Many big Original Equipment Manufacturers (OEMs) outsource part/whole of their manufacturing to contract manufacturers (CMs) as a business strategy. This is prevalent in the industry right from footwear business (Nike, Adidas etc.) to electronics/computer business (Apple, HP etc). According to manufacturingglobal.com about 30 to 50% of footwear manufacturing for Nike and Adidas is done by China-based CMs, while the rest is sourced from CMs based out of other countries. Apple and HP outsource most of their assembly to Foxconn, Flextronics and some other CMs based out of China (Wang et al. 2011). The purpose of this article is to explain how CMs have evolved with anecdotes from the consumer electronics industry. We also look at how the supply chain relation, and hence the supply chain contracts between the OEMs and CMs have become increasingly complex over years. Most of the information provided in this article is sourced from the research work of Wang et al. (2011).
Contract manufacturing is significantly prevalent in the consumer electronics space. Due to the intense competition among the CMs, many CMs started providing additional services like product design services to the consumer electronics OEMs. For example, Foxconn and Flextronics have built large R&D centres to offer product design services to OEMs. This move was welcomed by the OEMs since it helped the OEMs to reduce their lead times to introduce newer products into the market. OEMs in the consumer electronics space face the issue of products becoming obsolete with advances in technology and strive to achieve short lead times from design to manufacturing for new product releases. The ability of CMs to get into additional business functions of the consumer electronics market in addition to manufacturing proved to be a double-edged sword for the OEMs. CMs became increasingly capable of designing, producing and selling their own self-branded products thus increasing the competition for the OEMs in the market. Three examples of CMs turning into competitors for the OEMs are provided below:
Example 1: BenQ, which was a CM for Motorolla started producing its own cell phones in 2005
Example 2: Asustek, a Taiwan based CM for Apple,Dell and Sony now designs, produces and sells its own Asus brand of notebooks, computers and cell phones.
Example 3: Acer, a CM for IBM and Apple, became the third-largest computer manufacturer in the world in terms of sales.
Thus the simple supply chain relation of a contract manufacturer turned into a complex one since many CMs manufactures for the OEMs and at the same time compete with the OEMs with their own self-branded products. Thus the revenue function of a contract manufacturer will have two components
(1) Revenue from selling own products
(2) Revenue from manufacturing for the OEMs
Typically the OEMs have thinner profit margins than CMs as they are outsourcing the manufacturing to CMs. But the OEM's products are generally perceived to be of better quality by the market. This situation raises an important question: Should the OEMs outsource their manufacturing to a CM that can compete with the OEMs in the market? At first we are tempted to think no. Why would any OEM partner with a CM which the OEM knows is going to be his/her competitor? But there might be a rationale behind outsourcing OEMs manufacturing to a CM who is a prospective competitor. As was mentioned before, the CM's revenue function has two components in it. If the OEM provides business to the CM thus boosting the second component of the revenue of CM, the CM might be less aggressive in terms of competition as the increase in the second component can compensate for the decrease in the first component.
The situation mentioned above is similar to a situation where a manufacturer sells through a large retailer which has its own private label that competes with the manufacturer's products. Such supply chain relations/contracts are well studied in the literature. A game-theoretic approach can be used to model analyse these situations. Typically game-theoretic analysis is used in situations where one player's revenue/payoff is dependent not just on her own decisions, but also on the decisions of her competitor. For example in our problem the OEMs revenue function is not just dependent on how much the OEM decides to produce and sell but also dependent on the wholesale price decided by the CM to whom the OEM has outsourced manufacturing. You may read the paper referred below for a detailed analysis of this problem. It is interesting to note that some of the insights from the analysis are highly counter-intuitive to what we believe is common sense.
One of the primary objectives of analytical studies using mathematics and game-theory is to highlight situations where strategies to be adopted as optimal decisions are completely opposite of what common sense/common intuition might suggest. Such insights and policy implications of research provide motivation for researchers to do model and study challenging problems faced by the industry.
References:
Wang, Y., Niu, B., & Guo, P. (2013). On the advantage of quantity leadership when outsourcing production to a competitive contract manufacturer. Production and Operations Management, 22(1), 104-119.