The Expanding Role of Contract Manufacturers, and Their Limits

By Logan Wamsley

There was a time in the not-so-distant past where contract manufacturers (CMs) fulfilled a singular role in an OEM supply chain: product assembly. It’s a vital step in the manufacturing process, to be sure, but it was also a role kept isolated from the other processes necessary to fully realize a concept from design to end-of-life.

Times have changed. What was once a one-dimensional role has now become an indispensable piece of the supply chain, and in some cases contract manufacturers have created options that cover virtually all the responsibilities traditionally reserved for OEM customers. In some cases, contract manufacturers even handle some of the product design responsibilities, as well. East West Manufacturing, for example, utilizes a team of engineers that can recommend functionality improvements to current designs, as well as create custom designs of their own for customers. As competition in their industry continues to escalate, CMs are quickly trying to change their narrative from being a supplementary service provider into an equal, one-stop-shop business.

But these services come at a cost that traditional CM business models cannot handle, at least in the long term. In general terms, a company that chooses to expand or evolve does so with on-hand working capital garnered from a short cash conversion cycle. For many analysts, measurements judging the liquidity of their cash flow are one of the primary indicators of a company’s overall health. But even in the best of times, contract manufacturers typically operate on a profit margin of 3-5 percent. Such a model is sustainable in theory, but it severely limits the CM’s ability to deal with the unexpected.

Last time buys for critical electronic components are about as unexpected as it gets.

Crucially, contract manufacturers are also, by nature, the first point of contact with suppliers regarding the lifecycle status of critical electronic components – and as a result, they are usually the first to know if a component in a customer’s design is transitioning toward obsolescence via PCN. This does grant them an advantageous position to provide an additional service in notifying their OEM customers, but more complex is the question of who will handle the next step, which is, of course, who puts up the capital for the bulk purchase.

In comparison to contract manufacturers, OEMs operate on more favorable profit margins – often as high as 30 percent — but recent market conditions have not been easy on them, either. Many customers, such as governments, have been implementing mandatory payment terms as long as 6-9 months. Such terms can put significant strain on an OEM’s cash conversion cycle, and factoring in the time from raw material acquisition to fulfillment of the final invoice, OEMs can be waiting over a year to receive returns on their initial investment. As a result, an unexpected setback such as a last time buy can be a difficult financial hurdle to overcome.

Both sides of the supply chain have a legitimate case to expect the other to bear this burden. OEMs are seeing just how expansive the role of the contract manufacturer has become, and it’s reasonable for them to expect some kind of last time buy failsafe. On the other end, it’s also perfectly reasonable for the contract manufacturer to expect their OEM customers to commit to purchasing – and owning – their own inventory. With sound logic on both sides, an impasse inevitably occurs that, if left unresolved, can be detrimental for all parties involved.

To avoid such a scenario, it’s imperative that OEMs discuss with their chosen CMs beforehand the process that will be followed should a last time buy be needed. Preparation, attention to detail, and full transparency between all parties will go a long way toward making the unexpected manageable.

And if your contract manufacturer does not have a process in place to make a last time buy, don’t be afraid to explore the supply chain marketplace for last time buy options specifically designed to resolve such issues – while keeping OEM/CM relations firmly intact. The supply chain is continually evolving, and for every hurdle, there is a solution capable of resolving it seamlessly and efficiently.