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13 Feb 2008

Economists' Pick > Economic Forum > HKTDC Research - Archive

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value
EXECUTIVE SUMMARY In 2007, there were 83%, 61% and 40% of surveyed companies engaged in OEM, ODM and OBM business, respectively, about the same as in 2003. Seemingly, ODM and OBM business has become more concentrated, with companies specialising in only one type of arrangement still recording significant business growth. Looking ahead, Hong Kong companies are expected to continue to extend the supply chain with added value by engaging in ODM and OBM business, while the outlook of OEM business is relatively less promising. To further increase their added value, Hong Kong companies, be they engaged in OEM, ODM or OBM, should improve the overall quality of their products and services by shifting the whole value chain upward. According to a recent survey conducted by the HKTDC, there were 83%, 61% and 40% of responding companies engaged in OEM, ODM and OBM business, respectively, in 2007. The ratios were about the same as those in 2003. It appears that companies, in terms of their numbers, have not moved further up the value chain by involving more in ODM and OBM since 2003, when the previous survey was conducted. But the picture is somewhat different in terms of sales value. Particularly for companies involved only in ODM or OBM business, although there were no noticeable changes in the share of firm numbers, they showed increases, in terms of sales value, from 3% in 2003 to 6% in 2007, and from 7% in 2003 to 11% in 2007, respectively. Seemingly, ODM and OBM business has become more concentrated, with companies now focusing on one type of business only, compared with a few years back. Hong Kong companies do have the edge in developing ODM business. Our respondents indicated that Hong Kong's free flow of information helps companies discern global and product trends. Hong Kong companies also have good marketing knowledge and experience, which reflects that they have the ability to promote ODM products. Besides, surveyed companies opined that the availability of talented designers and intellectual property rights protection for product designs are other competitive advantages. Our respondents also said that Hong Kong companies have the edges in developing OBM business. They have a good reputation in the global market, which suggests that they have performed well in many aspects, and successfully gained creditability from customers all over the world. In addition to the ability in product quality and design, our

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

respondents considered Hong Kong companies have the competitive edge in good distribution network experience and capability in product quality control, and knowledge and experience in brand promotion. All in all, our survey shows that the prospects for developing OEM, ODM and OBM businesses will improve in the future. Respondents of all three types of business said they anticipated growth in the medium and long term, although OEM business is relatively less promising. In view of the less promising outlook of OEM business, companies are expected to increasingly engage in activities beyond manufacturing. Entering into ODM is a step towards this trend. Prototype creation, detailed product design and development of product concepts, the core activities of ODM, may prove easier for Hong Kong companies to master as those activities rely largely on one's expertise in the manufacturing process. But moving up the front-end of the value chain will involve devoted personnel to these newly added activities. Some Hong Kong companies may choose to adopt OBM, stepping into the back-end of the value chain to reap greater profits of having their own brands. But OBM is a difficult business model, and the tenet of success is the commitment to invest in the brand over the long term. Given a lack of brand development expertise and financial resources, Hong Kong companies can incubate their brands in some small pilot markets. After becoming successful, the brands may be promoted in other potential markets, especially the emerging markets, which are more receptive to new brands. In light of intensifying competition, rising product safety concerns and increasing environment consciousness, Hong Kong exporters and manufacturers, be they engaged in OEM, ODM or OBM, should improve the overall quality of their products and services by shifting the whole value chain upward. This upward shift may involve offering better designs and features, enhancing product safety and reliability, using environmentally friendly materials, improving warehousing and logistics, as well as strengthening marketing and distribution. I. Introduction Background and Survey Methodology Most Hong Kong exporters have traditionally engaged in original equipment manufacturing (OEM), under which products ordered are designed mainly by customers who usually own a brand name. Suppliers only focus on the manufacturing process, and the keys to success are low cost and high flexibility in response to customer demand. However, competition from suppliers in developing Asia, especially the Chinese mainland, has been rising, initially in terms of price, later in quality and other aspects over time. Hong Kong exporters are therefore continually compelled to develop strategies that help them stay ahead of competitors. Plant relocation provides a solution for Hong Kong companies in controlling their production costs, but to take a major lead, some other strategies are needed. Some choose to expand their grip along the value chain, by moving towards front- and back-end activities such as design, wholesale, retail and brand management, which usually entail higher added value.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

As a result, a lot of OEM companies have entered into the business of original design manufacturing (ODM), by providing enhanced design services. The proprietary design work is the guts of ODM, where overseas buyers purchase products designed and manufactured by suppliers, but which are sold under buyers' labels. Entering into ODM business may be seen as a move towards the front-end of the value chain. This expands the dimension of competition from price to quality and design capability, where Hong Kong exporters have a competitive edge. OEM and ODM have one thing in common: products are sold under buyers' labels. To avoid over-reliance on buyers, to achieve product differentiation and nurture customer loyalty, some Hong Kong companies instead develop their brands and distribution networks, stepping into the back-end of the value chain. This kind of business is also known as original brand manufacturing (OBM). To capture the trends of Hong Kong companies' involvement in OEM, ODM and OBM, the Hong Kong Trade Development Council initiated a large-scale survey for 2007, the third of its kind since 1999. This report presents the major findings from our latest survey, and discusses the attributes and prospects of engaging in ODM and OBM. The survey methodology is the same as in the previous surveys conducted in 1999 and 2003. Questionnaires were mailed to manufacturers and traders based in Hong Kong who are registered with the HKTDC's databank. Traders were included in the study because some were engaged in production activities offshore, mainly in the Chinese mainland. Returned questionnaires were examined before further processing to make sure that all necessary information had been provided. Unclear, invalid or incomplete answers were followed up with respondents through telephone interviews. Profile of Respondents The findings presented in this report are based on information collected from 2,200 completed returns. Among the surveyed companies, 26% identified themselves as manufacturers, 11% as traders, and 62% as both manufacturers and traders. The remaining 0.5% were involved in other businesses, including buying offices, wholesalers,

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

retailers, etc. Consistent with the structure of Hong Kong's manufacturing and trading sectors, which comprise mainly small- and medium-sized companies, 38% of respondents reported an annual turnover of less than HK$10 million, another 51% make between HK$10 million and HK$100 million, while the remaining 11% earned more than HK$100 million. They were from a broad base of industrial sectors, including electronics, clothing, textiles, toys, plastic goods, giftware, timepieces and jewellery.

II. Involvement of Hong Kong Companies in OEM, ODM and OBM In 2007, there were 83%, 61% and 40% of surveyed companies engaged in OEM, ODM and OBM business, respectively. The ratios were about the same as those in 2003. It appears that companies, in terms of their number, have not further moved up the valuechain by becoming involved more in ODM and OBM since 2003.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

However, the picture would be somewhat different in terms of sales value. In 2007, 74% of surveyed companies' business was in OEM, while the respective ratio was 81% in 2003. For ODM, the ratio also dropped from 67% in 2003 to 63% in 2007. In contrast, the ratio for OBM business remained about the same.

For companies involved only in ODM or OBM business, although there were no noticeable changes in the share of firm number, they showed increases, in terms of sales value,

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

from 3% in 2003 to 6% in 2007, and from 7% in 2003 to 11% in 2007, respectively. However, the percentage of those engaged only in OEM business remained relatively stable, in terms of sales value, despite a rise in firm numbers. Seemingly, ODM and OBM business has become more concentrated, with the companies now focusing on one type of business only, compared with a few years back. OEM business, for its part, is growing more difficult, as its share drops in terms of sales value but more companies are engaged in OEM-only business. The relative involvement of Hong Kong companies in OEM, ODM and OBM types of business, to some extent, varies by firm size and industry sector. Compared with largesized companies, proportionally more small- and medium-sized companies with annual turnovers less than HK$10 million, and between HK$10 million and HK$100 million, respectively, are solely engaged in OEM. For small-sized companies, the branching-out ratio is somewhat lower, likely because they have fewer resources to diversify their business and provide value-added services such as design inputs.

In some industry sectors, however, the move towards ODM and OBM seems to be more prominent. The branching-out ratios of food and beverages (87% of OEM respondents), stationery/office supplies (85%), jewellery (80%) and machinery (80%) are higher, while the laggards appear to be textiles (58%), raw materials, metal and commodities (59%), garments (61%) and footwear (64%).

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

The OEM business often involves activities of lower added value than ODM and OBM. OEM mainly refers to the activity of manufacturing on order of buyers. Insignificant design inputs, if any, are provided in the process. But ODM is design-oriented. Manufacturers not only produce, but also design and develop products. OBM, in addition to product design and development, also involves the activities of brand development, marketing, distribution, and sometimes retail management. In this way, OBM is expected to have the highest added value among the three types of business, followed by ODM and then OEM. Our findings support that higher mark-ups are pursued for OBM and ODM. The average gross margin of OBM, defined as sales minus direct cost of goods sold, is estimated at 29% of sales, whereas those of ODM and OEM are 26% and 20% respectively.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

III. From OEM to ODM Hong Kong manufacturers and traders mostly started with OEM business. In the old days, they were able to get many orders from overseas brands in the form of OEM because Hong Kong manufacturers and traders, with the Chinese mainland being the production hinterland, were very competitive in supplying products at low prices. Now, they can no longer compete on prices, because production costs in the southern part of China, the principle manufacturing or sourcing place of Hong Kong companies, have escalated. Also, competition from suppliers in other economies is increasingly keen. Mainland suppliers are obviously major competitors, as they are known to be cost competitive and are catching up fast in product quality. Developing ODM business is a way to enhance competitiveness. Evidently, many companies engaged in ODM have diversified from OEM business. Our survey found that in 2007, 61% of respondents were involved in ODM, and 84% of these companies were also engaged in OEM. Among those not currently engaging in ODM, 20% plan to develop ODM in the next three years. The average gross margin of our respondents' ODM business was 26% in 2007, higher than that of their OEM business by six percentage points. Reasons for Developing ODM Not surprisingly, the most important reason for companies developing ODM is to enhance competitiveness by taking part in a higher value-added production process, which ODM companies gave an average rating of 4.20 in a scale from 1 to 5, with 5 being the most important. Some companies engaged in ODM because they were requested by OEM customers to do the design work (3.91). Some thought keen competition from other countries for OEM business is the reason why they have to move up the value chain (3.90), while others were attracted by ODM's higher profit margins (3.87). Some other respondents planned to build their own name products, and considered developing ODM as a preparatory step (3.76).

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Attributes of a Successful ODM Business Obviously, design capability is the key to success in the ODM business. Our respondents indicated that availability of talented designers (4.51 out of 5) and ability to discern global and product trends (4.40) are the most important attributes of a successful ODM business. As product design is so crucial, adequate intellectual property right protection for product designs is certainly important too (4.16). A good design is important, but the ability to promote the ODM products is also necessary to make the business successful (4.14). Besides, having sufficient funds for initial investment (4.24) was also mentioned to be important.

Hong Kong Companies' Competitive Edge in Developing ODM

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Hong Kong companies definitely have the edge in developing ODM business. Our respondents indicated that Hong Kong's free flow of information helps companies discern global and product trends (4.28 out of 5), which is considered to be one of the most important attributes of a successful ODM business. Hong Kong companies also have good marketing knowledge and experience (4.09), which reflects the ability of Hong Kong companies to promote ODM products. Besides, surveyed companies opined that the availability of talented designers (3.90) and intellectual property rights protection for product designs (3.89) are other competitive advantages.

IV. Upgrade by Brand Development Apart from ODM, some companies have branched out into OBM business to increase the added value of their businesses. In 2007, 40% of our surveyed companies engaged in OBM business, and over 80% of these companies were also engaged in OEM and/or ODM business. Among companies not currently involved in OBM, 21% of them indicated that they planned to develop OBM in the next three years. OEM/ODM and OBM businesses are very different business models. The former takes the form of B2B (business-to-business), while the latter deals directly with customers (B2C, business-to-customer). Companies in OBM business sell their products directly to final consumers. They bear more risk, but the return is higher. OBM business has a higher gross margin than those of OEM/ODMs. As noted, the average gross margin of our respondents' OBM business is 29%, compared to OEM's 20% and ODM's 26%. Reasons for Developing OBM Similar to those engaged in ODM business, respondents of OBM business indicated that to enhance competitiveness (4.34 out of 5) is the most important reason for developing brands. It shows that many companies realise the keen competition of low value-added business and try moving upward along the value chain. Brand building helps create a unique identity and quality image so that Hong Kong companies may differentiate their products with those of competitors. Some revealed that developing brands can increase

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

direct sales to consumers (4.06). By doing so, they are able to get direct feedback from the market and respond fast. Some respondents reckoned that higher profit margins of the OBM business are tempting (4.05). However, not as many respondents agreed that the saturated OEM business has led them to build up brand names.

Reasons for Not Developing OBM For companies who are neither involved in OBM nor planning to develop OBM in the next three years, they are by and large put off by the high cost of brand promotion (67% of this subset). This is probably because respondents are primarily small- and mediumsized companies that may have limited financial leverage compared with larger-sized brand holders. 40% of the respondents said they lack internal expertise, which is very true as brand development and manufacturing require different marketing and management skills. The former involves expertise in product design, retailing and distribution with which companies focusing only on manufacturing may not be familiar. Evidently, some companies take ODM as a transitional step towards brand development. This is an example of how companies may acquire the new expertise required for OBM. On the other hand, 39% of the respondents were worried about competition from existing brands, and 33% thought the expected return does not justify the costs of developing OBM.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Activities Involved in Developing OBM Broadly speaking, OBM business involves three types of activities, namely product design, manufacturing and marketing. Companies can either participate in these activities directly or simply contract them out. Our survey results showed that most respondents of OBM business prefer getting involved in these activities on their own. For design work, 76% of respondents indicated that they developed their own designs, while only 16% said they subcontract the work to other design houses. Companies usually develop their own designs because other than the brands, good designs very much contribute to the success of the products, and it is easier to manage if they design the products in-house. However, in some cases, outsourcing design work may be a preferred way to adapt to the tastes and preferences of overseas consumers. Compared to design work, the ratio of subcontraction is higher for manufacturing. 73% of respondents said they make the products by themselves, while 25% contract out production to other companies. The high proportion of companies doing the design work and production themselves may be in part due to the fact that many OBM companies also have OEM and ODM businesses. Besides in-house product design and manufacturing, most OBM companies also make their own efforts in sales and marketing when selling overseas (44%), rather than relying on agents. Separately, 11% of the responding companies indicated that they have acquired existing brand names, which is a quick way of expanding OBM business.

Attributes of a Successful OBM Business As in the case of ODM, design capability is most important for a successful OBM business. Not unexpectedly, availability of talented designers was rated as the most important attribute (4.43 out of 5). Attributes related to product designs also top the list - the ability to discern global and product trends (4.39) and intellectual property rights protection for product designs (4.25). Unlike ODM, however, OBM business involves direct sales to customers, and therefore having a good distribution network (4.41) makes one's OBM business perform well. On the other hand, successful branding and marketing play a pivotal role in OBM business by boosting sales and profit. But brand development will incur advertising expenses and

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

require specific skills. That is why respondents said sufficient funds for initial investment (4.29) and ability to promote branded products (4.28) are other important attributes of a successful OBM business.

Hong Kong Companies' Competitive Edge in Developing OBM Companies with OBM business quoted design capability, good distribution network, sufficient funds and brand promotion ability the most important attributes of a successful OBM business. According to our survey, Hong Kong companies do possess most of these attributes. First of all, our respondents opined that they have a good reputation in the global market (4.28 out of 5). The comment seems to be general, but hinted that Hong Kong companies have performed well in many aspects and successfully gained creditability from customers all over the world. This is important because in many circumstances, customers make their buying decisions according to their impression of the suppliers. Having a good reputation in the global market can therefore help Hong Kong companies develop a popular brand. Yet customers' impressions of the products comes from their experience. Thus, product quality and design are still important. In terms of design capability, Hong Kong companies have free flow of information and the ability to discern global and product trends (4.25), good intellectual property rights protection for product designs (3.99) and availability of talented designers (3.93). Concerning other attributes, our respondents considered Hong Kong companies have the competitive edge in good distribution networks (4.05), experience and capability in product quality control (4.15), and knowledge and experience in brand promotion (4.08).

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Brand Promotion Expenditure Apparently, there are concerns over the high expenses incurred in OBM business. According to our respondents with OBM business, their average spending on brand promotion was 14.5% of sales in 2007, which can be a reference for companies planning to develop OBM. By industry, the ratio of advertising to sales (AS) ranges from around 11% to 18%, depending on the stage of brand development, company size and product types.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

At the early stage of brand development, the expenses relative to sales incurred may be higher, as companies need to make large initial efforts to build their brands, make them known to the customers and develop brand loyalty. This may involve significant investment in advertising, marketing, promotion and distribution. However, once the brand has been well developed, brand promotion expenses may stabilise, and its ratio to sales would decline amid strong sales growth. Company size also matters, as large companies may achieve economies of scale where they may have different products under one brand name. Besides, bigger firms are likely to have a lower AS ratio because brand promotion expenses are usually fixed at a flat rate topped up by sales turnover or volume. In our survey, for companies with OBM business less than HK$1 million, the average ratio of advertising to sales was 17%, while those with OBM business more than HK$100 million just spent some 10% of their sales on advertising.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Plans of Expanding OBM Business in the Future 75% of our respondents who are engaged in OBM indicated that they are determined to further develop their OBM business. Another 24% will maintain the status quo, while only 2% will trim down their OBM business. The majority of those who plan to expand their OBM business choose to develop their own brands. 80% will adopt this strategy only, and a further 14% will take it in addition to acquiring existing brands. The remaining 6% plan to expand by acquiring existing brand names only.

V. Prospects of OEM, ODM and OBM Over the past few decades, Hong Kong companies have been successful in developing their OEM business, particularly for light consumer goods. However, competition from developing Asia, especially the Chinese mainland, has been rising. In order to stay ahead of competitors, Hong Kong companies have chosen to stretch their grip along the value chain, by moving towards front- and back-end activities such as design, wholesale, retail and brand management. This development is well supported by our latest survey findings: some Hong Kong companies move towards ODM by providing enhanced design services. Others are developing their brands and distribution networks. Our survey shows that the prospects for developing OEM, ODM and OBM business will improve in the future, particularly for ODM and OBM business. Respondents of all three types of business said they anticipated growth in the medium term, with average ratings

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

over 3, in a 5-point scale from 1 to 5, where 5 represents the most rapid growth, 3 represents no change and 1 represents rapid decline. The outlook of OEM was rated at 3.27, the least promising among the three types of business. The prospects of ODM and OBM were rated better, at 3.73 and 3.80, respectively. Over the longer term, the prospects of ODM and OBM, with average ratings of 3.76 and 3.84, respectively, are also better than that of OEM (3.09). The long-term prospects of ODM and OBM are even better than the medium-term prospects. However, OEM business outlook is less promising in the long term (3.09) than in the medium term (3.27).

Outlook by Market In mature markets like the US, the EU and Japan, the prospects of ODM (3.61) are even higher than that of OBM (3.55). This suggests that in the face of intensifying competition from other low-cost suppliers, Hong Kong companies have chosen to develop ODM in hope of winning business in the mature markets as respondents have found it difficult to develop brands in mature markets. Regarding OEM, there remains keen competition, but long-term relationships with buyers help build up mutual trust and secure orders. For both the Chinese mainland and overseas emerging markets, the prospects of OBM are the best, with average ratings of 3.54 and 3.58 respectively, whereas the outlook of ODM is also good with average ratings of 3.33 and 3.52, respectively. Respondents are less confident on OEM business, with average ratings only marginally higher than 3, of 3.09 and 3.19, respectively. It reflects the challenges of market access to the Chinese mainland and other emerging markets, where competition from indigenous, low-cost manufacturers is severe, and business connections with importers, who mainly look for open items, are fairly new and exploratory.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Outlook by Company Size and Industry The outlook for companies with different sizes is consistent with the overall picture. In particular, bigger firms are more likely to perform well, irrespective of business type.

At the industry level, OEM companies in the fields of audio-visual equipment (3.59 out of 5), computers/telecom products (3.57), and machinery (3.56) are the most optimistic over the medium term, while those in decorations and craft (3.16) and textiles (3.17) are the least optimistic. The outlook of ODM companies is good in the medium term, with a rate of 3.6 or above for all industries. In particular, audio-visual equipment saw the highest rating of 4. OBM companies in the chemical industry are the most optimistic about their business over the medium term, with average ratings of 4.13. In general, the outlook for OBM business is better than that of ODM business for all industries in the medium term, except for audio-visual equipment, computers/telecom products, electrical appliances, hardware, machinery, plastic products, printed matters/packaging materials, raw materials, metal and commodities, and stationery/office supplies. In the long term, OEM companies of industries such as chemicals (2.75) and textiles (2.97) are more pessimistic than others, giving an average rating below 3. On the other hand, machinery (3.68) and audio-visual equipment (3.48) companies still expect bright prospects compared to others. Over the long term, food and beverages (4.00) companies are the most optimistic about their ODM business, while chemicals (4.17) and footwear (4.00) expect strong growth for their OBM business, with average ratings above 4.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

Implications and Recommendations If anything, producers and exporters will increasingly become involved in activities beyond manufacturing. Entering into ODM is a step towards this trend. Prototype creation, detailed product design and development of product concepts, the core activities of ODM, may prove easier for Hong Kong companies to master than product development, brand building, marketing and distribution, the core activities of OBM, as the former activities rely more on one's expertise in the manufacturing process. The inherent capital outlay and risk levels for those activities are also lower than those associated with OBM. In any event, moving up the front-end of the value chain will involve devoted personnel to the newly added activities. The incumbents will need to hire, or incubate, their own designers, engineers and other skilled workers to render quality services that can be offered to potential buyers of the manufacturers' goods. In order to avoid over-reliance on buyers, achieve product differentiation and nurture customer loyalty, Hong Kong exporters and manufacturers may choose to adopt OBM, stepping into the back-end of the value chain. Rather than just expanding the range of manufacturing-related services into ODM, these companies will try to capture greater profits by building their own brand names. Inevitably, this strategy will further involve the marketing and distribution of their own goods. So the advantages can cost quite a bit - a possibly formidable barrier to most Hong Kong companies. To be sure, OBM is a difficult business model, and the tenet of success is the commitment to invest in the brand over the long term. Given a lack of brand development expertise and financial resources, Hong Kong companies can incubate their brands in some small pilot markets. After becoming successful, the brands may be promoted in other potential markets, especially the emerging markets, which are more receptive to new brands.

Study on OEM, ODM and OBM: Extending the Supply Chain with Added Value

All in all, in light of intensifying competition, rising product safety concerns and increasing environmental consciousness, Hong Kong exporters and manufacturers, be they engaged in OEM, ODM or OBM, should improve the overall quality of their products and services by shifting the whole value chain upward. Among others, this upward shift may involve offering better designs and features, enhancing product safety and reliability, using environmentally friendly materials, improving warehousing and logistics, as well as strengthening marketing and distribution. But exporters and manufacturers must balance the higher costs required to increase the added value. In this respect, they should make use of new and innovative technology, including both production and information technology, to sharpen their efficiency in manufacturing and other valueadded activities, while containing rises in costs.

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