Outsourcing

Some Ideas about When and Why to Do It

Phil Baker

You no longer need to be a Sony with your own design staff and factories to build world-class products. Where making sophisticated electronic consumer products once was the privileged domain of a few, now virtually anyone can play. The advantage is now to the swift and the creative, rather than the big. But to get that advantage, you’ll need to go to Asia.

The Rise of the OEM and ODM Model

Companies that produce products for customers who brand, distribute, and market them under their own names are called original equipment manufacturers (OEMs) and original design manufacturers (ODMs). OEMs are companies that manufacture the product, while ODMs both design and manufacture them. Some OEMs and ODMs have grown so large and capable that it’s even common for them to make products for customers who compete with one another.

One of the most successful examples has been the manufacturing of notebook computers in Taiwan. Inventec Electonics Corporation, for example, is one of the largest ODM notebook companies in the world and has been making products for Hewlett-Packard, Toshiba, and several others. Quanta, another huge ODM, makes notebooks for Apple, Dell, and Hewlett-Packard, as well as others. It’s typical for the large computer companies to use several ODMs.

I used the ODM model when I worked for Apple. I selected Inventec to design and make the second-generation Newton and Quanta to design and make the PowerBook 1400, the first Apple notebook to be both designed and built in Taiwan.

The leading notebook manufacturers, including Inventec and Quanta, have become so experienced at building the products that they’ve taken over much of the design from their customers. They have the relations with the component suppliers, are the first to learn of and incorporate new technologies, and have become skilled at rapidly creating new models. Not only do they make and manufacture the notebooks, some companies manage the delivery process as well, shipping the finished product directly to the end customer within a few days after the customer ordered it.

This model is now being replicated across many other categories of consumer electronic products and in other Asian countries, as well. Thousands of OEM and ODM companies specialize in manufacturing and designing specific types of products for their customers who, in turn, take them to market under their own brands. Where once a company that branded a product did almost everything from design to manufacturing, that’s no longer the case.

From my experience in developing many products using OEMs and ODMs in Taiwan and China, Taiwan is exceptionally strong in its engineering and manufacturing skills and China in its manufacturing, infrastructure, and cost advantage. Although China is not strong in the design of technically complex products, their skills are constantly improving.

Japan, where I began doing ODM products, has become too expensive, and no longer is competitive. And with their established worldwide brands, Japanese companies do less ODM work for others and focus on their own products.

Asia’s Advantage

Unfortunately, it’s become difficult to build these products competitively in the United States or Western Europe, because many of the parts come from Asia. Furthermore, it’s also becoming more difficult to design products in the West that are to be made in Asia. Domestic companies don’t have the same access to many of the parts and road maps of future parts needed in new products. Component manufacturers set up their sales and support offices close to their customers, where the products are made. So, as manufacturing moved offshore, the expertise and support went, as well.

Is Outsourcing for All?

Outsourcing in Asia is not for all companies and products. The technology products and scenarios best suited for manufacture in China are

• Small electronic devices containing circuit boards, displays, motors, plastic moldings, and sheet metal parts. Electronic components are readily available at some of the lowest pricing in the world, and millions of circuit boards are manufactured each day. The cost of plastic tooling and molding is usually less than half the cost in the United States or Western Europe, and it takes less time to build it.

• Production volumes should be thousands per month rather than hundreds. It makes little sense to go to China for products with low volumes of fewer than 1,000 items per month, particularly if the product cost is less than $50. Yearly business should be at least $200,000 to $300,000 in the first year and have a good chance of growing to at least a $500,000 or more a year or two later.

• The more mature a design the better. Products that are complex or still going through design changes are best built locally where the engineers can spend more time debugging the design. While engineers in China can work on production level problems, few are equipped to solve complex design issues. Today, China works best when most the serious design deficiencies have been eliminated. Taiwan is different, and I would not hesitate to have a product designed from the ground up there.

• You need to be adequately funded. You’ll be making substantial investments in inventory and tooling that require prompt payment. Some of the manufacturers require companies whose products they take on to be backed by venture capitalists or major corporations. Because they work on small margins, credit is rarely provided.

• The product should be of high value and of relatively small dimensions so shipping costs will not be a burden. That makes consumer electronics ideal.

• Have a sound business plan. Your product should have good distribution and the potential for selling in reasonable quantities, as noted previously. One of the first questions you will be asked is how you plan to get your product to market. While few ask for guaranteed minimum quantities, they need to believe in the product’s potential as well as in the company’s business model. Companies in Asia are cognizant of our consumer channels, retailers, and business activities, thanks to the Internet and experience with other customers.

• Any company that goes to China should have sufficient resources in time, manpower, and money for managing their activities there, including having people frequently on-site.

Low volume products, such as medical devices, in which there is less price pressure, are best done locally; the overhead costs, primarily the cost of travel and personnel spending time in China, can be significant. Still, many low volume products can benefit by building the tooling and parts in Taiwan or China, where costs can be one-third to one-half of those in the United States or Europe.

Going to China is not a solution in itself. It’s an option that can be beneficial if done correctly; so set your expectations appropriately. No company is going to be so good that you’ll be able to drop off your idea and pick up a finished product six months later. Instead, expect to be working far away from home for long periods of time to nurture your product along.

Chinese companies are not monolithic, just as Western companies are not all the same. There’s a huge range of competency in China from companies with a few salespeople to those with broad capabilities. The challenge is finding the good ones.

Protection of Your Intellectual Property

One of the most frequently asked questions I get is whether a product brought to China to be manufactured will be copied. After all, China has a reputation for copying everything from designer purses to expensive watches to software. Do you face a risk of using a company to build your product if it’s already making a product like yours? Will they copy your ideas and incorporate them into their own products or, worse, into your competitors’ products?

I have never once encountered an overt act of a manufacturer copying products that were then sold to others. Never. Perhaps I’ve been lucky to work with companies that don’t engage in these practices. Certainly it happens to some. But the overt copying is done mostly by different types of companies, not OEM and ODM companies whose business model depends on trusted relations with their customers, on whom they depend for most of their business.

Still, there are some ways to protect a design if you’re concerned. Consign a unique part or custom chip to your manufacturer, but produce it elsewhere. Or manufacture parts of your product in several different factories and bring them to another company to do the final assembly.

But do note that a manufacturer may gain new skills just by building products for their customers. They become aware of new designs and new markets, and of course how well the products sell. From my experience, the advantages of working with a company with experience making similar products vastly outweigh trying to work with a company without that experience. But remember that once a product goes on sale and is on the market, the design is readily available to be reverse-engineered and copied by anyone.

Ultimately, the best antidote to your product being copied is speeding your time to market, expanding distribution quickly, and working on your next generation product while your competitors are busy copying your old one. The best lawyers and the best patents won’t help in the short term and often are of little value in the long term, particularly with product lives being shorter than ever. Put your money in product development and marketing rather than in lawyers.

I do recommend signing an NDA (nondisclosure agreement) and developing a simple agreement or letter of intent, but I’ve rarely waited for an agreement to be completed before beginning the project. Delays in the early part of the project can never be made up. I’ve begun many projects on a handshake and have never regretted it.

Product Quality

China is often in the news for producing products of poor quality. A number of consumer product companies have had to recall their products, everything from dog food to medication to toys, primarily because the products contained dangerous substances or ingredients.

If you believe the comments of politicians and talk show “experts,” you’d think that China is the last place you’d want to make products. From my own experience, these comments are misinformed and fail to address the real causes.

China has the broadest and most comprehensive manufacturing infrastructure in the world. Generalizing that products from China are good or bad, safe or dangerous means nothing. While China deserves some of the blame for failing to police its own industries with its huge growth, this would be hard to do anywhere.

Nearly every product being sold in the United States or Europe that comes from China has a local company behind it. These companies are producing or procuring a product there and then importing it and distributing it under their own name. A company’s role and responsibility, wherever they produce a product, and particularly when they sell it under their own brand name, is to oversee the development and manufacturing and ensure the product meets the requirements through careful inspection and auditing of production.

The companies with the tainted products failed to do this. They allowed defective products to reach the market because they didn’t adequately oversee their manufacturing and then failed to perform inspection and testing that would have caught the defects. When a consumer buys a product, he expects the company whose brand is on that product to take responsibility for it.

Many Chinese manufacturers, particularly of nontechnical products, are not sophisticated. They’re trying to produce products at low cost to please their customers and to make a profit. They’re constantly using a network of suppliers, some of whom use their own suppliers. At each step along the way there’s the incentive to cut costs to generate a little more profit.

Once production begins, some manufacturers or their suppliers may substitute lower cost materials or finishes. Some of these shortcuts are a result of carelessness or greed or a result of the constant pressure to cut costs from the customer. Employees in these companies might not even understand how the cost cutting impacts and compromises the product because they are so far down the chain. That’s why the company whose brand goes on the product needs to monitor the chain of manufacturers and constantly audit the product.

That’s why you will want an inspector to pick out sample units to test. Often products that have complex electronics should be powered up for as long as a day to check for early failures. Once a product is built and tested, it’s packaged at the end of the line and then goes to the shipping area for transport to the customer.

Seeing your product roll down the assembly line, being built by the thousands, is one of the most satisfying moments during the development of a product. It’s a sight that sometimes you think will never arrive. You’ve gone from struggling for months to get one unit to work to seeing thousands being built, all working perfectly. That’s the moment you go from worrying about the design to worrying about the sales.