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How much should we pay for contract electronics fees and services for our program? How do we determine program total landed cost? How much of the quoted pricing for CM fees and services goes straight to CM profit? How can we effectively compare quoted pricing from several CMs? What should our costs be for our outsourcing program and how can we find answers to these questions, and others?
Venture Outsource creates industry-leading and accurate costing modelers for electronics OEM (brand owner) manufacturers outsourcing their electronics equipment program design and manufacturing to providers of contract electronics services. This article reveals helpful information and answers to the above questions, and others, such as, how can equipment manufacturers build costing modelers to effectively compare quotes from various providers? What features and functions should our costing modeler have, and how can we use costing modelers to identify risks, and opportunities for better pricing and cost reductions?
The amount of time it takes for electronics manufacturers to build ‘effective’ costing modelers for their outsourcing programs depends on the level of internal expertise and experience sourcing and
pricing and managing costs tied to electronics outsourcing programs plus, understanding internal contract electronics operations and business finance across various contract electronics business models available to OEM manufacturer teams tasked with building costing modelers.
The reality is, because most manufacturing enterprises do not have a single internal source with a comprehensive base of knowledge and experience from which to draw from, contributions and input is needed from several departments and the number of staff required from each department can vary depending on the size of the electronics manufacturing organization, industry products produced and markets served.
Getting started
This article provides outsourcing program insights, and suggests goals and objectives, with examples, for OEM manufacturers when creating standalone costing modelers that create real, actionable leverage when contracting services from contract electronics providers.
Upon reading this article, electronics OEM equipment manufacturers with adequate industry experience and resources should have enough knowledge to assemble a team capable of building a costing modeler that can perform the following:
- Identify internal OEM departments to be included on costing modeler team
- Identify which OEM titles, roles and responsibilities – within each department – should participate
- Understand deliverables assigned to each OEM department
- Understand deliverables assigned to individual titles, roles and responsibilities within each department
- Understand features and functions your costing modeler should perform
- Understand which specific risks and exposures your costing modeler should be able to identify, and quantify, for your outsourcing programs and, within your extended contract electronics provider supply chain
- Build, test and validate an effective costing modeler for your outsourcing programs
- Know how to leverage output from completed costing modeler for leverage in discussions on pricing of services and fees, as well as cost reduction with existing programs, with contract electronics providers from positions of strength – that are also defensible
- Be able to use your costing modeler to perform robust ‘what if’ scenarios, on the fly, when preparing for, and during, program pricing and cost reduction discussions and (re)negotiations with providers of contract electronics services
When creating a costing modeler to determine optimal quote pricing for outsourcing services for a wide variety of contract electronics programs, input is typically required from several departments within the manufacturing organization.
The objectives for any costing modeler, at the very least, should be to:
- Identify and capture all internal CM costs, including fully-burdened indirect labor
- Calculate internal CM break-even profit
- Determine line item best pricing on program bill-of-materials (BOM)
- Calculate optimal total landed cost
- Identify currency exposure and ForEx risks
- Identify material exposure risks across the supply chain
- Robust ‘what if’ on-the-fly scenario modeling (useful during negotiations)
Expectations
A standalone costing modeler can be built using a workbook, such as Excel. This article assumes users are building a standalone modeler, similar to the Venture Outsource Compendium Costing Modeler, but know this information can be equally helpful for use in building a systems integrated, software costing modeler.
Expect to invest several months building a solid base from which you will need to build your costing modeler – spending time and money – in meetings, exchanging calls and emails between various departments and individuals in the following activities as they become clearer, and evolve, over time:
- Formulating hypotheses
- Identifying and gathering data
- Verifying data and inputs
- Manipulating data and inputs
- Identifying and assessing risks
- Formulating and verifying calculations
- Verifying outputs
- Making revisions
- Testing
- followed by more testing
- …etc
On this journey, understanding managing contract electronics sourcing and related business finance is ideal; setting up and managing CM P&L, balance sheets, and cash flow statements for various contract electronics business models plus, thorough understanding of internal CM finance and industry related processes and procedures within function departments inside contract manufacturing organizations.
Below are manufacturing organization functional departments, and roles and responsibilities typically found in each department, for Fortune 100 electronics manufacturer OEM (brand owner) companies, inclusive of the many action items or deliverables from each role (and/or department), as bulleted items, where appropriate.
Engineering
The engineering department provides technical information about the product and its specifications, which is used to determine the cost of materials and labor required to produce the product. When creating a costing modeler for a contract electronics outsourcing program, the roles and responsibilities identified from the engineering department needed to participate and provide input to help determine the cost of materials and labor required to produce the product, follow.
Design engineers
Design engineers can provide information on the materials and components required to produce the product and the design constraints that may impact the cost of production.
Process engineers (see also Operations)
Process engineers can provide information on the manufacturing processes used to produce the product and the cost of those processes and procedures, including the cost of direct labor and equipment, and manufacturing process instructions (MPI), and will be instrumental in creating program or product workflows from which more accurate program headcount staffing and costing can be determined.
Quality engineers
Quality engineers can provide information on program quality specs and requirements for the product and the cost of implementing quality control measures and monitoring during production.
Project managers (see also Program management office – PMO)
Project managers can provide information on program scheduling and timeline for the project and the impact that those factors may have on the cost of production.
Procurement
The procurement of purchasing department can also provide information on the cost of raw materials, plus components, and other supplies, needed to produce the product. The roles and responsibilities identified from the procurement department needed to participate and provide input, can include:
Sourcing/procurement specialists
These individuals can provide information on current market prices and availability of raw materials, components, and other supplies.
Logistics/transportation specialists
These individuals can provide information on the cost of shipping and handling for the materials and components, as well as distribution of finished goods inventory (FGI).
Quality assurance/control specialists
These individuals can provide information on the cost of quality control and inspection processes that need to be implemented during the production process.
Compliance specialists
These individuals can provide information on any compliance and regulatory requirements that need to be met during the production process, and the cost of complying, or failing to comply (penalties), with those requirements.
Some examples of other supplies that may be needing to be identified and attributed, include:
- Packaging materials and related costs such as boxes, bags, and labels used to package the finished product for shipment.
- Shipping and handling supplies like pallets, crates, and packing materials used to protect and transport FGI.
- Production tools and equipment, such as torque wrenches, conveyors, molds and fixtures, and specialized tools used in production and processes.
- Maintenance, repair, and operating (MRO) supplies, such as lubricants, adhesives, and cleaning supplies to maintain and repair equipment used in the production process.
- Consumable supplies, like solder past, flux and solder, soldering irons and guns and tips/cleaners, tweezers and flush and wire cutters…that are used in the production process and need to be replaced periodically.
- Safety and personal protective equipment (PPE), such as gloves, ESD straps and smocks, goggles, fans and respirators used to protect workers and product during the production process.
The list of ‘other supplies’ will vary depending on product specifics, industry and market of the product, and the manufacturing process. It’s important that all necessary materials and supplies are considered when creating the costing model to obtain the best possible outcome in terms of accuracy and budget forecasting capability.
Operations
The electronics manufacturer’s operations department provides information on the cost of manufacturing and assembly processes, including labor and overhead costs. The following roles and responsibilities identified from the operations department needed to participate and provide input, can include:
Supply chain managers
Supply chain managers can also provide information on the cost of logistics, transportation and inventory management, including receiving, storage and kitting, and material handling costs. Contract manufacturers capture a lot of their profits from receiving and warehousing raw materials, MRB storage fees, and FGI so inviting supply chain managers into the discussion, armed with this knowledge and understanding, can be helpful.
Production managers, supervisors
Production supervisors can also provide information on the cost of labor, including wages, benefits, and training costs for hourly, direct labor workers involved in the production process.
Manufacturing engineers (see also Engineering)
Manufacturing engineers can provide information on the specific manufacturing processes and instructions (MPIs) and equipment that will be used to produce the product, as well as the cost of those processes and equipment such as that used for surface mount technology (SMT) lines, printed circuit board (PCB) assembly and box build systems integration work cells, including the staffing for these production environments – as well as information on the cost of labor required to assemble the product.
Facility managers
Production facility managers can provide information on the cost of maintaining and operating the facility or factory where the product will be manufactured, including utilities, rent, and property taxes. This can be quite an extensive list. Capturing as many of these costs as possible is important to accurate costing.
Maintenance and repair managers
These individuals can provide information on the cost of maintaining and repairing the equipment used in the production process to manage against costly line and workcell downtime.
Finance
Manufacturing company finance professionals from this functional department will be able to better provide information on the company’s financial constraints and goals, which are then used
to determine the overall profitability of the outsourcing program. The following roles and responsibilities identified from finance needed to participate and provide input, can include:
Financial controller
Manufacturing financial controller can provide input on the budgeting, forecasting, and cost analysis for the outsourcing project. Having a CFO or financial controller familiar with setting up and managing contract manufacturing factories, divisions and companies can be helpful.
Cost accountant
The cost accountant can provide detailed information on the costs associated with outsourcing the product program, including direct costs, indirect costs, and overhead costs. (Think: S,G&A vs F,G&A)
Financial analyst
The financial analyst can provide input on contract manufacturing industry intelligence tied to pricing strategy, risk management, and financial modeling for your modeler.
Capital budgeting analyst
A capital budgeting analyst familiar with contract manufacturing is ideal. They can provide input on internal industry capital budgeting, including determining appropriate rates of return on investment (ROI), distribution and depreciation of capital, amortization…
Treasury analyst
The treasury analyst can provide information on the company’s cash flow, which can be important for determining the financial feasibility of the outsourcing project and, how contract manufacturers derive their profits, given all of the tier-1, tier-2 and most tier-3 contract manufacturers book revenues in one currency while leveraging ForEx variables.
Tax manager
The tax manager can provide information on tax implications of the outsourcing project, which can also contribute helping determine overall program profitability.
Specific titles in manufacturing finance departments can vary depending on the size of the manufacturer. The key is to involve individuals in finance who have relevant electronics contract manufacturing expertise and experience to provide input on the financial aspects of your outsourcing programs to help you achieve needed inputs for your costing modeler that are capable of producing actionable output.
Again, here is a good time to emphasize the benefit of coordinating among different people staffed in different departments. Category managers, procurement and operations managers are usually always instrumental helping uncover hidden costs and risks associated with outsourcing in other
geographies, as well as the impact on the company’s overall operations capabilities with focus on adequate staffing.
Sales and marketing
Manufacturing sales and marketing departments can provide information on the pricing and demand for your company’s products in your markets, which can then be used to determine optimal pricing targeted with your costing modeler to then be evaluated against pricing quotes you receive from potentially suitable CMs during your request-for-quote (RFQ) process.
The following deliverables for sales and marketing to provide for input, may include the following:
- Product costs, this includes the costs of raw materials, labor, and overhead associated with each product, including aggregate costs for product families.
- Sales data – information on historical sales, current demand, and projected demand for each product.
Market data – intelligence on the competitive landscape, including pricing for similar products and services in the market. - Margin targets – targets for gross and net margins for each product or service required for your program provided by contract manufacturers.
- Volume discounts -information on any volume discounts offered by components distributors, contract manufacturers, various suppliers and other vendors.
- Lead times – lead times for obtaining materials, components, and other inputs.
- Production capacity – the capacity of the CM’s manufacturing facility, including constraints on labor (direct and indirect), equipment (costs and amortization), and space and OH needed.
- Product lifecycle – the expected life of the product and any known end-of-life dates. Keep in mind, sometimes its more cost-effective, and better for market share to add features to existing products instead of costly R&D for new product launch (NPD)
Legal
Manufacturing legal departments provide information on contractual requirements, potential liabilities and warranties, and their impact on overall corporate financial health and maintaining corporate longevity while minimizing risks for the manufacturer.
When manufacturers create costing modelers, the following titles and roles within the legal department may be needed to participate:
Legal counsel or general counsel
Contracts manager or contract administrator
Intellectual property lawyer
Supply chain lawyer or procurement lawyer
Specific titles and roles needed may vary depending on specific program requirements and the manufacturer’s internal structure. Additionally, external legal and industry experts, with specific experience in contract manufacturing and outsourcing, are also often brought in to participate.
Actions and inputs manufacturing legal departments may provide include guidance on legal and regulatory compliance issues related to outsourcing manufacturing, including intellectual property rights, data privacy and security, and compliance with laws and regulations specific to the industry and geographies where the contract manufacturing is taking place.
Legal will also review and provide input on contract service level agreements (SLA) between the manufacturer and the outsource provider, to ensure they are legally sound and protect the manufacturer’s interests, including, but not limited to:
- Identify legal risks associated with the outsourcing program and developing strategies to mitigate or minimize those risks.
- Providing input on any disputes or issues that may arise during the course of the outsourcing OEM-contract manufacturer relationship, and working with the other departments to resolve them in a timely and efficient manner.
- Reviewing and interpreting clauses in the SLAs and related exhibits and articles, providing internal manufacturer commercial teams with guidance on potential legal implications of any commercial decisions.
- Reviewing and negotiating any change orders or amendment to the SLAs.
Office of program management
The program management office (PMO) is a department that is strategic in nature, guiding manufacturing enterprises with individuals who play a central role of central point of contact between the enterprise and the contract electronics services provider.
Specific titles within an electronics manufacturing enterprise’s PMO include:
Program manager
Senior program manager
Director of program management
Chief program officer
Program management specialist
Program coordinator
Program analyst
Project manager
Project coordinator
Project analyst
Individuals, or teams, within the PMO will typically contribute the following deliverables, when the manufacturing enterprise is tasked with creating an effective costing modeler for outsourcing its electronics design and manufacturing and supply chain services to contract electronics services partners:
- Bill-of-materials (BOM) analysis and review to determine material costs
- Labor and overhead costs analysis and estimation
- Equipment and facility utilization analysis
- Cost breakdown structure and analysis of each production phase or stage
- Supplier and vendor pricing analysis
- Analysis of logistics and transportation costs
- Cost of quality analysis and estimation
- ‘What if’ scenario analysis and modeling to identify most cost-effective options
- Recommendations and strategies for cost optimization
- Detailed cost model with transparent, traceable, and defensible cost elements
All of these inputs above are important to consider when creating a costing modeler to determine optimal quote pricing for contract electronics services.
The PMO can provide these inputs and by considering these inputs the manufacturing enterprise can determine optimal quote pricing for contract electronics services when outsourcing to contract electronics solutions providers.
Importance of identifying and defining direct vs indirect labor
Direct labor and indirect labor categorize the type of work performed in a manufacturing process.
Direct labor refers to labor costs directly involved in production of the equipment or product, such as an SMT or PCB assembly line worker or box build integration assembler or final systems test operations. These labor costs are directly tied to the output of the production process and can be directly traced to the final product. Direct labor is not typically a large percent of MCOGs for most electronics programs.
However, indirect labor refers to labor costs supporting the production process, yet not directly involved in production of a the equipment or product, such as supervisors, maintenance workers, or administrative office staff like engineering managers, program managers, finance managers…to name a few. These indirect labor costs are not easily traced to the final product and are considered indirect costs. They are also costly, and therefore must not be ignored.
The importance of identifying and capturing fully burdened costs for ‘indirect’ labor staffing in functional departments supporting manufacturing production cannot be underscored enough when the goal of the enterprise is to create effective costing modelers.
Capturing such costly indirect labor staffing can best be determined by using a combination of methods such as time study, activity-based costing, or standard costing.
These methods are, in addition, or sometimes can be similar to, takt times used for direct labor, involving analysis of specific tasks and responsibilities of indirect labor functional department indirect staff – assessing and calculating the cost for their time involved and resources used to perform such roles and responsibilities. Once determined, these costs can then be allocated to the contract electronics program based on the proportion (percentage) of their work dedicated to supporting a particular outsourcing program relative to fully burdened salary earnings.
Having access to accurate contract electronics industry data for indirect labor costs for each department role and responsibility is crucial for piecing together and determining contract electronics provider program operating margin and internal program costs, which is necessary for contract electronics costing modelers to provide the manufacturing enterprise the knowledge needed for defensible pricing strategies, cost reductions, and SLA contract (re)negotiations.
Moving forward
Ideally, you want product and program pricing quoted by contract electronics providers you are considering to equal your optimized pricing. And while this win-win rarely occurs, you also want your contract manufacturing partner(s) to be profitable – otherwise, they might fall under financial hardship and no customer wants their suppliers to fail.
In addition to obtaining information about how to create costing modelers for contract electronics programs, a secondary objective of this article is emphasizing the need for sound understanding of internal costs tied to contract manufacturing business models and that such information be accurate, because having this information then informs you precisely how much room for negotiations you have against quoted pricing for contract electronics provider fees and services – and you should never be in a position where you left money on the table because you were not fully informed.
Both Venture Outsource Compendium and Enterprise costing modelers, on average, save manufacturers 5% to 15%+ in annual spend for their contract electronics services and we can help you.
If you want help with your outsourcing objectives, including cost modeling of your contact electronics manufacturing programs and supply chain business interests, please contact Venture Outsource. We look forward to hearing from you and answering all of your questions.
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