Something that can be a source of confusion when looking at outsourcing manufacturing is the differences and overlap between the various production models. Two of the most common models, are contract manufacturing and OEM, or original equipment manufacturing. Contract manufacturing is a manufacturing-as-service approach: the customer provides all designs and specifications, and the supplier simply build to the drawing, while in OEM, the customer is providing a portion of the design (external, internal, some specs), and the supplier is incorporating their existing components and expertise to create a finished product.

Both models each have unique benefits and drawbacks that make them best suited to different business needs, making it imperative for businesses to select the suitable model that matches their requirements. This article delves into OEM vs contract manufacturing, two widely used outsourced manufacturing models, exploring how they work, their applications, unique benefits and drawbacks, and how these affect your business. The article also directly compares OEM vs contract manufacturing providing guidance on choosing the right model to match your business needs, goals, and resources.

OEM is a manufacturing model in which a manufacturer develops and produces a product to be marketed under a different company's brand name (private label manufacturing). The manufacturer is called the original equipment manufacturer. In original equipment manufacturing, a company approaches a manufacturer specializing in a particular product type and contracts them to produce the customer’s own product. The company provides the design and specifications and, in such cases, holds the rights to the designs. There will often be custom tooling or new development work, but OEM suppliers are developing products on the platform of their existing product line.

A typical OEM scenario is as follows; a company that sells TVs approaches an electronics manufacturer that produces TVs to manufacture their product. The company provides the specifications and product industrial design (possibly some of the electronic design), such as size, picture quality, input/output ports, internet connectivity, viewing angle, etc. The manufacturer uses their existing facilities, tooling, machinery, and established supply chain to manufacture and deliver the product according to the customer's specifications, and also opens any customer tools required for the new design. The customer then markets and sells the TV under their own brand (private label). 

The OEM model gives the customer ownership of the product, and the manufacturer leaves no indication or claim of their involvement. The product design is then owned by the customer, a key difference between ODM and OEM production models. However, because the customer is using the OEM’s existing product architecture, there is often a mix of IP; the customer can own the design and tooling, while the supplier may have rights to the electronic design or patents on innovations within the product. Overall IP ownership is much less clear than pure contract manufacturing, which makes moving manufacturers complicated at times.

Advantages of OEM

The original equipment manufacturing model has many unique benefits, including;

• Original equipment manufacturers typically specialize in a specific type or category of products. This specialty translates to high-quality products due to high levels of supplier familiarity and capability in this category.
• Original equipment manufacturers also have established, reliable supply chains and direct access to high-quality suppliers. These factors lead to potential cost benefits due to economies of scale, faster product development cycles, and higher product quality.
• OEM enables companies (customers) to stipulate product designs and specifications and retain the finished products' design rights.
• By outsourcing manufacturing to an expert manufacturer, companies free up time, resources, and staffing to focus on other aspects of their businesses.

Disadvantages of OEM

The OEM model also has inherent disadvantages. Some of these are:

• The customer depends entirely on the manufacturer for the product. Any issue or mishap that affects the manufacturer or their supply chain affects the customer directly.
• The level of customer control over product design, component-level selection, and certain specifications is more than ODM but considerably less than CM. OEM suppliers generally use their existing supply chain and product architecture for these projects.
• One manufacturer is often responsible for the products of many companies. This means that while the design may be unique, performance will be similar (as the suppliers and internal components are often the same); this makes product differentiation much harder.
• Customers can lack knowledge of the internals of the product – if there’s a bad part or a failure in the OEMs quality system, that will affect all of its customers. An example is the infamous capacity failure saga of the early 2000s that affected the products of major brands, including IBM, Apple, HP, and Dell. It was speculated that an original equipment manufacturer common to these brands was responsible for the capacity failures.

In contract manufacturing, a business contracts a manufacturer to produce and package a product on its behalf – the supplier is essentially building according to the customer drawings. This means the customer is responsible for the initial design and qualification of the product and holds all IP rights to the product, and the factory is purely providing labor and manufacturing services.

Contract manufacturers generally do not specialize in specific product categories and do not have ready-made tooling or designs for their own product lines (unlike OEM or ODM manufacturers). Instead, they have facilities that can produce custom tooling for a client's requested product. This is why contract manufacturing is commonly associated with custom manufacturing, as businesses often use this model to develop niche products where there is no mature ecosystem of OEM and ODM factories, or where the product is unique and there is significant intellectual property.

In contract manufacturing, the client may approach the manufacturer at different stages in the product development life cycle, such as design, testing & prototyping, assembly, etc. If the client contracts a single manufacturer to handle everything from design to delivery, this is a form of CM known as turnkey manufacturing. Another form of CM is contract assembly, in which a client contracts a manufacturer to assemble ready-made parts into a finished product.

Contract manufacturing scenarios vary greatly. An example of one such scenario is as follows. A company develops an underwater scooter. They fully design the product and test that it functions properly. They then contract one manufacturer to produce the electronic portions of the scooter and another to create the outer casing and assemble the final product. In this scenario, the customer is responsible for ensuring that the electronics manufacturer produces and delivers their components to the second manufacturer, who is in charge of manufacturing the scooter frame and assembling the final product.

Advantages of contract manufacturing

Some of the advantages contract manufacturing offers businesses are as follows:

• Contract manufacturing allows far greater control over all aspects of product design, specification, structure, etc. The customer can specify the product design down to the supplier and component level. 
• A customer doesn't have to rely solely on one manufacturer for all aspects of product development. It is easier for a customer to swap out a problematic supplier at any stage of the process, as they own designs, tooling and intellectual property.
• Contract manufacturers are more flexible in their approach to new projects, as it does not have to fit within an established product line or strategy. This means they are easier to work with on new product development and for small and medium-sized businesses
• The customer holds all IP rights to the product and product tooling. This is much more clearcut than OEM.

Disadvantages of contract manufacturing

• Customer has to invest significant resources in design, design validation, technical drawings and general product engineering.
• There is generally a longer project lead-time, as the tooling and product is being developed from scratch, rather than adopting existing architecture or modifying existing product design (OEM and ODM).
• Unless working with a turnkey manufacturer, dealing with multiple contractors multiplies the potential risks of lower product quality, supply chain delays, and IP leakage.

Fig 1. Komaspec's Contract Manufacturing Facility

In analyzing the OEM versus the contract manufacturing model, they have several overlapping characteristics, which is natural as they are both forms of outsourced manufacturing and have a number of similar benefits and drawbacks. However, a direct comparison of OEM vs contract manufacturing reveals several key differences that are crucial when deciding between the two models:

Product specialization

In OEM, the manufacturers typically specialize in a specific product type or category, such as electronics, home appliances, automotive systems, and advanced medical equipment. The manufacturer will have existing tooling, approved vendors and components, application know-how and their own products.

Customer involvement

In contract manufacturing, the customer is responsible for the product design and specifications, typically from scratch, while the contract manufacturer builds according to design. Sometimes, the customer may have a product that is past the prototyping stage or is already on the market. In either case, the final responsibility for the entire design and design validation is on the customer side. The manufacturer only carries out DFM optimization.

On the other hand, an OEM manufacturer, being a specialist in the product, may have a similar ready-made design of the client's product, the tooling to make it, existing suppliers for key components, and an existing quality control system for the product. The customer generally provides input on external design, desired specifications, and features, while the OEM uses its existing product platform and expertise to finalize product design. Often, the OEM manufacturer handles the heavy lifting of the design, such as structural and electrical engineering.

Product design and tooling rights

Because a contract manufacturing customer is responsible for the product design, they hold all IP rights to it. They will also generally own rights to the tooling, as it will be custom-made.

In OEM, IP right ownership varies and is mainly dependent on the agreement between the customer and the manufacturer. Typically, the manufacturer retains the rights to internal designs and tooling, while the customer owns the rights to external designs they developed, any custom tools or designs paid for, or any new technology developed if paid for or specified in the agreement. IP ownership is mixed, and this can create problems in the case of conflicts between the customer and manufacturer, especially if the customer wants to change suppliers.

Initial investment in product development

The initial investment cost is a significant difference between OEM vs contract manufacturing. Being product specialists, OEM manufacturers often have ready-made tooling for specific products that can be used when creating new designs. They may also have tooled, tested, certified, and cost-amortized components and product prototypes. These factors contribute to lower initial investment costs in OEM than in contract manufacturing, as contract manufacturers have to develop custom tooling for new products, qualify component suppliers, conduct testing and certification, and generally invest in getting the project off the ground.

Product development timeline

OEM usually has a faster product development timeline than contract manufacturing. This is because OEM manufacturers spend less time in product design, prototyping, and material sourcing, as they have readily available designs, tooling, and supply chains.

Table 1: Comparing OEM vs Contract Manufacturing Models

Product type

For a different build, model, or adaptation of an existing product or product category with moderate to low differentiation, the OEM model is often the better choice. It is also commonly selected for high-volume, price sensitive products, or those that require a high level of capital investment for production – this is why OEM is a popular model for home appliances, computers, mobile phones, etc. These products require highly specialized capital equipment and production lines; it’s much easier for a customer to find a supplier with these already existing than to pay for the infrastructure themselves.

Contract manufacturing is often better suited for new, unique, or niche products where there is not a strong OEM or ODM supply base, or where the intellectual property is sensitive. Medical products, mining equipment, IOT products, and agritech are often common applications produced by contract manufacturing.

Initial investment cost

Initial investment costs are significantly lower in OEM. This is due to the availability of prefabricated tooling, prototypes, and an established supply chain that provides economies of scale benefits.  In contrast, CM requires new designs and tooling. OEM is generally the better choice if development or tooling budgets are limited, though that comes with the tradeoff of less product differentiation.

IP rights

If IP is limited to product external design and a few features, OEM is a good choice. For products with more extensive or sensitive intellectual property such as custom software, firmware, innovative functions or performance, contract manufacturing will provide more protection against IP leakage or theft.

Time to market

If time-to-market is a critical consideration, or if the product is being updated on a regular basis (seasonally, annually, etc.), OEM is the better option, as it will shrink timelines.

Manufacturing flexibility

In the OEM model, the customer typically contracts the manufacturer at the product design stage. There's little flexibility after the initial contact. Contract manufacturing, on the other hand, offers greater flexibility. A customer can approach a manufacturer at any point, from idea and conceptualization to assembly of ready-made parts. The customer also works more closely with the manufacturer, giving them more control over the process. CMs are willing to take consigned parts, work with customer-designated suppliers, and provide greater detail on part specifications.

Market competitiveness and brand differentiation

Because OEM manufacturers typically cater to niche industries and product categories, it is highly likely for multiple businesses, possibly competitors, to contract the same manufacturer simultaneously. Such scenarios diminish or eliminate brand differentiation and will make competitiveness mostly about branding and price.

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Table 2: OEM vs Contract Manufacturing: Factors to Consider

Most businesses today outsource manufacturing to external manufacturers. A great example is Apple, a mobile phone giant that, despite having the resources to build its own manufacturing facilities, uses OEM manufacturers to produce its mobile phones. Apple designs the iPhone and contracts Foxconn, one of the world's biggest electronics manufacturers, to build the phones.

This model saves Apple billions of dollars in overhead facilities costs, workforce, and time. Thus enabling the company to focus on various other aspects of the business.

Another example is Toyota, a car manufacturer combining OEM, CM, and in-house manufacturing. Toyota contracts both OEM and CM manufacturers to produce and deliver the numerous parts that go into a car. The company then assembles these components in-house to create the final product.

OEM and contract manufacturing are two of the most ubiquitous outsourced manufacturing models. Despite their similarities, these models have significantly varying benefits and drawbacks that make each better suited to different businesses' needs, goals, and resources. This makes choosing between OEM vs contract manufacturing critical.

OEM is better suited to specialized products, niche industries, and big companies with large production. This model also offers faster time-to-market and lower initial investment costs.

Contract manufacturing, on the other hand, cuts across numerous product categories across various industries. It is often associated with custom manufacturing. CM offers greater manufacturing flexibility and control, complete ownership of IP rights, and product uniqueness.

• “ODM, OEM, CM – Which type of manufacturer should you pick for your project?” Komaspec, https://www.komaspec.com/about-us/blog/odm-oem-cm-which-type-of-manufacturer-should-you-pick-for-your-project/
• “Original Equipment Manufacturer (OEM): Definition and Examples“ Investopedia, https://www.investopedia.com/terms/o/oem.asp
• “Capacitor plague” Wikipedia, https://en.wikipedia.org/wiki/Capacitor_plague
• “What is turnkey manufacturing” Komaspec, https://www.komaspec.com/about-us/blog/what-is-turnkey-manufacturing/
• “What is Contract Assembly?” Komaspec, www.komaspec.com/about-us/blog/what-is-contract-assembly/
• “Foxconn, Apple and the partnership that changed the tech sector” Nikkei Asia, https://asia.nikkei.com/Business/Foxconn-Apple-and-the-partnership-that-changed-the-tech-sector