Expert opinions, INVESTMENT CLIMATE

Asia-based production: ODM vs. OEM

There is a question pivotal to launching production and sales as to whether to manufacture original products (ODM model) or duplicate the existing ones (OEM).

Choosing benefits

Each option has its own advantages and drawbacks. ODM is more suitable for multinational corporations that sell their products across the globe. Our company is not a big one: we sell products in Russia and the CIS, and we find OEM an advantageous model. The Russian and neighboring markets are small on a global scale, while own design, sketch and project normally pay off only with large sales volumes starting at 200-300K items or with a very high added value. But sadly, not everyone can sell their goods at a price several times higher than the prime cost, like Apple does.

Once we made attempts to employ the ODM model for producing and selling push-button phones in China. We spent $75K on mold alone – a model made to a customer’s design and sketch which can be used to make a prototype. The quality turned out to be sub-par, and no-one returned the money. This proved to be an unfortunate experience for us, and we never utilized the ODM model anymore.

Depending on the product and complexity, the cost of developing a mold ranges from $3K to $100K, with expenses to be included in the prime cost. This is yet another reason for the product to be either very cheap and mass-marketed or include a very high mark-up to cover all the costs in the case of ODM.

Things to consider

In one specific case, we chose to manufacture and sell computer mouse devices. This is a popular product, with its sales amounting to hundreds of thousands of items per year in Russia alone – but we will not able to capture the entire market due to high competition as well as huge variety. At the initial stage, the share will be 5% at most. Consumers want choices; there are over 40 different colors and designs of the product available in physical and online stores. Also, there are certain commitments to sales channels. The stores to sell our mouse devices would be willing to sell them exclusively, with consumers unable to buy them at a lower price from a competitor. Even the largest retailers such as M.Video, Eldorado and DNS have a market share of 15% at most. Marketplaces have an even smaller share: they are the future but not the present. In addition, there are large payment delays in the retail sector: you will receive money for your product in a year at best, and you can only guess changes in the ruble, dollar and yuan exchange rates. But exchange rate is not the sole thing relevant for the economy of the project; trends in computer mouse devices are also unpredictable: what is popular today may be replaced by a brand new model tomorrow. A major retailer may change its strategy: mouse devices could be removed from the product range, or another major supplier may approach the retailer to offer the same mouse model as ours, or a very similar one. All of these factors prove the advantages of the OEM model.

Intellectual and physical protection

There are also the specifics of doing business in China: you can develop a unique design, pay for a mold, start mass production, but fail to provide protection for your product – and not so much intellectual as physical protection. If production lacks a certain specialist to monitor the process and literally take the mold away after each shift to protect it, and some other client or an agency that provides access to the factory becomes interested in the development, there is a risk that the Chinese can outsource it to some other manufacturer, and will show their sincere surprise at your subsequent discontent. These are socio-cultural specifics: what we see as fraud may be just regular business for the Chinese. There are legal mechanisms for protecting the rights of foreign customers in Asia, but the cost and duration of such proceedings make them economically inexpedient.

In theory, you can work solely with well-known and impeccably reputable factories. In this case, the risk of unique design leak becomes significantly lower – but the production cost at such factories is so high that it makes retail prices for their products non-competitive. If we calculate production and logistics costs, as well as retail chain sales, and add fixed costs for employees and warehouse services, we will receive a markup of 10–45% – meaning an investment of $100 will bring a maximum payoff of $145 in 1.5 years at most.

As regards OEM, the process is simpler, with lower costs and manufacturers fixing specific positions in specific markets with pre-agreed turnovers for customers. Also, you can choose several design options and make some changes, albeit insignificant, in the one you have picked, for a greater exclusivity.

For ever-changing business segments

Our company operates in the computer accessories and devices market, where OEM proves to be more profitable – including due to this segment being rapidly changing in terms of design and products. As regards ODM, a model development takes about six months, with further quality inspection. To test a prototype, the manufacturer must send it to the customer, which also takes valuable time and serves as yet another argument in favor of the customer’s trustee present in China to take over the testing. It is unwise to entrust this process to representatives of the manufacturer or agency.

When the price is irrelevant

ODM can be employed by manufacturers and distributors that produce a complex or unique product whose price is irrelevant to consumers, as is the case with Apple. If you can position your brand in the same way as iPhone, without taking the OEM level, then ODM will be fine for you – while OEM will be more suitable for a dynamically developing company that considers price and price-sensitive customers as important.

Yet, OEM isn’t suited solely for small businesses. This is the way the aforementioned corporations operate, such as Apple, IBM, Microsoft, and Nintendo, which have contractors less known to the general public that produce and assemble inexpensive products of their assortment range, such as Foxconn, Inventec, Flextronics, and Pegatron. Surely, the major companies on the list have both capacities and finances for research and development – but why invest so much labor into inexpensive low-margin products when you can choose ready-made solutions offered by other companies, make minor adjustments, and sell them under your own brand with a high markup you’re accustomed to.

By Alexander Petrov, General Director, NeoTechnology Ltd electronics distributor and manufacturer

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