myoem inc

OEM FAQ 50

General Questions

What is manufacturing outsourcing?

Manufacturing outsourcing occurs in several different ways. First, a company can outsource the production of components, which are then assembled by the Purchaser at their own facility. Second, a company can outsource solely the assembly function of the final product while continuing to manufacture the component parts itself. Finally, a company can outsource both the component part manufacturing and assembly functions, essentially removing the management of the manufacturing function from the company.

What is OEM?

OEM stands for Original Equipment Manufacturing or Manufacturer. Original Equipment Manufacturing is a process in which an organization retains the services of a manufacturing service provider to make a product or component of a product exclusively for that purchasing organization. We use the terms 'OEM' and 'manufacturing outsourcing' interchangeably, although the term 'OEM' can represent both outsourced and subcontracted manufacturing.

Why would a Purchaser want to use OEM?

Manufacturing outsourcing can allow an organization to benefit from the following: new skills; more effective management; additional time to focus on core competencies; avoidance of costly investments; enhanced ability to meet product and growth cycle requirements; improved flexibility; reduced overall costs; improved investor relations; general appeal to new investors; improved investor-related ratios; the ability to maintain a classic product; improved internal manufacturing performance; and a newfound ability to spearhead a reorganization process.

Benefits of an OEM Relationship

How could OEM possibly allow a Purchaser to utilize effective management? How could OEM allow Purchasers to focus more time and energy on the core competencies of my business?

An OEM Supplier or manufacturing service provider can alleviate problems of high turnover, absenteeism, poor product quality, and excessive deadline tardiness for the Purchaser by substituting their [the OEM Supplier's] effectively managed manufacturing process - that may not be plagued with such problems - for the Purchaser's inefficiently managed manufacturing process. Rather than a company's managers having to spend the bulk of each day concentrating on day-to-day issues involved in the manufacturing process, a company can hire an OEM to focus on the daily problems, while in-house managers spend more time on strategic issues like market positioning, new product development, mergers and acquisitions, and long-term financing.

How does manufacturing outsourcing reduce the need for costly investments?

Using a manufacturing service provider allows the Purchaser to avoid making large investments in the manufacturing of the good that is now being outsourced to the OEM Supplier because that service provider will either already have the tools needed to produce the good or will then be responsible for undertaking the significant investments.

How could manufacturing outsourcing assist a Purchaser's company when they are in the fast growth stage? When Purchasers are in a seasonal business? When Purchasers are in a cyclical business?

A company at risk of not meeting consumer demand due to rapid demand growth or product cycle highs can utilize an OEM's capacity to ensure consumer satisfaction by structuring delivery of the goods according to the varying demand levels. For example, a toy company could structure delivery of the toys manufactured by the OEM Supplier so that the toy company received twice as many in November than they do in June.

How can manufacturing outsourcing actually improve the flexibility of my cost structure?

Purchases from an OEM Supplier will fluctuate depending on the number of transactions made - allowing the company to move from a fixed cost basis of production to a variable cost basis. Such a move allows a company to essentially "free-up" needed cash from what would traditionally be a fixed cost (property, plant and equipment) to a less demanding (and hopefully less expensive) variable cost (cost per unit sold by the OEM Supplier to the Purchaser).

How can OEM actually save and/or reduce costs?

Utilizing an OEM provides a distinct production cost advantage based on the OEM's ability to produce the good using existing production capacity (property, plant and equipment), cheaper labor, a larger knowledge base (to increase efficiency) and many other factors detailed in this section. Keep in mind, that such a reduction in costs potentially enables the Purchaser to maintain price levels and, thus increase the available profit margin!

How could an OEM Supplier help a Purchaser to maintain production of a classic product?

By outsourcing the production of the classic product, the Purchaser is able to "free-up" cash for research and development while (as shown in the cost saving question) enhancing the profitability of the classical product, as well.

How could manufacturing outsourcing improve the internal performance of a Purchaser's company? How could OEM help a Purchaser start a reorganization process within their company?

Putting in-house Suppliers at risk of losing production to a manufacturing service provider by instigating the offer/bid process has been utilized in the past to instigate enhanced effectiveness among the internal production staff.

By outsourcing the manufacturing function (a traditionally significant part of a company's employee and asset base), a company is more easily able to instigate change in the organization toward the more appropriate size and shape because of the increased flexibility resulting from the paring down of the organization's excess employee and asset bases.

Locating OEM Partners

Where does a Purchaser locate an OEM Supplier?

Sources of manufacturing service providers are many. Aside from utilizing the convenience and security of MyOEM.com, a Purchaser can start by first looking at Suppliers for past purchases by looking at purchase-order or Supplier-history files. Next, a company can ask company personnel in such areas as engineering and maintenance for suggestions. If a Supplier still has not been located, a Purchaser can then look for local Suppliers in the Yellow Pages. If no local Suppliers exist, a Purchaser can use library resources like the Thomas Register and Moody's Industrials, which list information regarding Suppliers by commodity and company name.

Where does an OEM Supplier locate an OEM manufacturing Purchaser?

Sources of Purchasers are many. Aside from utilizing the convenience and security of MyOEM, an OEM Supplier can start by first looking at Purchasers for past purchases by looking at purchase-order or purchaser-history files. Next, a company can ask company personnel in such areas as engineering and maintenance for suggestions. If a manufacturing service provider still has not been located, an OEM Supplier can then look for local Purchasers in the Yellow Pages.

Risk of an OEM Relationship

What are the risks associated with utilizing OEM?

The primary risks associated with utilizing a manufacturing service provider are the following: that the relationship between an OEM and an organization may become strained if the OEM's financial situation becomes negative, controlling interest of the OEM changes, or an OEM initiates a change in its' fundamental strategy/structure; that the technological needs of an organization may become more sophisticated than a given OEM is capable of handling; and that an organization with an existing investment in manufacturing in relatively small communities that are dependent on that organization puts itself at risk of negative publicity and employee morale.

Does a manufacturing outsourcing relationship put a Purchaser at risk of losing their intellectual property - those intangible elements held by a Purchaser that, if known by rival organizations, would take away the Purchaser's competitive advantage?

Such a risk is definitely a concern when dealing with an OEM Supplier. However, a company can reduce this risk by engaging in a thorough due diligence process when choosing the OEM Supplier, by tightly controlling the transition phase to the manufacturing service provider and by continually monitoring the OEM Supplier's subsequent activities to ensure that such threatening action does not occur.

If a Purchaser develops a need for technological capabilities that the Purchaser's OEM Supplier is not equipped to handle, is the Purchaser obligated to continue using the manufacturing service provider until the contract has been satisfied?

In the OEM Supplier -Purchaser agreement, if the scope of the Purchaser's business changes and the manufacturing service provider is unable to technologically function for the benefit of that Purchaser, the Purchaser may terminate the agreement without additional cost or liability (unless otherwise specified in the contract) placed upon their organization.

What are the possibilities for a Purchaser to attempt an early termination of the contract?

Early termination of a contract is possible for any irreparably negative event involving the technological, fundamental or financial change in either company. As a result, the possibilities for either the Purchase or the OEM Supplier to attempt an early termination of the contract is high depending on the risky nature either of them possesses.

What is the best way to alleviate the risks associated with utilizing manufacturing outsourcing? If a Purchaser contracts with several different OEM Suppliers, is the Purchaser's risk compounded or do more Suppliers decrease risk by adding security?

By utilizing the above termination clauses and diligently choosing a quality Service Provider, a company can protect itself against irreparable harm that could potentially result from an OEM Supplier - Purchaser relationship.

By contracting with multiple OEM Suppliers, a company can alleviate risk by transferring incoming production from one manufacturing service provider to another in the event of increasing financial or country risk, increased demand base, or lack of technological capability of one OEM Supplier versus another.

What is the best way to alleviate the risks associated with an international Purchaser?

The most effective way to alleviate risk associated with an international Purchaser is to ensure that the financing of the transactions provides the OEM Supplier with a guarantee of payment through a secure bank or factoring institution. In addition, a manufacturing service provider should make absolutely certain that it is aware of any possible scope changes in the business and what those scope changes would require in the form of technology held by the OEM Supplier. Another preventative measure to alleviate this risk is to incorporate a penalty into the contract in the event that the Purchaser chooses to opt out of the contract due to a change in the scope of the business. Such penalties are termed "termination fees" or "payment for unearned profits."

Does an attempted risk aversion decrease an OEM Supplier's chances of completing a contract with a potential Purchaser?

Measures taken by an OEM Supplier to reduce the risk of financing the transaction are now commonplace. Thus, this form of risk alleviation should not decrease one's chances of completing a contract with a potential Purchaser. However, as will be demonstrated in the financing section, some forms of financing are more acceptable than others. For example, pre-payment is the least acceptable form of payment for the Purchaser and the most acceptable for the manufacturing service provider. Accordingly, this form of payment relatively decreases the chances of completing a contract with a potential Purchaser versus other, less restrictive, forms of payment.

The Future

What does the future hold for manufacturing outsourcing (OEMs) and outsourcing in general?

The future of outsourcing is going to be greatly influenced by the experiences of the companies willing to attempt such a relationship. While low-cost and low-strategic value forms of outsourcing will undoubtedly expand, high-cost and high-strategic value forms of outsourcing (such as an OEM relationship) simply have too much at stake to be undertaken on a whim. However, because of the added interaction among OEM Supplier - Purchaser partners that is currently in place with electronic means (internet, e-mail, information technology systems, etc.), the needed security for such relationships exists. The potential cost savings are now accompanied by measures to reduce the risk of achieving such savings. Thus, the propensity for a company to attempt an OEM Supplier - Purchaser relationship and succeed will most certainly continue to expand.

What sort of promise does the future hold for the prospects of the OEM Supplier business?

The future of outsourcing is going to be greatly influenced by the experiences of the companies willing to attempt such a relationship. While low-cost and low-strategic value forms of outsourcing will undoubtedly expand, high-cost and high-strategic value forms of outsourcing (such as an OEM relationship) simply have too much at stake to be undertaken on a whim. However, because of the added interaction among OEM Supplier - Purchaser partners that is currently in place with electronic means (internet, e-mail, information technology systems, etc.), the needed security for such relationships exists. The potential cost savings are now accompanied by measures to reduce the risk of achieving such savings. Thus, the propensity for a company to attempt an OEM Supplier - Purchaser relationship and succeed will most certainly continue to expand.

Will global demand for manufactured products current OEM Suppliers can produce continue to exist?

Depending upon the nature of the product, each and every OEM Supplier should often address this question in order to assess the company's ability to meet its' strategic goals in the future. Analysis of this question should emphasize research of the current state of the art and how the state will most likely change into the future, determining the future needs of the Purchaser, and matching those changes and needs against the technological capability of the company.

How important is the financial position of the Purchaser and OEM Supplier?

The financial position of the Purchaser should be strong with respect to the funds available to pay the amount of work the OEM Supplier completes. That is, while the Purchaser may not have a tremendous amount of cash with which to complete a transaction, the Purchaser should already have access to the funds through a securing bank that can ensure payment upon completion of the work.

The manufacturing service provider should maintain a financial position that secures the necessary funding for all associated costs of manufacturing the product for the Purchaser.

Would it benefit an OEM Supplier to attempt to form an alliance with the other OEM Suppliers who are performing the same manufacturing function?

Inconclusive. Based upon the premise of economies of scale and scope, an OEM Supplier could potentially benefit from allying itself with another manufacturing service provider. However, as with any merger, acquisition or alliance, such pursuits present as many dangers as opportunities. Thus, the best recommendation is to thoroughly assess the situation and make a decision based upon the hundreds of factors associated with such an opportunity.

How will an increase in the number of capable manufacturing service providers affect the competition OEM Suppliers currently face? Affect the price OEM Suppliers are able to demand per unit? Affect the contract terms manufacturing service providers are able to negotiate?

Although there will undoubtedly be an increase in the amount of capable OEM Suppliers throughout the world, the number of organizations looking to retain manufacturing service providers will also increase. As a result, the ability of OEM Suppliers to find potential Purchasers will not be hindered as much as the inability of OEM Supplier's to meet the technological needs of those Purchasers.

As with above, the key to the possibility of price changes does not necessarily come from increased competition. Rather, the ability of competitors to simply produce the good cheaper because of better technology will more significantly influence the price OEM Suppliers are able to charge for their services.

Due to the increased need for manufacturing service providers by small and midsize companies, the ability of OEM Suppliers to negotiate shared rewards in exchange for shared risk will be enhanced. However, with regard to large companies, the opportunity to negotiate these more favorable terms is less likely because they will be attempting to lock small and midsize companies out of gaining favorable terms by tying up OEM supply capabilities in long term contracts.

What will be the future of the market relative to OEM Suppliers ability to gain the opportunity to form alliances with other manufacturing service providers? With venture capitalists? With additional purchasing companies?

A continuing trend for companies is to have one Supplier for several different services and/or component parts of a product. Since most OEM Suppliers are limited by the scope of their manufacturing capability and geographical area, they will be forced to come together to offer bids to companies that contain the full spectrum of services desired. Thus, a requirement will exist for a lead Supplier who will coordinate the activities of the alliance.

In order to reduce risk of a start-up company proving itself unable to perform the manufacturing tasks needed to succeed, venture capital organizations now have the opportunity to ally themselves with Suppliers whom they know to be of the highest quality. These Suppliers would then be hired as a stipulation to the start-up by the venture capital organization in order to ensure that the manufacturing tasks are performed as needed. In such an arrangement, some manufacturing service providers are reluctant to ally themselves with a start-up that does not represent a substantial revenue boost at inception. However, the promise of growth will lure a significant portion of these OEM Suppliers to ally themselves with the venture capital organization.

OEM Supplier - Purchaser alliances may arise for two reasons. First, an alliance may arise to market a component part, software or an entire product that was created by the manufacturing service provider for the Purchaser. This product is then marketed elsewhere while both companies benefit from the profits generated because the OEM Supplier made the product while the Purchaser funded its construction. Second, an alliance may arise when a Purchaser decides to acquire the OEM Supplier (and sometimes vice versa) in order to gain more control over the manufacturing process, keep it from going bankrupt, or simply ensure that the manufacturing service provider continues to provide for the Purchaser with the best terms possible in the long run.

The OEM Transaction

How does the transaction process begin in an OEM project?

After locating potential OEM Suppliers from the various sources available, a Purchaser should begin paring down the possible Suppliers. This should start with a simple determination of whether or not the potential Suppliers desire to sell to the Purchaser.

If such interest does exist, a Purchaser should then observe the condition of the OEM Supplier's plant and equipment, the general financial state of health, the relative activity level of the organization, location of the other manufacturing service providers, and the Suppliers' view and use of technology. The remaining qualified candidates should then be evaluated against the following questions and how the responses adhere to the needs of the Purchaser: How long has the Supplier been in business? Who are the principal owners and managers? Who are the Supplier's major customers? May the Purchaser contact them to perform due diligence? What have been the Supplier's business trends over the past ten years? What is its history in labor relations? Is there a union? When is the contract due for renegotiation? What percent of sales is spent on research and development? What quality-control systems do they use? What is current backlog and delivery lead-time? What is its history of price changes? Etc.

After completion of all of the above analyses, an organization should be able to fill out a statement of qualifications (SOQ) to create a list of firms they believe are qualified to bid on the Request for Proposal (RFP).

What is the purpose of a statement of qualifications (SOQ)?

The statement of qualifications purpose is to pare down the number of qualified OEM candidates into a number that is efficiently manageable.

What is a Request for Proposal (RFP)?

An RFP is a document sent to prospective OEM Suppliers that gives the Supplier background information about the Purchaser and its industry, describes the nature of the OEM service desired, the specific tasks expected of the manufacturing service provider, any current transaction volumes, the Purchaser's performance criteria for the OEM Supplier and a deadline for when the RFP must be received by the Purchaser.

Note: that a Request for Proposal (RFP) is synonymous with a Request for Quote (RFQ).

What is the most effective way to structure a Request for Proposal (RFP) to convey exactly what a Purchaser wants to be conveyed and to avoid potential problems in the future?

The most effective way to construct and structure an RFP is to thoroughly itemize all tasks that are to be completed by the OEM Supplier and the expected transaction volumes in great detail. The great amount of detail is necessary because if a Supplier bids on an RFP that contains incorrect or unclear tasks or expected transaction volumes, the Purchaser will have to use often-precious time to negotiate further with the OEM Supplier than would otherwise be necessary. The following is an example of how a Purchaser could structure an RFP that can help ensure that it is as clear as possible:

General Section
	Format for and outline of the proposal
	Detailed description of the services sought
	Specific guidelines for performing the work
	Detailed analysis of the factors that will be used to evaluate the proposals and weights for different factors
	A sample of the contract form that will be entered into
	Notice of any proposal meeting dates, logistics, etc.
	�Due date of the response from the proposal
Cost Section
	Labor hours and rates by individual or category
	�Cost multiplier for overhead
	�Direct expenses (for allowable expense items that are also set forth in the RFP) like cost of transport, living expenses, car rental, gas, etc.
	Allowable profit level
Technical Section
	Open-ended questions to be answered by the OEM Supplier:
	Qualifications for performing the work
	�Demonstration of an understanding of the work to be performed and performance metrics to be met
	Description of the approach to meet the needs of the Purchaser
	Description of the supply team (experiences, resumes, etc.) along with any plans for additional staffing

In addition the above sections, there are some other questions that should be addressed with regard to including the necessary information in the RFP.

How should quality requirements be stated?

Quality is one of the most difficult aspects of international trade to define and accurately assess because of the difference in quality between such things as a pacemaker and an everyday hex nut. Further, while certain definitions of quality may involve commercial grade and/or required trade custom levels, others may have to adhere to federal standards or, at the very least, blue-print specifications of either the Purchaser or OEM Supplier. Fortunately, each of these varying definitions of quality do demand that the products produced are uniform in quality - one unit's quality is as good as another unit's quality of the same product - and that the products meet or exceed the expectations of the Purchaser.

How can Purchasers assist manufacturing service providers to assure the quality levels required are understood and attainable?

The most effective way to assist OEM Suppliers in understanding and attaining the given levels of quality is to have a process engineering team review the desired quality levels at multiple stages of the relationship. Beginning with an evaluation of the quality requirements in the RFP, the team will make sure that the requirements are reasonable and attainable. Then, the team will periodically review the OEM Supplier's operations. This review will consist of a check of the OEM's process control charts to see if the units are being manufactured within agreed upon tolerance levels, a functional test of completed products to see if they function as desired, and a review of the materials scrap and receiving records to ensure that all incoming components are acceptable.

How many potential OEM Suppliers should a Purchaser offer an RFP to?

A Purchaser can oftentimes find itself attempting to evaluate too many potential OEM Suppliers after the Statement of Qualifications has been completed. This is a problem because it forces the evaluating personnel to restrict the evaluating criteria, potentially allowing an undesirable OEM Supplier - Purchaser relationship. As a result, the most common recommendation is to pare down potential candidates as much as possible in the SOQ stage so that the Purchaser has no more than six or seven potential Suppliers for any given unit.

How long should a Purchaser wait to receive all respondents to the RFP?

Depending upon the nature of the purchase, different lengths of time may be required for different products. However, the typical length of time to wait for responses to the RFP is approximately three weeks, with additional time granted to all candidates for purposes of clarification to the RFP.

What is a typical timeframe for evaluating potential OEM Suppliers?

A significant mistake made by many Purchasers is that they spend too little time evaluating the bids. Much like having too many potential candidates, allowing an insufficient amount of time to evaluate the candidates puts the Purchaser at risk of narrowing the selection criteria even to the point to where the lone factor is lowest price. Such action again puts the Purchaser at risk of choosing a manufacturing service provider who is not the best choice, and possibly even the worst. Thus, it is not unreasonable for a Purchaser to allow anywhere from six months to a year to choose the best candidate depending upon the size of the service provided.

In addition the above sections, there are some other questions that should be addressed with regard to including the necessary information in the RFP.

What is the best way to evaluate potential OEM Suppliers?

While going through the proper due diligence functions, the Purchaser should begin the process of evaluation by ranking the candidates relative to their ability to answer the following questions:

	What is the bid price? (Note: Make sure that the prices are all in relation to the same baseline services. If the prices are not all the same, then request new ones that are.)
	Can the OEM Supplier meet the quality requirements?
	Can the OEM Supplier meet the logistics terms of the relationship, including the delivery needs?
	Can the OEM Supplier meet the after-sale support and service needs of the Purchaser?
	How responsive is the OEM Supplier to possible design and schedule changes?
	Is the OEM Supplier's operating style compatible? (Note: The Purchaser's evaluation team should spend a great deal of time assessing the management of each candidate in order to get a good idea of how the OEM Supplier operates. If the operating style is similar to that of the Purchaser than it may be beneficial to pick that Supplier in order to avoid discontinuity within a relationship that may exist for several years.)
	What is the OEM Supplier's reputation? (Note: Besides interviewing references given the Purchaser by the OEM Supplier, the Purchaser should ask those references for other organizations that may have direct contact with the OEM Supplier. From these organizations, a more accurate assessment of the OEM Supplier's reputation will be gathered.)
	What is the OEM Supplier's level of experience? (Note: The level of experience should be evaluated in two distinct areas. First, the evaluation team should request from each manufacturing service provider all of the resumes for the persons who will be performing the services outlined in the RFP. These resumes should be evaluated relative to the skill level, industry experience and functional experience held by the OEM Supplier's personnel. Second, the evaluation team should make sure that the OEM Supplier has not won a service contract in the past by using experienced personnel to win the contract and then switching to inexperienced personnel after that. This is done to protect the Purchaser from joining a relationship that appears to be better than it actually is with respect to the applicable experience.)
	Does the OEM Supplier possess a special technical advantage that the other candidates do not? (Note: Certain manufacturing service providers may have a superior technical advantage that may prove to be invaluable to the Purchaser in the relationship. For example, an OEM Supplier with particularly high levels of training, patents or research and development may present a significant quality upgrade or cost savings to the Purchaser that would not otherwise be obtained. Just make sure that the given technological advantage necessarily applies to the needs of the Purchaser.)
	What is the Supplier's financial condition? (Note: In an OEM Supplier - Purchaser relationship that typically lasts for several years or more, a secure financial position within each party is crucial to ensure that the relationship remains functional. If no secure financial position exists, then the Purchaser puts itself at risk of losing the Supplier or having to take great expense to keep the Supplier afloat until the Purchaser can find a suitable replacement - either way a non-desirable outcome. In addition, the evaluation team should perform a more detailed analysis of the candidates through a Supplier quality audit or another alternative method of evaluation in order to ensure that all possible aspects of the relationship are analyzed prior to forming a partnership.)

What is a Supplier quality audit?

A popular form of evaluation, a Supplier quality audit is a series of evaluation sheets completed by the evaluation team (each evaluator analyzing their specific specialty area) that is designed to evaluate any or all of the following business aspects: quality control, manufacturing, management, strategic planning processes, training, materials purchasing, inventory management, warehousing, shipping, materials receiving, preventative maintenance, facilities management, finance, safety, data processing areas.

What are some potential problems associated with using a Supplier quality audit?

The Supplier quality audit does have several problems. They are the following: assume that the auditor can fairly audit their particular factor, assumes that the auditing company could pass the same quality control assessment, time-consuming, requires full access to Supplier's facilities, personnel and process, and no assurance that the quality will continue throughout the relationship exists.

Legal Aspects of an OEM Relationship

What is the importance of having a non-disclosure agreement signed prior to entering the bidding process?

Either the OEM or organization may attempt to utilize information that is critical to the success of either company to its' own benefit at the expense of the other company's competitive advantage. A non-disclosure/confidentiality agreement requires each company to not utilize any such information. If such information is used anyway, the agreement should allow for the termination of the contract and allow for the pursuit of punitive damages.

How can a company ensure that all items in the contract are clearly defined so they do not pose such a legal problem in the OEM Supplier - Purchaser relationship?

The organization and OEM should review all tasks being performed and verify that all tasks are clearly itemized (with stated performance appraisal qualifications) in the formal agreement.

What is the purpose of having a clause in the contract that allows a third party vendor to come in and evaluate the manufacturing service provider's financial position during the time of the contract?

An organization may be unable to verify the financial position of an OEM and, thus find itself in partnership with a company that is financially unstable. A clause in the contract that ensures the ability of an organization to evaluate the financial position of an OEM through a third-party vendor protects the organization from termination for bankruptcy or other financially related problems.

What is the importance of adding stipulations to the termination fees? What stipulations should be added?

Stipulations on termination fees allow a Purchaser to limit the possibilities under which such fees can occur and how much of a fee can be assessed.

The stipulations that should be added are a cap on the possible fees that can be charged along with a gradual reduction for of payments over time (for things like severance that would stop after payment).

What is the importance of using cost caps in the contract? What cost caps should be added to the contract?

When dealing with international trade, a good number of escalation clauses may be built into a contract that may force the Purchaser into a higher cost category than was anticipated.

Any number of cost caps can be utilized to prevent excessive escalation of costs incurred by an organization. Such caps should be used whenever price escalation is possible (for example, additional charges for units or services requested over and above a certain level) in order to minimize the Purchaser's vulnerability to excessive changes in price. For example, a contract may stipulate that an extra $5 be charged for every additional hour worked on a "rush" project over and above eight hours a day. A Purchaser would prevent excessive working hours by stipulating that the contract contain a cost cap that pays such an amount for extra hours up to an extra $50 in a week - preventing the excessive compounded costs of labor that are possible.

What are performance metrics and why should they be added to the contract?

Performance metrics are inserted in a contract in order to continually measure the performance of the OEM Supplier against the requirements set forth in the contract. These metrics provide for penalties if they are not met. For example, failure to ensure that requests from an organization to an OEM are processed and responded to in an expedient manner can hurt not only the communication channels between the two parties, but the ability of an organization to capitalize on opportunity. The utilization of performance metrics that are stated in the contract and penalize the OEM for failure to comply in a timely manner ensures that the communication channels and opportunity flexibility of the organization remain in a strong position.

Marketing to Potential Purchasers

How does an OEM Supplier ensure that it gets on the potential Purchasers statement of qualifications (SOQ)?

After going through the process of ensuring that a manufacturing service provider is being seen by potential Purchasers, the Supplier should be knowledgeable of the process that it will be put through when the Purchaser begins evaluating it in order to make it attractive enough to get on the Purchaser short list - the SOQ. The process that the Purchaser will go through in evaluating the potential OEM Supplier is as follows: The Purchaser starts with a simple determination of whether or not the potential Suppliers desire to sell to the Purchaser. If such interest exists, a Purchaser will then observe the condition of the OEM Supplier's plant and equipment, the general financial state of health of the Supplier, the relative activity level of the Supplier, location of the other manufacturing service providers, and the Suppliers' view and use of technology. The remaining qualified candidates will then be evaluated against the following questions and how the responses adhere to the needs of the Purchaser: How long has the Supplier been in business? Who are the principal owners and managers? Who are the Supplier's major customers? May the Purchaser contact them to perform due diligence? What have been the Supplier's business trends over the past ten years? What is its history in labor relations? Is there a union? When is the contract due for renegotiation? What percent of sales is spent on research and development? What quality-control systems do they use? What is current backlog and delivery lead-time? What is its history of price changes? After completion of all of the above analyses, an organization will then have a sufficient number of candidates to fill out a statement of qualifications (SOQ) and send out Request for Proposals (RFP). Thus, an OEM Supplier would want to best address the above questions relative to how the manufacturing service provider can serve the needs of the Purchaser in order to capture the business of the Purchaser.

Negotiation

Why should a Purchaser demand a very detailed outlay of the baseline services in an OEM Supplier - Purchaser relationship?

A Purchaser will demand a very detailed outlay of the baseline services because if baseline services (those services that are most core in the relationship) are stated very narrowly between the manufacturing service provider and the organization relatively hidden additional charges may be permitted that distort the actual price of the goods being purchased. Thus, the Purchaser will most likely be diligent in ensuring that the baseline services' costs include as much of the possible costs that can be included.

What services are considered baseline services?

Baseline services are those core services that an OEM Supplier will provide to the Purchaser. These services usually comprise the most negotiated aspect of the contract and are usually the price a Purchaser looks at when determining the price relative to competing manufacturing service provider.

Financing an OEM Relationship

Which methods of financing would typically benefit an OEM Supplier - Purchaser relationship the most? Least?

From the Purchaser's point of view, the most beneficial form of financing is the open account due to the freedom of the payment terms. The next most beneficial is the documentary collection the Purchaser can still refuse to accept the goods for delivery. Third most beneficial is a letter of credit which is followed closely by factoring because they allow some measure of freedom to both the Purchaser and OEM Supplier while alleviating a great deal of risk for both. Finally, cash pre-payment is the least beneficial to the Purchaser because it puts all of the risk on the Purchaser rather than the two companies sharing the risk or the manufacturing service provider taking on the risk.

Why does the variable pricing method benefit both the OEM Supplier and the Purchaser throughout the life of the contract?

Variable costs vary in direct proportion to the usage level. Variable costs will decrease relative to the price per unit as the production level rises and rise as the production level falls. For example, the price per unit to manufacture twenty component parts may be five$; whereas, the price per unit to manufacture 100 component parts may be only $4. Both the OEM and the organization benefit from utilizing a variable pricing method over a fixed price method because the manufacturing service provider is protected from losses in a higher than expected demand situation and an organization is protected form losses in a lower than expected demand situation.

What is the most common form of financing that is used when completing such an international OEM transaction?

The most common form of financing in an international transaction is a letter of credit.