Surviving Downturns With Your Contract Manufacturer
It's inevitable: sometimes you need to reschedule the backlog. Mitigating liability is the number one priority. Downturns are unpredictable, so proper preparation is necessary. Below are a few strategies that will allow you and your contract manufacturer to make it through.
Have a manufacturing agreement in place
It's critical that you negotiate a manufacturing agreement that addresses WIP and material liability in the face of a downturn. It is far too common to skip this step and simply issue POs. This is not best practice and almost inevitably leads to conflict in the future.
When the downturn hits, you need to reschedule or cancel your backlog.
Reschedule rights- You should negotiate an agreement that grants you very flexible reschedule rights for items due 90 days and beyond, ability to push out 90 days for any items due between 30 and 90 days, and you should take any items due within 30 days. These windows should be adjusted to fit your particular circumstance, but the concept of different reschedule rights based around due dates should remain.
Cancellation for convenience- The agreement should specify the liability for both WIP and material in the event you simply wish to cancel open orders. WIP liability should be limited to the value of labor and materials consumed up to the point of notification. Material liability should be limited to the value of material the contract manufacturer reasonably procured (or is committed to procure) to support your order rate, less whatever material the contract manufacturer can cancel or return to its suppliers, and less material the contract manufacturer can consume itself.
Cancellation for cause- Cancellation for breaches of the agreement should be included, but is not directly related to handling a downturn. The liability terms related to cancellation for cause will usually be much different than the terms related to cancellation for convenience. It is equally important to ensure that once a downturn occurs, both you and your contract manufacturer appropriately enforce this agreement.
Communicate information immediately
Complete transparency between you and your contract manufacturer is crucial to protecting both businesses. Promoting an open relationship will allow them to take appropriate cost-saving measures in the face of an economic downturn and mitigate the acquisition of excess inventory. Regularly scheduled program updates made on a weekly basis to discuss progress, challenges and timeline is a good strategy to promote transparency. When in doubt, if you think there is information you should be sharing with your contract manufacturer, make sure to contact them as soon as possible, even if informally. Often you become aware of a major downturn, but it may take days or even weeks for the planning data to be reviewed, approved, and put into ERP. Tell your contract manufacturer as soon as you know; don't wait for the schedule approvals. Very often your CM can begin mitigating liability.
Focus on materials
In most electronic contract manufacturing relationships, materials will account for 80 percent or more of the product cost, and is often near 100 percent of liability claims. Almost always, the bulk of the liability will be in a relatively few component line items. You should immediately focus on identifying and understand the liability status of these few components.