Technology Forecasters, Inc.
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A contract-manufacturer client wrote to us last week about how unfair it is for medical-electronics customers to expect their electronics manufacturing services suppliers to take on significant risk when the medical product fails while in use: He wrote,
“We are continually faced with justifying to potential customers in the medical space why in the EMS industry we limit the amount of risk that we will sign up for. Now in casual conversation with friends from other EMS providers, the consensus is that none of us is willing to take on the amount of risk that we are being asked to.”
We chatted with others of our contract-manufacturing clients who serve both medical and other high-risk-product industries, and heard similar complaints. Catch this one about the automotive industry:
“Automotive OEMs want their contract manufacturers to contractually take on risk as well. If one of the millions of parts we supply to the OEM fails and causes their manufacturing line to shut down, we are responsible for paying for the line’s missed productivity. If we said no, the OEM would not do business with us. So our quality has to be beyond 6 Sigma. If my company can control a process, then I’m comfortable owning some risk for that part. But if a customer-designed product fails owing to the design or other factor beyond our control, it’s inappropriate for us to take on the risk.”
We at TFI think that with contract manufacturers’ razor-thin margins, it’s unreasonable for typically quite higher-margin customers to expect their outsource-manufacturing suppliers to take on product risk based on the customer’s design. The customer, after all, typically owns not only the product design, but also usage instructions, integration into the rest of the product (or body, in the case of medical), and usually a lot of liability insurance.
In some electronics sectors for which contract manufacturing has been prevalent a long time–computer systems, computer peripherals, consumer electronics, non-critical telecommunications, etc.–product failures are rarely critical to human life and significant business interruption.
Speak up on this issue, TFI community: How much risk is fair to expect contract manufacturers to take on, and under what circumstances?
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The EMS provider should never take financial responsibility for the design unless it owns the design. Liabilities should be proportional to pricing/margin; however, it is generally not possible to increase the price enough so most liabilities should be declined. This is a place where the industry should stand together.
PaPam,
Your timing is impeccable, as a supplier we have just been approached by one of our large EMSI partners to accept this type of risk as pass through for particular industry segments such as mentioned in this article.
As you know for the most part the supply base who has been dealing directly with these segments for many years understand and takes a firm position regarding what makes good business sense. The liability associated with accepting such risk can put a company out of business.
It is no secret that the OEM’s have leveraged their outsourcing dollars to pass on many unfair liability and terms with their EMS partners but at some point the sales organizations within the EMSI need to learn to push back.
Maybe they should consult with their suppliers before they accept these requests as an entry to doing business with these customers. They need to remember we have been doing business with these customers long before they got on the outsourcing wagon. We could be a valuable resource to them.
Perhaps the only times liability should be accepted by the CM is when they are responsible for supplier and/or component selection and manufacturing errors. So CMs should be very wary of the slight benefits they get by ownership of supplier selection if the potential liability is high.
Completely agree with the point of this blog.
But the EMS industry also seems to want to take on no risk in any area – which makes them sound hypocritical. In particular, The EMS industry in general – with a very few notable exceptions - pushes back very hard in providing certifications of hazardous material content of the components and/or subassemblies they provide to OEMs. Knowledge and/or control of these materials are far more within the control of the EMS industry than they are of the OEMs they service, yet the poor fulfillment rate of hazardous material content information, and apparent reluctance of many EMS companies to even address the question, force the OEMs to set aside financial reserves against future risk of non-compliance.
Seems not very fair to want it both ways. If the EMS industry does not want to be asked to share risk in an area of product design and development that they do not control, then they need to take some responsibility for risk in areas in which they do.
I have worked in the Contract Manufacturing Business for many years. And liability and resulting incurred expenses is a very interesting topic! But I look at it this way. The liabiliy of anything anyone sells should be limited to the product sold. So if we buy 100,000 capacitors and they turn out to be defective and have to be removed. Are we going to ask the capacitor supplier to pay the rework costs, the lost productivity charges, etc. which are a lot more expensive than the capacitors? I think the capacitor company should replace the 100,000 bad capacitors. Similarly, if a CM builds a product that fails, the CM should gladly replace the producct within the warranty period, but not take on extended costs. For example, if a CM builds a circuit board that is installed in a Boeing 747 and the plane crashes as a results of that defective assembly, should the CM be responsible for the lost lives, the plane, and all other consequences? NO! The CM should replace the defective product. The liability ends with the product shipped. Or how about the case of buying a shirt from Nordstrom’s which turns out to be defective? Sure, Nordstrom’s will replace the shirt, provide credit, or give you your money back for the shirt. But should Nordstrom’s pay for your transporation to and from the store for the extra visit, for the lost opportunity costs of having to visit the store when you could be doing something else? No. Again, the liability ends with the product sold.
Thanks,
Glenn
Great article and I think this is a significant issue and well worth more investigation. This is especially true when the principle asks the EMS to do some peripheral design work but with no margin expectations for the EMS. I think you’re on to one of the cutting edge foundational issues for the EMS industry going forward.
Real partnership means sharing the risks and the margins to support the liability represented in these risks. This is not the typical supply chain relationship though.
I agree with many of the comments here… Risk should be adjudicated according to the material, process, and design ownerships of the contract. If the end user wants to share assignment of the liability of the end use of the product, then they should be prepared to look for an EMS that can handle that size of risk… MANY TIMES above the cost they are willing to pay for the product.
The liability should be limited to the supplies used to manufacture the end item and the product delivered. It is understood by the entire EMS supply base that just one wrongful judgment would put them in the position to close their doors.
I also have worked for many of the EMS providers in the industry and am firmly behind the reporting of RoHS items… after all, this is a global request, not just one request from one of our clients.
If we as ODM or EMS providers own the design and sign off on it, we should also be prepared to own up to the use of the product and it’s faults ONLY IF THE PRODUCT IS USED FOR IT’S INTENDED PURPOSE AND UNDER THE CONDITIONS SPECIFIED BY DESIGN!!
And we should also get our suppliers to follow the rules of reporting and traceability… one area that I personally am skeptical of. I try NOT to use independent distributors that cannot provide the paperwork proving where the component parts come from… sometimes that means missing a contract or two. But the end results are far more costly.
Another issue on this subject surrounds the poor design coupled with customer supplied test equipment. Who pays for the internal rework due to tolerance issues? The test equipment gets qualified by the FDA with certain pass fail parameters, the design does not take into account stack tolerance issues and a large number of out layers fail test even tough the production process is within control. The OEM did not carry out a proper gauge r&r and now somebody is left with a pile of !!!!! the oem states this is the cost fo doing business. A good answer is to shut the line down stating that with such test fails the process is out of control and it is not recommended to continue building. The customer will have approved the EMS line and has 2 options either accept liability fopr the test fails or pay to have the new test equipment requalified through FDA. Both options cost the OEM and remove cost from the EMS.
As an EMS provider and partner, we continue to walk that tenuous line: Accommodate the customer’s needs while keeping the risk at a fair level.
It all boils down to thoroughly understanding the customer’s needs up front and communicating the issues as clearly as possible.
It is a constant, never-ending balancing act.
Very interesting topics, and all of your points are well taken.
We are a small EMS company in business since 1991. As a CEM our limited warranty is 5 feet or 5 minutes which ever comes first and I tell the client this right up front.
We do not supply components for CEM services. Do the math, and it does not make good business sense to lay out $100 for parts and charge $25 for an assembly service at often less than 10% margins. How can $2.50 insure $125 of parts and service and grow a capital intense business?
Our warranty is limited to the work we do. If we put a part in wrong we will fix it, but the client supplies new parts if required. If a solder defect gets through QC we will fix it, but if a part failed in testing on the clients bench and has no manufacturing defects then the buck stops there. We fix and pay for manufacturing defects ONLY.
We do not offer test services to our CEM clients as the exposure is much too high. ie The board doesn’t work and there is no obvious manufacturing defect, so why should our techs hump over the board to make it work before we get paid?
Just like Brian says above - keep it all up front, and it’s about keeping realistic clientelle expectations and meeting those expectatinos.
On the other hand, our business is now aprox 80% ODM for all the above reasons. These are long term contracts where client retention is much higher, and we can see gross margins as high as 65% on the product as supplied to our clients.
We offer full manufacturers warranty from 30 days right up to 1 year. We purchase and inventory everything, and for new designs we do our best to keep our BOM’s overlapping with our other products in order to minimize our purchasing and inventory requirements and maximize volume discounts.
If an ODM unit fails it is FOB our dock and warranty is subject to a review for any potential abuse of the product. We control the design so if it turns out a design flaw it is in our best interest to fix the board and we can do something about it.
Warranties are not free! The important point of warranty is to understand it is not a clients privilage, but rather it is another service which we offer our ODM clients. We charge accordingly for the warranty service relative to the risk and exposure of the project.
All the comments are valid and arguable.
OEM or EMS can take on the risk, as along as the cost is justify. If the OEM wants the EMS to take on the risk, then the cost will need to include the manufacturing price.
EMS pricing have been driving down by the OEM and now they want to add the risk. I’ll say yes, just include the risk of the cost into the price.
When I purchased a toaster from X.X. back in the days, X.X. made it, sold it and stood by it.
If this toaster were to be plugged in and I decided to wash it, X.X told me not to do this in the manual. If the toast popped out and hit me in the eye, X.X. looked at its design and promptly corrected it, stopping the line until the CAR could come into effect.
X.X. decides that making toasters isnt as attractive as it was margin wise, so they took it out sourcing.
Made more money too.
If an OEM decides to outsource, it is THEIR decision and therefore THEIR responsability for the product. The decision to outsource is theirs alone and thus too is the choice of which sub contractor THEY choose based on: PRICE? Quality? Value? In the end, it is still X.X’s choice: make that toaster myself the way I beleive it should be made or slap a label on a totally sub contracted one. Due dilligence on the part of X.X. is where liability should lay.
A toy company with deep pockets decided to have all their toys sub contracted out and THEY decide not to test for lead content. Who is liable? Due dilligence.
They should be ON SITE themselves to make sure things are done the way THEY THEMSELVES would do things to keep their standards. If this were the case, in the end, maybe X.X. would be making their own toasters or sourcing appropriate sub contractors NOT based on the cheapest producer.
Remember, the sum of the cheapest bidders is what we use to go to the moon with!
This was an issue 20 years ago, and an effort was made to come up with a “standard” CM contract (like the standard Rep Agreement). Meanwhile, most of us covered this issue with similar Limited Warranty language limiting to the cost of replacement/repair of manufacturing (later, purchased components) defects.
As OEMs cut overhead to analyze their designs for RoHS/WEE issues, they wanted CMs to take this on.
CMs need to take on liability to assure compliance to meeting their contractual obligations, or quality will ultimately suffer. This means being very clear up front who is responsible for what. A “standard” contract would be a good tool so that everything is at least addressed up front, and then could be negotiated as the OEM/EMS agreed if different.