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Reducing Total Cost of Ownership
December 31, 1969 |Estimated reading time: 10 minutes
Many variables comprise total cost of ownership (TCO). To determine TCO for the life cycle of a product, variables such as bill of materials (BOM), time-to-volume (TTV), field return rate (FRR), and end of life and product ramp-down processes (ELPR) matter most, and often get insufficient attention. These, along with complete design for excellence, analysis for after-market services, yield optimization, and test times to cover every aspect of the product’s life cycle, are major contributors to reducing TCO.
For more than 10 years, handset makers have turned to outsourcing as a way to cope with volume demands. With reduced time-to-market, many companies have also started farming out some product design. To date, over 30% of all OEM mobile handsets are designed and/or produced by third parties. Making TCO part of a company’s strategy provides a consistent, systematic framework for comparing alternatives and evaluating costs. It ensures that a company is making strategic sourcing decisions to reduce total net cost and taking into consideration less obvious costs that are unrelated to the initial purchase price but that have a strong influence on overall product life-cycle costs. A recent study shows that OEMs ranked an EMS provider’s or original design manufacturer’s (ODM) ability to reduce TCO as the most important factor in an outsourcing relationship.1
TCO can be defined as the systematic quantification of all costs generated over the lifetime of a product or service. The essence of TCO is to determine a figure that reflects the total cost of the investment, including one-time purchases and recurring costs, not just initial start-up costs. One-time and recurring costs are determined by looking at each stage of a product program, starting with planning, design, and procurement - through ramp-up, manufacturing, and ramp-down to ongoing support and maintenance, after-market services, as well as end-of-life management. Generally, TCO is applied when purchasing a piece of equipment. Industry calculators have been developed to provide a standard metric to evaluate unit production cost effectiveness of manufacturing equipment. However, it is more difficult to develop a similar algorithm for a service, such as the one provided by an EMS company.
What Does TCO Include?
Cost of elements of TCO in order of significance are:
- Bill of materials (BOM);
- Time-to-volume (help customers achieve time-to-market targets);
- Field failure rate (FFR);
- Volume (higher volume leads to amortization over more units, thus a lower per unit TCO);
- Product program costs, including product development, new product introduction (NPI), tooling, and certification;
- Time-to-market;
- End-of-life process and ramp-down;
- Product maintenance and end-of-life management;
- Ability to spin-off variants or follow-up products;
- Quality assurance;
- Training support personnel;
- Environmental compliance to ensure energy conservation and recycling, reuse, or disposal of electronics.
Design for Excellence. TCO starts with a company’s approach to design and engineering. Top-tier EMS firms usually include ODM-type services. In the handset industry, where time-to-market is critical and the life of a specific model can be shorter than the time from design to market, planning a product’s entire life cycle in the design phase allows more flexibility and opportunities for cost reductions.
DFx includes design for sourcing, logistics, assembly, test, repair, and the environment. Considerable savings can be achieved by addressing each of these factors during the design phase. This is the time to select materials and components. It also is the time to determine how many parts are needed; how the new design can be manufactured to achieve the highest level of manufacturability for the least amount of money; then how it can be disassembled for repair, recycling, or reuse. A major cost to both the OEM and the EMS occurs when there are design changes after manufacturing has begun. Besides the actual costs involved in additional labor, retooling, wasted materials, rework, and revising the details of logistics and schedules, delayed time-to-market means delayed product sales.
One design approach to lower TCO and speed time-to-volume and time-to-market is to design modules, standard platforms, and universal software that can be adapted to accommodate a variety of styles, features, and requirements. The modular approach creates economies of scale and makes tear-down and recycling more efficient. Designing a reusable user interface and software platform minimizes development efforts and portfolio cost, reduces the learning curve, and speeds development of newer phone technologies such as GSM and 3G.
The BOM. Sourcing - BOM selection and procurement - is a major factor. If a company ships a million products, and the BOM for each can be reduced by $1, that’s gives savings of $1 million. The BOM should not be based just on its value when the contract is signed, but how the BOM reduces its cost over the lifetime of the product, including the cost of licenses. EMS companies can often leverage market and product expertise, as well as buying power. They can design with second sources and select components and architectures that can be reused or used in other products to bring volumes up and costs down. Because they use millions of components, they know which have the best quality and will work best in various designs and under various conditions, as well as which are legacy products and might be nearing obsolescence. Sourcing and maintaining inventory for materials, parts, and components involves extensive study and expertise. An OEM that collaborates with an EMS with a large global footprint and a focus on that OEM’s product and market stands a better chance of achieving a lower cost of ownership through wise sourcing decisions.
Figure 1. Quality inspection at volume manufacturing.
Time-to-volume. This is the time it takes to get a product to full-scale volume manufacturing. It makes little sense for a customer to launch a product with only a few tens of thousands of product in its supply chain. This is extremely difficult to express in terms of money, but it is an industry norm that a delay of a few months makes a whole program unprofitable. That would mean that the major portion of the product life-cycle margin is generated in the first months. The ability to guarantee time schedules is vital.
Time-to-volume includes design, sourcing, prototyping, and ramp-up. It is not only how fast a product gets to volume manufacturing, but also how accurately a company predicts the length of time it will take to get there so the customer can prepare product marketing. Mobile phone ramp-up is not a trivial process, especially if key areas are neglected. Cutting corners to quickly reach volume manufacturing usually produces high failure rates, products that do not meet market expectations, and many complications along the way.
Field failure rate (FFR). This can be the difference between a great business case and a disaster, both for the OEM and EMS provider. Costs associated with returns can drive reserves to significant percentages of the product cost, depending on the complexity of the product and reverse-logistic solutions provided. Many failures can be avoided with careful attention during the planning, design (DFx), and manufacturing stages. Poor focus on DFx can be the root cause of high FFR, and, in fact, overall field return rate (FRR). Quality and consistency in systems and operations must be built into the product from conception through the product’s end life (Figure 1). When selecting an EMS provider, the OEM should evaluate the consistency of the firm’s technologies, processes, systems, and development roadmaps. Consistency eases process transfer from the NPI center to volume manufacturing (Figure 2). Workers are skilled from one plant to another, so training time is reduced. These, among other factors, drive efficiencies leading to shorter production time lines ensuring the OEM that time-to-market is minimized.
Test procedures must be in place with in-house laboratories for electrical, environmental, mechanical, reliability, safety, and regulatory testing, as well as specialty testing capabilities for the OEM’s products. Look for assistance in meeting international compliance standards. Not only do FFR and FRR negatively impact TCO, they negatively impact the brand value and the company’s relationships with its vendors, customers, and others throughout the supply chain.
Figure 2. DFx analysis at NPI center.
Volume manufacturing. Once the prototype has been approved and the product is ready for volume manufacture, many cost variables come into play. A major consideration is where the product is manufactured. There is no definitive answer as to the most cost-effective geography for volume manufacturing. It depends on the product, where the product’s market is, how quickly the product needs to reach the market, labor costs, training, tariffs, taxes, duties, shipping costs, etc. If the EMS has a broad geographical base, a global supply chain simplification strategy can reduce costs and increase the OEM’s global service capability. A broad global footprint enables the EMS firm to use and take advantage of market fluctuations in various parts of the world and provide the best costs and services depending on market conditions.
To allow for optimal manufacturing, for example high yields and minimal flashing and testing times, design for manufacturing (DfM) and design for testing (DfT) are crucial. Early involvement of manufacturing engineers in product design is critical, and a major determinant for flawless mass manufacturing ramp-up. When looking to reduce cost of ownership, some manufacturing considerations are transfer price, FFR, the corrective action needed on the OEM side, and high reusability of follow-up products. TCO can be reduced through indirect and direct costs.
Ramp down. Often forgotten in the TCO equation and the supply chain is ramp down. Ramp-down elements include material phase-out, processes to avoid and minimize excess and obsolete material, component cross-selling activities, third-party distributor component sales activities, and a controlled and cost-efficient process for ramping down manufacturing capacity.
After-market services (AMS). These services involve warranty, repair, and replacement services, as well as recycling and disposal. These services are integrally entwined with product design, NPI, and manufacturing, and should be part of a 360° feedback loop. Good design for repair can increase the extent to which a product can be repaired, reducing the costs of service. Early involvement of AMS experts in the product design leads to lower costs, and allows for higher service levels to end customers.
OEM/EMS collaboration. EMS companies operate in a very competitive environment. Some have structures in place that enable design and manufacturing of handsets in a low cost and sustainable way. Having an open costing and pricing structure with a handset OEM can create a better understanding of cost structures and supply-chain issues. In partnership, OEMs and EMS providers can work toward a competitive cost level.
OEMs can be hesitant to work with an EMS firm. In many cases, they already have developed the technology and established their own sourcing relationships. By working together from the R&D stage, building on each other’s strengths and expertise, and through open communication, the two companies can reuse what the OEM has invested and optimize that with the services of the EMS provider to achieve the most desirable TCO. Many top-tier EMS companies have NPI centers located close to customers for easier collaboration on initial design and prototyping stages. Collaboration consists of product roadmap sharing, process alignment, open communication, flexibility, mutual long-term commitment, and co-location. OEMs that locate and cooperate with EMS firms most aligned with their end products often have greater opportunities to minimize TCO. Quick reactions to customer demands are among competitive advantages.
Conclusion
Collaboration and transparency help both the OEM and EMS anticipate the market’s movements and provide agility to evolve with market demands. When OEM and EMS providers work together from the design phase, share their expertise, and consider the product’s entire life cycle, there is less chance for unexpected changes and costs. They can anticipate changes in the supply chain and react to them more quickly. When there is an honest exchange and understanding of the goals of both the OEM and EMS provider and an open appreciation for what it takes for each company to be successful, the companies can jointly reduce cost of ownership and increase each other’s profits.
REFERENCES
- Chanoff, Matt, “EMS/ODM Report Card & Buyers’ Guide,” Technology Forecasters.
Patrick Åhgren, vice president, sales and business development, Personal Communications of Elcoteq SE, may be contacted at patrik.ahgren@elcoteq.com. Folkert Wierda, Ph.D., director, business development, Personal Communications of Elcoteq SE, may be contacted at: folkert.wierda@elcoteq.com.