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Original Equipment Manufacturer (OEM)

Guide to Understanding Original Equipment Manufacturer (OEM)

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Original Equipment Manufacturer (OEM)

Original Equipment Manufacturer (OEM) Agreement

Role in Supply Chain Management and Procurement

The term original equipment manufacturer (OEM) describes any manufacturer of parts, components, or products with the intent to sell them to other companies (B2B).

On the other side of the transaction, the purchaser of the finished item – i.e. the value-added reseller (VAR) – now shapes the item into their desired end product, which the OEM is aware of. The purchased OEM parts are integrated into the VAR’s system until deemed marketable and able to be sold under the VAR’s branding (i.e. with added features).

The OEM business model initially gained traction in the computer software industry but has now spread and become deeply ingrained across industries such as automobiles, information technology (IT), hardware components, and advanced manufacturing.

OEMs play a critical role in reducing production costs, especially for less established companies that lack the capacity to build all equipment/components in-house. Therefore, OEMs could be viewed as a form of outsourcing.

By partnering with an OEM, a manufacturer (or reseller) can reduce costs and improve their profit margins since there is no need to build out certain in-house manufacturing facilities and manage production.

Original Equipment Manufacturer (OEM) vs. Value-Added Reseller (VAR)

The relationship between an OEM and VAR can be best described as mutually beneficial because both sides rely on each other.

The producer of the initial product is the original equipment manufacturer (OEM), while the buyer from an OEM is the value-added resellers (VARs).

Before selling the finished products to potential customers, the value-added reseller (VAR) integrates their own unique set of features into the OEM’s product.

VARs partner with OEMs to save significant time and capital, as well as to focus on developing and incorporating their technical features. From the OEM’s perspective, the reason the business model is feasible in the first place is because of the consistent end customer demand from VARs.

Since OEMs handle a specified stage of the production process, VARs can shift more of their time and effort on integrating features that enhance the end product.

How Do OEMs Work?

OEMs are perceived as more efficient due to the concept of economies of scale, where increased output causes an incremental decline in the per unit production costs.

Most OEMs partner with numerous manufacturers and related companies, so their products are manufactured at a larger scale (and thus lower costs) while delivering features that are on par (or better) than if it was manufactured in-house.

The decision to partner with an OEM typically comes down to the company’s core competency, where the company weighs the pros/cons of in-house production vs. outsourcing to an OEM to reduce the production and material costs (and focus on delivering their differentiated value-add).

OEM vs. Original Design Manufacturer (ODM)

An original design manufacturer (ODM), much like an OEM, also builds products for another company.

The distinction between the two is that the ODM designs the product themselves and manufactures it, i.e. sells pre-designed and/or finished products.

An OEM can still attach its own branding such as a logo (or participate in a licensing agreement), but the design tends to be pre-determined by the specifications provided by the customer (i.e. a product design blueprint).

Still, most OEM products are ultimately designed and manufactured to meet a particular company’s specifications.

The use of both OEMs and ODMs has risen in popularity in recent years.

An OEM would typically provide any replacements for defective or missing parts, which are often critical to the reseller’s reputation for reliability (and maintaining their long-term customer relationships).

However, for certain products, consumers nowadays can replace the parts and seek repair (or replacement) from a third-party company (non-OEM).

For instance, there are many cell phone repair shops not formally recognized by Apple that offer services to fix iPhones, but using such a service could cause Apple’s formal warranty to be voided.

In fact, many technology products such as laptops and computers now come with legal language in the terms and conditions of purchase stating that any repair work performed by non-OEMs voids the warranty.

In spite of typically being priced at cheaper levels, non-OEM (i.e. aftermarket) products are not guaranteed to function at the same level of performance as the actual OEM product.

OEM Trends in 2022

Prior to the ongoing technological advancements and trend of hyper-connectivity, the aftermarket role of an OEM would at most be to send replacement parts and perform planned maintenance and reactive repairs on behalf or directly for a VAR.

As a result, the traditional OEM historically had limited visibility into the existing installed base and minimal connectivity (or engagement) with the end-user/end-customer base.

Industrial IoT has enabled OEMs to become more active in the overall process, and aftermarket in particular.

  • Predictive Analytics
  • Augmented Reality
  • Remote Monitoring
  • Diagnostic Software
  • Machine Learning (ML)

Another notable development is service level agreements (SLAs), which guarantee quality assurance (and facilitate closer relationships between OEMs and customers).

Formerly, the term original equipment manufacturer (OEM) only meant that a manufacturer built an original product and sold it to other companies, with the expectation that the buyer would make changes and rebrand the end product to make it more marketable.

Gradually, the OEM business model shifted. Globalization has created substantial opportunities and also presented numerous challenges.

Currently, the OEM industry is far more complex, as the days of purely business-to-business (B2B) OEMs are foregone.

OEM Software Industry – Microsoft Example

OEMs are frequently associated with the software industry, which is where the concept originated, broadly speaking.

As a real-life example, Microsoft is an OEM to a personal computer (PC) manufacturer, such as Dell Technologies.

While the hardware differs by each company, the operating system (OS) running within those PCs is the product of the OEM, i.e. Microsoft’s Windows.

Microsoft supplies its Windows software to Dell, which is the reason that most, if not all, of Dell’s PCs and laptops run Windows software.

Technically, Microsoft is the OEM while Dell is the VAR, but that statement is not necessarily true considering the amount of value provided by Microsoft (e.g. Windows updates, added features), which is a real-life example where the line between the two has begun to blur.

Microsoft Windows OEM Example

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