OEM — or original equipment manufacturer — is defined as a company that manufactures a product that is sold to another company, which resells the product under its own brand name. Business textbooks often refer to OEMs as "contract manufacturers."
The genesis of the term OEM comes from the Dutch phrase, "onder eigen merk" which, loosely defined, simply means "under own brand."
The term is flexible, but OEM usually refers to manufactured products in major industries. Yet it could also mean a company that makes the ingredients that go into a fast food milkshake, for example.
OEMs are different than value-added resellers, or VAR's. A VAR is a company or business that buys the OEMs component, part or product, and either improves on it or adds even more components to increase its value and ultimately sell it to customers directly.
A good way to look at OEMs and VAR's is this . . .
- An OEM usually sells their products on a business to business model.
- A VAR sells directly to customers.
OEMs most commonly sell their products business to business, while VARs most commonly sell to consumers or other end-users.
So-called "principal" companies can call OEM products, parts, and components as their own, after signing a resell document giving a company the right to resell an OEM product. Aside from the financial benefits of being an OEM provider, OEMs gain free publicity on their products (think Goodyear tires on a Ford vehicle or an Intel microchip in a Dell computer.)
Consider these prominent OEM examples:
- Auto Industry: A company that manufactures the steering wheel or the tires on a new car, truck or SUV.
- Computer software: A company like Microsoft that sells the operating system used in computers or other digital devices.
- Electronics: A company that builds the car radio that is included in a new vehicle.
- Manufacturing: A company that builds the engine that goes into a new bulldozer or airplane.
There's no doubt that OEMs are widely used by manufacturers across the global business landscape.
Why the Need for OEMs?
OEMs are in great demand as companies turn to OEM manufacturing partners for two big reasons:
- They have the expertise needed to build the product, device or component that another company needs to build its product, primarily because they can mass produce the product on a regular and specialized basis.
- They can build a component, part or device more inexpensively than the company who buys the OEM product for their own products.
Yet there are additional reasons why companies like to partner up with OEMs. For instance, when a manufacturer or other business does business with an OEM, they receive a precision product component that meets their exact demands and conditions for production, delivery and management.
There are more reasons to align with an OEM…
- Quick response times: With an OEM, you're dealing with a precision product component expert. They can turn around a request or a product delivery request in a short amount of time, given their experience and expertise in building a specific product component.
- Quality component: When you ink a contract with an OEM, you're getting a production partner with years of experience in building specialty products and components. All parts built by an EOM are tested for quality and to ensure they match the partnering company's exact specifications.
- Good customer service: A solid OEM partner knows that if they don't deliver the product and support a partnering company needs, they'll go elsewhere to get it. Consequently, an OEM doesn't only deliver quality products, it's expected to back that product up with robust technical and engineering support.
- You get a warranty: Companies that partner up with an OEM should expect to get a manufacturer's warranty. If there are any problems or product defects, the warranty protects the partnering company's investment.
Adding value to your product. OEMs also provide a good return on investment to their business partners. Their parts, components and products extend the life of the partnering company's product, thus maintaining top performance and saving money with replacement parts, thus increasing the company's financial bottom line.
How Do OEMs Work?
To best understand how OEMs work, you need to understand how OEMs and principal manufacturers work together.
Basically, OEMs and principal partners work under the following arrangement:
The OEM develops a product, part or component, and sells the product to a principal partner, who resells the product, usually directly to the public, under its own brand.
The principal partner does have some flexibility in dealing with OEMs. For example, a principal partner can structure a deal where it has an option to only work with selected products and under flexible terms.
Under that arrangement, the reseller can elect to purchase specific components, or can have the OEM manufacturer complete products for it to resell. These products come in plain boxes and aren't for sale, by and large, in retail outlets.
That scenario is changing, though, as online retailers are beginning to market OEM products directly to end users for a discounted price. Auto enthusiasts rebuilding a new car or technology lovers who buy parts to build their own customized computer are good examples of end users who buy parts, often online, direct from retailers.
OEM Vs. Aftermarkets
In certain manufacturing markets, especially the auto industry, consumers have two choices when looking to make repairs on a product or a vehicle – take it to the original manufacturer (who can guarantee OEM parts) or take it to an independent aftermarket shop or service center.
There are pros and cons to consider when making a decision on OEM versus aftermarket parts.
In most cases, the original manufacturer's shop or service center will offer original parts (it's often a selling point for them) while the aftermarket service provider will offer aftermarket (or secondary) parts and components.
Think of a Ford dealer which can guarantee original Firestone tires or an Apple service center that can offer original parts, like a Sony camera on an iPhone, for consumers looking for repairs and/or new parts. Aftermarket service providers don't have a direct channel to OEMs, and thus often depend on parts and components made by third-party manufacturers.
Here are some pros and cons to mull over when weighing OEM versus aftermarket service and product providers.
- OEM parts are considered a safer bet and more dependable, as they are made by the original product provider.
- If you're making a repair to a principal product, like a car or a computer, OEMs represent the "known" and aftermarket parts represent the "unknown."
- Quality is generally guaranteed with OEM parts, including the offer of a warranty.
- Aftermarket products are generally less expensive than OEM parts.
- Aftermarkets offer a wider variety of parts. As aftermarkets aren't beholden to a single OEM, end users can have more parts and products to choose from.
- A wider variety of service providers. In general, there are more aftermarket service providers than OEM providers.
OEM Vs. ODM
When dealing with OEM providers, businesses should know they have other options.
For example, you can elect to choose an OEM to build your products or, in certain situations, opt for an original design manufacturer (ODM.)
Let's say you're a manufacturer with an idea for a product and you need help in developing that product. While you have the projects specs and a blueprint that outlines the idea, the OEM can be brought on board to manufacture some or all of the product, and you have to do is brand it and sell that product to the public.
With an ODM, the process is different from a financing point of view. If your company doesn't have the money to efficiently design the product, an original design manufacturer can step in and take control of product research and development, design, testing, and manufacturing the product.
The big advantage of an ODM is that it allows companies looking to manufacture a product to hire a product provider that already knows how to build the product you want. They have the existing assembly lines and experienced product developers, and can design the product as well — something an OEM doesn't do.
ODM suppliers can design and produce the needed product in bulk and often at a discounted bulk price, too. That enables cash-strapped companies (often new companies just trying to get off the ground) to leverage product economies of scale and to benefit from the knowledge and expertise of the ODM provider.
Companies that seek to do business with ODMs should do their due diligence and set needed business boundaries before signing on the bottom line. For instance, when you sign on with an ODM, you may not have much of a say in the product design and specs.
Additionally, you may not maintain the intellectual property on the product, and would likely have to work out a deal that works for both parties – and that's not an easy task on a key issue like intellectual property.
OEMs and Economies of Scale
OEMs are attractive to principal partners because of their economies of scale.
That is, partners can benefit from OEM products and parts without having to dig deep and fund a new manufacturing facility and handle that production in-house.
Economies of scale mean the competitive leverage a larger company usually has over a smaller company. The bigger the business, the lower its costs of doing business. With OEMs, companies can benefit from the economies of scale of having a business partner take on the responsibility of building a product, component or part, instead of the partnering company. The OEM excels in building one product and only one product only, and thrives by building hundreds of thousands, or even millions of those products on a cost-effective, streamlined basis, and selling them to VAR's and principal partners.
The purchasing partners benefit from an OEM's economy of scale, as both pricing and manufacturing times are reduced by buying from an OEM partner. Those indirect cost savings are a big incentive for companies to do business with OEMs
Potential Conflicts With OEMs
Conflicts between OEMs and potential business partners may arise as well.
For example, the absence of a plain and simple definition of OEM can cause problems.
To some businesses, OEM is defined as a strictly component provider. To others, the term means primary product manufacturer. It's up to specific OEMs and VARs to hammer out their own unique partnership model, and sync together to make it work.
OEM and principal partner relationships can also suffer because both of their business cultures are likely different, and communications between the two can become problematic.
For instance, when the principal partner insists on OEM product changes or adjustments, the OEM may balk, and insist on their own that their knowledge and experience shows changes don't need to be made. They may make an argument based on internal knowledge, and what the market requires, which is the stance the principal partner likely knows best.
Additionally, the OEM might request sales or technical support from a principal partner, thus draining the principal company's resources, both in time and in finances.