'Spending Dollars to Chase Pennies' Print E-mail
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Written by Jennifer Read   
Saturday, 31 January 2009 19:00
Global Sourcing

When it comes to OEM-EMS relationships, greed isn’t good.

In each of Pieter Bruegel the Elder’s famous 16th century illustrations of the Seven Deadly Sins, a symbolic animal occupies center stage. In the woodcut made from Bruegel’s illustration of Avaritia (Figure 1), greed is represented by a poisonous frog that sits in front of a beautiful woman serenely counting gold coins. The woman is surrounded by hideous creatures engaged in various cruel and horrifying activities. As she focuses exclusively on the number of gold coins in her possession, the beautiful woman ignores the carnage and destruction taking place all around her. Clearly an unsustainable situation: She even fails to see the containers that are the source of the beautiful woman’s gold coins are crumbling and full of holes, illustrating her obvious lack of a long-term business strategy for income production.

We are not suggesting outsourcing professionals are knowingly cruel. However, there are some useful parallels to be drawn from this lesson of antiquity. As we repeatedly have noted, the electronics industry has ignored several fundamental tenets of business over the past decade, leading to the current unsustainable situation. It is our contention one of these fundamental errors – or sins, in 16th century terms – is that of Avaritia. When greed takes over the OEM-supplier relationship, it becomes asymmetrical, more akin to a master-slave relationship.

Here’s how it typically plays out: The OEM ignores the fundamental business reality that its EMS suppliers must deliver reasonable shareholder value, and demands continuous and irrational cost reductions. The EMS supplier eventually reaches a point where these cost-cutting requirements equate to business suicide. They then begin pulling resources away from the account and hiding things to stay in business. The OEM becomes increasingly mistrustful and dissatisfied with the supplier and starts looking for a replacement.

In the failed cases we see in our research, the cost of replacing a supplier far exceeds savings sought by the continuous cost reductions. The OEM starts spending many dollars to chase pennies. When you think of the jobs lost, the companies that have shut their doors, and the general human misery, it starts to look like a Bruegel illustration.

A second oft-ignored fundamental tenet of business is there are only so many gold coins available to the outsourcing enterprise, and for continued success, they should be shared on a fair and reciprocal basis. Ultimately, the consumer of the end-product determines how many coins are available, based on what they are willing to pay for that product. That’s the hard stop on all negotiations. To use another analogy, the angles of the slices of the outsourcing pie can be adjusted based on the perceived value of each of the participants, but the size of the pie is determined by what the consumer pays for the end-product. A common fallacy in negotiations is the search for a win-win situation. That’s simply not possible in the outsourcing relationship. If one piece of the pie increases, other pieces must decrease because the size of the pie, i.e., the price the consumer is willing to pay, is not negotiable. If one part of the supply chain demands more of the pie, those coins must come from what’s available for manufacturing, logistics or the other tasks that must be accomplished to get the product into the hands of the consumer, the ultimate source of income. There is no inherent value to the OEM product. If no consumers are willing to pay for what the OEM enterprise produces, there is no pie. Value is always based on the consumer. A diamond would be just a worthless rock if royalty, couples in love and the fashion industry hadn’t transformed it into a priceless gem.

But don’t just take our word on this. Consider a recent quote from ex-Flextronics CEO Michael Marks, who said in an interview: “Make sure your supplier is making a fair return! So many companies just grind the suppliers down to where there is absolutely no margin and no return in the business, and then they try and push more risk to the EMS side of the table. It creates animosity between the two teams and between the two companies. Then the EMS player under-resources the project to try and make at least a few bucks – performance suffers – and then the OEM gets all pissed off and wants to leave. If your supplier can’t make a fair return on the business, they will either find a way to hide some money from you, or they’ll end up kicking you out. Either way it’s expensive and counterproductive.”

We teach outsourcing managers how to read signs when cost-cutting requirements are pushing their suppliers to the business suicide ledge. Our failed case analyses reveal how much disengagement would cost the OEM on a total cost of ownership basis over the life of the contract. By following these lessons, the poisonous frog can officially be banished.

Last Updated on Monday, 23 March 2009 11:01
 

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