The Role of Contract Manufacturing Service Providers in the Global Manufacturing Supply Chain - Term Paper Example

? The role of Contract Manufacturing Service (CMS) Providers in the global manufacturing supply chain Introduction Contract manufacturing services play an important role in global manufacturing supply chain by supplying the intermediary products and providing services for the growth and development of the industries and economy. The concept of CMS in the production processes has been adopted by the companies and integrated into the manufacturing strategies with a view to concentrate on their core activities, leaving noncore activities to CMS. CMS forms part of the manufacturing strategy of the companies in terms of quality, time frame, logistics, assembling and after sales service. Broadly, there are two types of CMS, one involving supply with materials and the other involving only labor contract. The growth of CMS has been phenomenal in the recent years due to globalization. In order to preserve the core competency, the companies in the manufacturing sector setting up plants overseas to meet the consumer demand rely heavily on CMS, and the industry has evolved into a major economic force worldwide in the recent years. Factors influencing CMS The factors influencing the decision making process of an organization with reference to contract manufacturing service are multifarious of which, the opportunity cost of capital, marginal efficiency of the capital, benefits of mass production, cost-volume-price relationship, indigenization commitments required to be made in line with the economic policies of the host countries and cost structure in manufacturing versus CMS are the most important ones. The degree of the influence of each factor in the decision making varies from product to product, industry to industry and the company to company based on the circumstances obtained in each case. These factors are considered very important since they are related to the growth of CMS industry and the competitiveness of the companies utilizing CMS, by tilting the balance towards CMS in manufacturing. A product primarily considered for in-house production might be switched over to CMS at a later stage due to the developments taken place in the intervening period. The CMS is on the growth path and Weber (2002) states “As OEMs slim down, electronic contract manufacturers have been bulking up. Indeed, these growing companies have become the new heavyweights of production in many industries”. Opportunity Cost “Cost of using something in a particular venture is the benefit foregone (or opportunity lost) by not using it in its best alternative use”. (Lipsey, R. G. p. 259) If the capital could be deployed in another economic activity instead of investment in machineries, buildings or facilities required for the manufacture of the product by offloading through CMS, the company takes the decision based on the opportunity cost of capital for increasing its competitive advantage. Marginal efficiency of the capital The returns expected on different capital investments are compared by the company, and if efficiency in the case of the alternative investment is higher compared to the investment that may be required to be made for manufacturing the product which could have otherwise been off-loaded under CMS, the decision in favor of CMS is taken by the companies. Mass production Economy of mass production is an important feature that many a times tilt the balance towards CMS. The auto manufacturers throughout the world prefer to procure standard components through CMS for cost advantage in view of the benefits of mass production enjoyed by the contractors. Janet (1992) states “The contract distribution operation has and will continue to play an increasingly important and rapidly developing role in the physical distribution scene”. Cost- Volume-Profit Analysis The benefit of volume in operations could be effectively achieved by the contractors and could be leveraged by the companies through CMS. Parasuraman (2000) says “If a linear relationship could be established among costs, volume and profits, it would help decision-makers to figure out the right volume, the right cost and consequently the right profit”. Indigenization commitments The cars are exported initially in CKD (Completely knocked down) or SKD (Semi knocked down) conditions to the different markets or countries by the manufacturers in the west, Japan and the USA. These cars in CKD or SKD conditions are assembled in their plants in various countries. In such a case, it is not economical for them to manufacture standard auto components required for this purpose in those countries due to volume considerations as discussed above. For example in India, the car makers have to enter into agreement with the Director General of Foreign, and as per the standard conditions of the MOU, the companies have to achieve “Trade components up to a minimum level of 50% in the third year or earlier from the date of first import consignment of CKD/SKD kits /components, and 70% in the fifth year or earlier”. (WTO, 2001, p. 3) Cost structure Apart from the benefits arising out of volume, the cost structure of the companies would vary from the cost structure of the contractors due to various reasons such as managerial remuneration, salaries to employees, administrative and other overheads and corporate taxation. Growth of CMS “Advances in information technology have opened new venues for companies to create flexible supply chains by offering high-speed communication and tight connectivity.” (Elmaghraby, 2000, p. 350) In the past, initially the concept of CMS was predominantly practiced in auto sector. However, it has grown in a rapid pace and entrenched itself firmly in all engineering sectors, construction, pharmaceuticals, electronics and so on. Gregory, S. (1988, p. 55) states that manufacturers are more willing to contract out work that they used to do themselves to service firms (for example, engineering design, market research, legal work, office upkeep). This concept of contract service is also adopted in service sector such as software and BPO where no manufacturing activity per se is involved, in a very large scale. According to Granwel, A, (2008) in the centralized supply chain business model, the entrepreneur company obtains the residual returns while contracting with limited risk manufactures (that is, contract manufacturers) and the business reasons for this shift are to increase growth, enhance margins, leverage resources, lower costs and manage costs. The industries that use CMS CMS is predominantly used in the industries auto, electronic, pharmaceutical and construction though more and more industries are using the services of contract manufacturing and it has extended to software and BPO in services industries as well. Also, according to Rothstein (1998, p. 7) outsourcing of professional work in the manufacturing sector ranged from 40% to in computer information upward to 78% in both programming and product design. The pharmaceutical industry is a large player on a global level in contract manufacturing. They enter into arrangements with the contract manufacturing suppliers for various intermediate chemicals by restricting capital investments to the core area of production of research and technology based end products using these base chemicals. Some of the companies provide technology, material and other ingredients necessary for manufacturing to the subcontractors, and the subcontractors are responsible for the value addition activities such as machining or assembling of the spare parts, ancillary assemblies or components, for example. Usually, criteria for quality, tolerance levels, rejections and rework are stipulated by the companies. The supply of materials for the contract work is prevalent where the cost of material is very high, consumption of raw material has to be strictly accounted for as per the regulations as in the case of explosives or nuclear fuel, defense service contracts with stampings on the materials and further reuse is prohibited or for other reasons such as heat-treatment of metal components. Also, the company supplies raw materials to the contractors, where the quality of the materials such as hardness or chemical composition is very important in quality and performance of the end-product. Manufacturing supply chain: Competitive advantages and CMS Apart from reduction in cost, competitive advantage in respect of CMS is due to flexibility in terms of factors such as time of delivery, place of delivery and service. Managing lead times in CMS is very important in manufacturing supply chain for competitive advantages. According to Petri (2004, p. 571) the customers are expecting fast delivery, the other companies in the chain are not willing to carry excess inventory and the price erosion calls for faster movement along the chain. Stevenson & Spring (2007, p. 696) state “The flow of accurate and real-time information in the supply chain is considered by many to be as important as the flow of goods” Therefore, in order to maintain the level of competitiveness, retrieval and transfer of data needs to be efficient along the supply chain and the CMS seamlessly integrated into the manufacturing strategy. Lean manufacturing aims at elimination of waste, and the lean manufacturing techniques, and the areas include inventory management, distribution and after sales service in addition to production. The economic benefits and efficiency in the manufacturing supply chain forced the OEMs increasingly to outsourcing. Greene & Bruno (2006) state “Original Equipment Manufacturers (OEMs) consider Electronics Manufacturing Services (EMS) companies as an extension of manufacturing facilities. EMS providers and Contract Electronic Manufacturers (CEMs) are quickly turning into the foundation of the electronics industry”. An effective communication system in place eliminates interference in the outsourcing activities with the level of risk greatly reduced in the process. Also, Ronan(2003, p.389) states “As well as impacting on the primary value chain activities, the company’s policy on outsourcing is impacting on the support activities by reducing the level of procurement resources being used.” Order qualifying and Order winning criteria The compatibility of the facilities or expertise of the CMS provider with the manufacturing strategy of the company is decided based on the Order qualifying criteria and order winning criteria of the company as applied in the selection process. Order qualifying criteria are basically the conditions stipulated with reference to eligibility in respect of a CMS provider for inclusion in the selection process. Order winning criteria refers to the characteristics envisaging competitive advantages which differentiate the potential winner among the qualifiers to be considered for selection by the company. Brown, S. (2005, p. 65-66) states “A powerful means of linking operations capability with market requirements is presented by Hill (1995, 2000), where he discusses the need to understand order-winning and order-qualifying criteria. Order winners are those factors that win orders in the market-place over other competitors; order qualifying criteria are those factors that the firm needs to be able to achieve in order to compete at all in the market place”. CMO selection team may consists of professionals drawn from different faculties such as Marketing, Production, Quality, Finance and R&D and the basis of analysis for the purpose of selection in this case would be comprehensive and balanced. It is important to ensure that the selection process is meticulous, efficient and complete before finalizing the agreements, transfer of technology wherever required and establishing support services. Also, “the supply contracts will be influenced by dynamic spot markets through the resulting accrual of network benefits to participating buyers and sellers”. (Milner & Kouvelis, 2007, p. 327) CMS Service providers: Selection process Apart from ‘make or buy’ decisions, the criteria to be adopted for ‘Order qualifying’ and ‘Order winning’ in the process involves consideration of the factors such as the legal frame work of the contracting firm, competence in manufacturing, capability in maintaining the quality standards of the company, capacity considerations to meet the demands and the comparative cost advantage. Long terms strategy in selecting the appropriate supplier depends upon the commitment level of the contractor considering the values of the company, continuity from the long term point of view, assurance of timely delivery, communication facilities for accurate and timely information and the financial resources at their disposal in technological up-gradation and for meeting the additional investments needed. Vanelle, Salles & Junior (2009, p. 118) state “The lean manufacturing in the manufacturing companies and in the ones that compose their nets of suppliers, demand new and growing quality requirements, price, technical capacity, etc. regarding the practices of purchases and supply”. In the background of outsourcing by various industries cutting across the borders of the nations in the backdrop of globalization, the selection of the partners hinges on their leadership position in the products, improvements in quality standards and the production processes, research and development capabilities, growth in market share, diversifications and expansion plans, their reputation in the industry and so on, as these factors may be very important and in the marketing of the end products also. Ian & Roy (1998) state that there has been a change in the contract manufacturing business with the ability of a manufacturing company to win business based on cost and product quality alone now being limited. Customers are increasingly seeking competitive cost, high product quality and service plus flexibility in delivery as fundamental requirements to giving their business. Successful cases of CMS It is essential to understand how global manufacturing supply chain improves their competitive advantages by using CMS. For example, contract Manufacturing Service (CMS) Providers in Auto sector in the global manufacturing supply chain play an important role in the world economy, as the industry is spread over the world with all the leading players having significant stake in the developed countries and the emerging economies such as China, India and Brazil. MICO-BOSCH Founded in 1951, Bosch Limited is one of the largest manufacturers with the products range that includes industrial components, auto components and power tools with their operations spread across the world. With their core competencies in automotive and industrial technologies the company is a leading market player in India for the supply of auto components to the local and international brands. Bosch is a leader in diesel technology and gasoline systems with strong group support in technology transfer and high degree of localization, maintaining its dominance in the domestic and international markets. Bosch’s Automotive Aftermarket business has 5000 outlets in a fast developing country like India for widespread availability of parts and effective after sales service with 900 authorized workshops covering 2 & 3 wheelers, Cars, MUVs, LCVs, HUVs, Buses, Tractors, etc. Bosch has more than 30,000 R&D associates worldwide. Jain, P. et al (2009, p. 10) state that the client base in [India] includes Tata Motors, Mahindra & Mahindra, Suzuki, General Motors, Honda, TVS and other leading international brands, The role played by Bosch in the global manufacturing supply chain in the auto industry is important from two angles, supplying components for manufacturing to the plants directly and supplying components to the companies for the purpose of assembly of cars in several developing countries including after sales in both the cases, thereby improving the competitive advantages of the companies using CMS. According to Hartung (2010, p. 6) volatility in demand, shifting of sales to emerging markets, tightening global trade regulations, manufacturing footprint options, increase in shipping costs data integration in supply chain are the external challenges on today’s supply chain. Hon Hai Precision industry Taiwan’s Hon Hai Precision industry is a leading player in the contract manufacturing industry in electronic components. Salleh (2009, p. 154) states “Hon Hai’s success may be attributed to two main factors: its ability to maintain its position as the lowest cost producer, and its diversification into higher end or new products. The low cost structure was achieved by concentrating 80 percent of its manufacturing capacity in China…” Advantages and disadvantages in CMS The major advantage which prompts the companies to go in for CMS rests on the cost factor. Outsourcing enables organizations to focus on their core business. The capital investment required for this purpose could be deployed in the areas where the technology is a plus point for these companies. Ulku, Toktay & Yucesan (2007, p. 237) states “The supply chain may benefit from the separation of risk ownership and production capability. One of the primary drivers of outsourcing is the transfer of risks to a third party…”Apart from these basic benefits, the other considerations in the decision making process includes the need for indigenization in the overseas expansion, volume considerations in the new markets and use of readily available marketing and after sales network of the CMS providers. A case in point is the tie-up with the existing auto manufacturers and their ancillary units in the Asian countries by the western, Japanese and the US auto giants for using their manufacturing facilities and marketing infrastructure. However, selection of the right partner with the mutually beneficial agreement in the long run is of paramount importance. This strategic initiative with the underlying purpose of good customer service and overall quality of service would be defeated if the integrity and trust necessary on the part of the partners is overshadowed by the cost or profitability considerations.   Timing of the contract or agreement for the long term supply plays a very crucial role. The long term contracts finalized at the time of depression could be beneficial to the company. Also, in this case, the contractor would be in a position to make back to back arrangements for raw materials and other supplies in line with the agreement. However, in the absence of synchronization, the agreement may not be practical in giving the desired results. As a result, the complete control over the supply chain which is essential for the growth and development of the business would be lost. Wherever, technology transfer is involved there is also the risk of violation of security aspects. Future of CMS industry According to iSuppli Corp., the global electronic contract manufacturing industry is undergoing a period of deceleration and consolidation, a phenomenon that will transform the market by 2013 as competitors are forced to rethink how they deliver value to their customers. (EE Times India, 2008). The stability of the contractors and their ability to adapt to the changes would be very crucial for the sustainability in the long run. The layoffs or retrenchments and the attendant legal issues resulted on account of the deceleration process may lead to resentment among the employees. Therefore, any decision with regard to CMS needs to be analyzed carefully after taking into account the negative aspects associated with such decisions. Business Wire (2011) states “The global pharmaceutical contract manufacturing industry has registered strong growth during the past few years” According to RNCOS (2011) the recent global economic slowdown was a major factor for the adoption of the contract manufacturing model, and GBI Research (2009, p. 1) suggests that the global contract manufacturing outsourcing (CMO) market is set to grow steadily due to increased outsourcing of pharmaceutical production for western pharmaceutical manufacturers to Asian countries. Conclusion The concept of globalization coupled liberalization calls for comprehensive Corporate Social Responsibility (CSR) policies on the part of the CSR providers. They are expected to abide by the international best practices in human rights, health and safety standards, environmental protection, emission of greenhouse gases and waste disposal. For example, the companies and retailers in the western countries banned the products manufactured by using child labor in Asian countries, food products using fertilizers and pesticides and leather products using banned chemicals by the tanneries. Therefore, selection of the CMS Providers in the global manufacturing supply chain needs careful consideration of all these factors before introducing contractors to the supply chain through proper screening mechanisms. Constant review of the parameters in the light of the developments taking place globally as well as review of the performance of the CMS providers in tune with these developments is necessary for sustainability of the CMS strategies in the long run. 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