Written by René Hol and Valerija Olsevska
It is almost impossible to imagine a supply chain of an OEM-er without subcontractors. Subcontracting means that a portion of the manufacturing process of an OEM-er is assigned to an external party – subcontractor. Subcontractors don’t have their own product: they manufacture products of their customers. There are several reasons to outsource manufacturing activities. It can be either due to capacity reasons or the need for certain capabilities of a subcontractor (e.g., technology, equipment). However, in today’s business strategic reasons are on the top. OEM firms want to be more agile, want to share risks and need better performing manufacturing processes to meet their customer’s requirements.
The DNA of subcontractors has multiple dimensions, we want to address three of those which affect the value delivered to an OEM-er.
The nature of manufacturing technology
As in any manufacturing company, the nature of the used manufacturing technology is a key strategic differentiator. In general, subcontracting can be divided into two major groups: object (or item)-oriented subcontracting and an operation/activity subcontracting (e.g., painting, surface protection treatment, sterilizing). Object subcontracting involves performing a complete production process, while an operation subcontracting is a step within a production process of a customer. Within the object subcontracting we can distinguish part subcontracting, component or assembly subcontracting (e.g. PCB’s) and a system or complete product subcontracting. This distinction affects the relationship and material and information flows between a subcontractor and an OEM-er.
The capabilities of subcontractors
Since by the definition the subcontractor does not have its own product, the capability profile of a subcontractor is one of the major criteria used by OEM-ers. Most subcontractors position themselves as manufacturing service providers, but their critical capabilities are mainly defined by their degree of the involvement into R&D and innovation. Here, as the first group we can distinguish subcontractors who deliver based on the specifications of the client. The middle group is characterized by the engineering competences and specialized technology knowledge – the subcontractor makes the drawings and produces according to them. The third group of subcontractors are problem solvers, they strongly deploy R&D skills and undertake a higher development risk.
The position of the subcontractor within the supply chain of OEM-er
In most cases the capability profile defines the tier in the supply chain to which a subcontractor belongs. In the automotive and other assembly-based manufacturing, higher tier subcontractors outsource to their own subcontractors, creating a multi-tier structure. The first-tier subcontractors are involved in the product and system development. The lower tier subcontractors typically are smaller, have less expertise and are specialized in production or processing of a narrower range of products. Some OEM-ers prefer to establish a direct contact and processes with most of the subcontractors in their supply chain, lifting them to the tier one. However, the same subcontractor can belong to multiple tiers with respect to different customers or sometimes even to a single customer. The tier structure mainly indicates the level of influence in the supply chain – the one on the top has higher technical influence on the rest of the supply chain.
The strategic development of a subcontractor can take different paths. The firm can operate on the border between being a supplier of standard components and a subcontractor (take Lenovo company as an example, who originally was an IBM subcontractor, but nowadays has its own product line (1)). Other subcontractors try to secure their competitive position by becoming a value-adding subcontracting partner. This is a major strategic move. It lifts the company from a lower tier subcontractor closer to an OEM-er. This has big consequences for the way how you account, steer and monitor your business. In the next blog we discuss the consequences of the strategic choice to move towards an added value subcontractor – a strategic partner for the OEM-er.
(1) Arrunada, B., & Vázquez, X. When Your Contract Manufacturer Becomes Your Competitor (2006). Harvard Business Review, Vol. 84, No. 9, pp. 135-145. Available at: https://hbr.org/2006/09/when-your-contract-manufacturer-becomes-your-competitorBack to archive