Strategies for OEM Manufacturing – Contract Manufacturing
Posted October 9, 2009 by Bierce & Kenerson, P.C. · 
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Instead of exiting a losing line of business, companies can retain customer relationships and full product lines by creative outsourcing of manufacturing capacity. A contract manufacturer could rescue the customer.
Computer Manufacturing.
Nowhere do we see this more than in the personal computer business. Economic recession, sharp declines in unit prices and direct-to-customer customized mail order manufacturing have forced PC manufacturers to either exit the business (as did Unisys), reduce internal capacity (as did Gateway) or outsource the manufacturing process (as Apple Computer, Hewlett-Packard and now IBM have done). In this case, after continuing losses totaling about $2.8 billion since the beginning of 1998, IBM saw outsourcing as a defensive tool to maintain market share, a full range of products for varying types of customer needs, a “one-stop” shop, and control over design and integration among a product line. As of January 2002, IBM agreed to outsource the manufacture of all its PC’s (“Netvistas”) and transfer manufacturing facilities to the contract manufacturer. When the PC industry produced greater competition, IBM exited the business by its sale of the PC division to Lenovo, a Chinese manufacturer.
Rationale for Contract Manufacturing.
Outsourcing of “original equipment manufacturing” enables the customer to private-label the OEM products. For technology leaders, OEM manufacturing also gives the customer access to skills of specialists in manufacturing efficiency, flexibility in volumes of OEM products that can be made and sold, and control over research and design. Where the customer earns significant revenues from sources other than manufactured products, an asset sale and outsourcing of manufacturing can redirect revenues to higher-profit operations such as operations management services, licensing of generic and custom software, security design, management for the manufactured products, and lease financing. OEM manufacturing allows the customer to convert investments in property, plant and equipment into cash for infusion into R&D and marketing, for example.
Control without Ownership.
Customers like IBM maintain control contractually through choices of components, configurations and design. They lose control, however, over the processes of managing raw materials, assembly operations, the manufacturing employees and the real estate and manufacturing equipment.
Pre-Contract Planning.
Prior to such an outsourcing, the vertically integrated manufacturer should strip out the non-manufacturing functions so that the shell can be transferred. For example, before choosing to sell its PC manufacturing plants to Sanmina SCI, Inc. in January 2002, IBM re-integrated PC sales functions into the IBM corporate sales department, leaving the PC sales unit dependent on salesmen who promote a variety of products, not merely the PC.
Flexibility in the Business Model.
Contract manufacturing can promote flexibility in business strategy and risk-shifting shock absorption in business cycles. As demand for the manufactured goods declines, the enterprise customer can reduce its variable costs and does not need to carry fixed costs (except to the extent of minimum purchase commitments, such as under a “take-or-pay” pricing model with the contract manufacturer). As demand grows, the enterprise customer can pay only variable increases of the costs in excess of its baseline of purchase commitments.