as part of the cost of goods sold figure, but will appear in the general wages, travel & subsistence and administration costs centres.
For instance, your EMS supplier may use low-cost locations to reduce the unit price, yet should anything go wrong during manufacturing, you may have to fund business trips to Asia to put things right.
These travel expenses and management time all fall outside of the budgetary remit calculated just using unit cost. Consequently, your costs go up and your profitability decreases.
Arriving at a total cost figure for contract electronics manufacturing projects involves considering exactly how your EMS provider’s services have an impact on your own organisation, in order to understand the true cost implications of making your product.
Not only should this figure include a contingency margin, it should also include the cost benefits of the value-added services your supplier offers.
According to consultancy Venture Outsource: "Smarter OEM customers look deeper to see how sourcing decision will impact their internal costs, downstream of the EMS provider’s operation."
This can be, for instance, how your EMS supplier's expertise in design for manufacture (DFM) can improve your product’s functionality and - as a result - speed up its time to market. Or, how their expertise further up-stream will reduce the amount of product returns.
The outsourcing landscape is becoming more complex and less defined. As a result, costing out projects based only on the immediate, visible costs and the number of units being built is becoming outdated.
Focusing instead on the true total cost of a project over its lifetime - incorporating margins for things going wrong, as well as the added value elements your EMS supplier can provide - will lead to a more insightful, accurate and informed view of your future profits.
It'll improve your decision making and help you avoid establishing a business culture whereby hidden costs are overlooked. It'll also help you define the potential cost savings from your EMS supplier's broader service offering, so that you end up working with a partner that will reduce the total true cost of the project over its lifetime, rather than see them having to squeeze their operational costs to unsustainable proportions.