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Economists' Pick > Economic Forum > HKTDC Research - Archive

Study on OEM, ODM and OBM: Extending the Supply Chainwith 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, withcompanies specialising in only one type of arrangement still recording significantbusiness growth.Looking ahead, Hong Kong companies are expected to continue to extend thesupply chain with added value by engaging in ODM and OBM business, while theoutlook of OEM business is relatively less promising.To further increase their added value, Hong Kong companies, be they engaged inOEM, ODM or OBM, should improve the overall quality of their products andservices 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, in2007. The ratios were about the same as those in 2003. It appears that companies, interms of their numbers, have not moved further up the value chain by involving more inODM and OBM since 2003, when the previous survey was conducted.

But the picture is somewhat different in terms of sales value. Particularly for companiesinvolved only in ODM or OBM business, although there were no noticeable changes in theshare of firm numbers, they showed increases, in terms of sales value, from 3% in 2003to 6% in 2007, and from 7% in 2003 to 11% in 2007, respectively. Seemingly, ODM andOBM business has become more concentrated, with companies now focusing on one typeof business only, compared with a few years back.

Hong Kong companies do have the edge in developing ODM business. Our respondentsindicated that Hong Kong's free flow of information helps companies discern global andproduct trends. Hong Kong companies also have good marketing knowledge andexperience, which reflects that they have the ability to promote ODM products. Besides,surveyed companies opined that the availability of talented designers and intellectualproperty rights protection for product designs are other competitive advantages.

Our respondents also said that Hong Kong companies have the edges in developing OBMbusiness. They have a good reputation in the global market, which suggests that theyhave performed well in many aspects, and successfully gained creditability fromcustomers all over the world. In addition to the ability in product quality and design, our

13 Feb 2008
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respon ents consi ere Hong Kong companies ave t e competitive e ge in goodistribution network experience and capability in product quality control, and knowledgeand experience in brand promotion.

All in all, our survey shows that the prospects for developing OEM, ODM and OBMbusinesses will improve in the future. Respondents of all three types of business saidthey anticipated growth in the medium and long term, although OEM business isrelatively less promising.

In view of the less promising outlook of OEM business, companies are expected toincreasingly engage in activities beyond manufacturing. Entering into ODM is a steptowards this trend. Prototype creation, detailed product design and development of product concepts, the core activities of ODM, may prove easier for Hong Kong companiesto master as those activities rely largely on one's expertise in the manufacturingprocess. But moving up the front-end of the value chain will involve devoted personnelto 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 difficultbusiness model, and the tenet of success is the commitment to invest in the brand overthe long term. Given a lack of brand development expertise and financial resources,Hong Kong companies can incubate their brands in some small pilot markets. Afterbecoming successful, the brands may be promoted in other potential markets, especiallythe emerging markets, which are more receptive to new brands.

In light of intensifying competition, rising product safety concerns and increasingenvironment consciousness, Hong Kong exporters and manufacturers, be they engaged

in OEM, ODM or OBM, should improve the overall quality of their products and servicesby shifting the whole value chain upward. This upward shift may involve offering betterdesigns and features, enhancing product safety and reliability, using environmentallyfriendly materials, improving warehousing and logistics, as well as strengtheningmarketing and distribution.

I. Introduction

Background and Survey Methodology

Most Hong Kong exporters have traditionally engaged in original equipmentmanufacturing (OEM), under which products ordered are designed mainly by customerswho usually own a brand name. Suppliers only focus on the manufacturing process, andthe keys to success are low cost and high flexibility in response to customer demand.

However, competition from suppliers in developing Asia, especially the Chinesemainland, has been rising, initially in terms of price, later in quality and other aspectsover time. Hong Kong exporters are therefore continually compelled to developstrategies that help them stay ahead of competitors. Plant relocation provides a solutionfor 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 valuechain, by moving towards front- and back-end activities such as design, wholesale, retailand brand management, which usually entail higher added value.

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


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retailers, etc. Consistent with the structure of Hong Kong's manufacturing and tradingsectors, which comprise mainly small- and medium-sized companies, 38% of respondents reported an annual turnover of less than HK$10 million, another 51% makebetween 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, ODMand OBM business, respectively. The ratios were about the same as those in 2003. Itappears that companies, in terms of their number, have not further moved up the value-chain by becoming involved more in ODM and OBM since 2003.



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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% in2003. 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 noticeablechanges in the share of firm number, they showed increases, in terms of sales value,



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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 relativelystable, in terms of sales value, despite a rise in firm numbers.

Seemingly, ODM and OBM business has become more concentrated, with the companiesnow focusing on one type of business only, compared with a few years back. OEMbusiness, for its part, is growing more difficult, as its share drops in terms of sales valuebut 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 large-sized companies, proportionally more small- and medium-sized companies with annualturnovers 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-outratio is somewhat lower, likely because they have fewer resources to diversify theirbusiness and provide value-added services such as design inputs.

In some industry sectors, however, the move towards ODM and OBM seems to be moreprominent. 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%).



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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. Insignificantdesign 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 additionto product design and development, also involves the activities of brand development,marketing, distribution, and sometimes retail management. In this way, OBM isexpected to have the highest added value among the three types of business, followedby ODM and then OEM.

Our findings support that higher mark-ups are pursued for OBM and ODM. The averagegross margin of OBM, defined as sales minus direct cost of goods sold, is estimated at29% of sales, whereas those of ODM and OEM are 26% and 20% respectively.



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III. From OEM to ODM

Hong Kong manufacturers and traders mostly started with OEM business. In the olddays, they were able to get many orders from overseas brands in the form of OEMbecause Hong Kong manufacturers and traders, with the Chinese mainland being theproduction hinterland, were very competitive in supplying products at low prices.

Now, they can no longer compete on prices, because production costs in the southernpart 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 costcompetitive and are catching up fast in product quality.

Developing ODM business is a way to enhance competitiveness. Evidently, manycompanies engaged in ODM have diversified from OEM business. Our survey found thatin 2007, 61% of respondents were involved in ODM, and 84% of these companies werealso engaged in OEM. Among those not currently engaging in ODM, 20% plan to developODM in the next three years. The average gross margin of our respondents' ODMbusiness was 26% in 2007, higher than that of their OEM business by six percentagepoints.

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 5being the most important. Some companies engaged in ODM because they wererequested by OEM customers to do the design work (3.91). Some thought keencompetition from other countries for OEM business is the reason why they have to moveup 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, andconsidered developing ODM as a preparatory step (3.76).



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Attributes of a Successful ODM Business

Obviously, design capability is the key to success in the ODM business. Our respondentsindicated that availability of talented designers (4.51 out of 5) and ability to discernglobal and product trends (4.40) are the most important attributes of a successful ODMbusiness. As product design is so crucial, adequate intellectual property right protectionfor 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 mentionedto be important.

Hong Kong Companies' Competitive Edge in Developing ODM



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Hong Kong companies definitely have the edge in developing ODM business. Ourrespondents indicated that Hong Kong's free flow of information helps companies discernglobal 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 havegood marketing knowledge and experience (4.09), which reflects the ability of HongKong companies to promote ODM products. Besides, surveyed companies opined thatthe availability of talented designers (3.90) and intellectual property rights protection forproduct 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 theadded value of their businesses. In 2007, 40% of our surveyed companies engaged inOBM business, and over 80% of these companies were also engaged in OEM and/or ODMbusiness. Among companies not currently involved in OBM, 21% of them indicated thatthey planned to develop OBM in the next three years.

OEM/ODM and OBM businesses are very different business models. The former takes theform 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 finalconsumers. They bear more risk, but the return is higher.

OBM business has a higher gross margin than those of OEM/ODMs. As noted, theaverage gross margin of our respondents' OBM business is 29%, compared to OEM's20% and ODM's 26%.

Reasons for Developing OBM

Similar to those engaged in ODM business, respondents of OBM business indicated thatto enhance competitiveness (4.34 out of 5) is the most important reason for developingbrands. It shows that many companies realise the keen competition of low value-addedbusiness and try moving upward along the value chain. Brand building helps create aunique identity and quality image so that Hong Kong companies may differentiate theirproducts with those of competitors. Some revealed that developing brands can increase



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irect sa es to consumers 4.06 . By oing so, t ey are a e to get irect ee ac romthe 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 thatthe 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 nextthree 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 medium-sized companies that may have limited financial leverage compared with larger-sized

brand holders. 40% of the respondents said they lack internal expertise, which is verytrue as brand development and manufacturing require different marketing andmanagement skills. The former involves expertise in product design, retailing anddistribution 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 fromexisting brands, and 33% thought the expected return does not justify the costs of developing OBM.



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Activities Involved in Developing OBM

Broadly speaking, OBM business involves three types of activities, namely productdesign, manufacturing and marketing. Companies can either participate in these

activities directly or simply contract them out. Our survey results showed that mostrespondents 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. Companiesusually develop their own designs because other than the brands, good designs verymuch contribute to the success of the products, and it is easier to manage if they designthe products in-house. However, in some cases, outsourcing design work may be apreferred 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 outproduction to other companies. The high proportion of companies doing the design workand production themselves may be in part due to the fact that many OBM companiesalso have OEM and ODM businesses.

Besides in-house product design and manufacturing, most OBM companies also maketheir own efforts in sales and marketing when selling overseas (44%), rather thanrelying on agents. Separately, 11% of the responding companies indicated that theyhave 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 OBMbusiness. Not unexpectedly, availability of talented designers was rated as the mostimportant 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 rightsprotection for product designs (4.25).

Unlike ODM, however, OBM business involves direct sales to customers, and thereforehaving a good distribution network (4.41) makes one's OBM business perform well. Onthe other hand, successful branding and marketing play a pivotal role in OBM businessby boosting sales and profit. But brand development will incur advertising expenses and



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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 successfulOBM business. According to our survey, Hong Kong companies do possess most of theseattributes.

First of all, our respondents opined that they have a good reputation in the globalmarket (4.28 out of 5). The comment seems to be general, but hinted that Hong Kongcompanies have performed well in many aspects and successfully gained creditabilityfrom 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 companiesdevelop a popular brand.

Yet customers' impressions of the products comes from their experience. Thus, productquality and design are still important. In terms of design capability, Hong Kongcompanies have free flow of information and the ability to discern global and producttrends (4.25), good intellectual property rights protection for product designs (3.99) andavailability of talented designers (3.93). Concerning other attributes, our respondentsconsidered Hong Kong companies have the competitive edge in good distributionnetworks (4.05), experience and capability in product quality control (4.15), andknowledge and experience in brand promotion (4.08).



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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 brandpromotion was 14.5% of sales in 2007, which can be a reference for companies planningto develop OBM. By industry, the ratio of advertising to sales (AS) ranges from around11% to 18%, depending on the stage of brand development, company size and producttypes.



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At the early stage of brand development, the expenses relative to sales incurred may behigher, as companies need to make large initial efforts to build their brands, make themknown to the customers and develop brand loyalty. This may involve significantinvestment in advertising, marketing, promotion and distribution. However, once thebrand has been well developed, brand promotion expenses may stabilise, and its ratio tosales would decline amid strong sales growth.

Company size also matters, as large companies may achieve economies of scale wherethey may have different products under one brand name. Besides, bigger firms are likelyto have a lower AS ratio because brand promotion expenses are usually fixed at a flatrate topped up by sales turnover or volume. In our survey, for companies with OBMbusiness less than HK$1 million, the average ratio of advertising to sales was 17%, whilethose with OBM business more than HK$100 million just spent some 10% of their saleson advertising.



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Plans of Expanding OBM Business in the Future75% of our respondents who are engaged in OBM indicated that they are determined tofurther develop their OBM business. Another 24% will maintain the status quo, whileonly 2% will trim down their OBM business. The majority of those who plan to expandtheir OBM business choose to develop their own brands. 80% will adopt this strategyonly, and a further 14% will take it in addition to acquiring existing brands. Theremaining 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 developingtheir OEM business, particularly for light consumer goods. However, competition fromdeveloping Asia, especially the Chinese mainland, has been rising. In order to stayahead of competitors, Hong Kong companies have chosen to stretch their grip along thevalue 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 surveyfindings: some Hong Kong companies move towards ODM by providing enhanced designservices. Others are developing their brands and distribution networks.

Our survey shows that the prospects for developing OEM, ODM and OBM business willimprove in the future, particularly for ODM and OBM business. Respondents of all threetypes of business said they anticipated growth in the medium term, with average ratings



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over 3, in a 5-point scale from 1 to 5, where 5 represents the most rapid growth, 3represents no change and 1 represents rapid decline. The outlook of OEM was rated at3.27, the least promising among the three types of business. The prospects of ODM andOBM 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 and3.84, 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, OEMbusiness 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 evenhigher than that of OBM (3.55). This suggests that in the face of intensifying competitionfrom other low-cost suppliers, Hong Kong companies have chosen to develop ODM inhope of winning business in the mature markets as respondents have found it difficult todevelop brands in mature markets. Regarding OEM, there remains keen competition, butlong-term relationships with buyers help build up mutual trust and secure orders.

For both the Chinese mainland and overseas emerging markets, the prospects of OBMare 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 Chinesemainland and other emerging markets, where competition from indigenous, low-costmanufacturers is severe, and business connections with importers, who mainly look foropen items, are fairly new and exploratory.



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Outlook by Company Size and Industry

The outlook for companies with different sizes is consistent with the overall picture. Inparticular, 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 optimisticover 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 sawthe highest rating of 4. OBM companies in the chemical industry are the most optimisticabout 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 themedium term, except for audio-visual equipment, computers/telecom products, electricalappliances, 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 otherhand, machinery (3.68) and audio-visual equipment (3.48) companies still expect brightprospects 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) andfootwear (4.00) expect strong growth for their OBM business, with average ratingsabove 4.



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Implications and Recommendations

If anything, producers and exporters will increasingly become involved in activitiesbeyond manufacturing. Entering into ODM is a step towards this trend. Prototypecreation, detailed product design and development of product concepts, the coreactivities of ODM, may prove easier for Hong Kong companies to master than productdevelopment, brand building, marketing and distribution, the core activities of OBM, asthe former activities rely more on one's expertise in the manufacturing process. Theinherent capital outlay and risk levels for those activities are also lower than thoseassociated with OBM. In any event, moving up the front-end of the value chain willinvolve devoted personnel to the newly added activities. The incumbents will need tohire, or incubate, their own designers, engineers and other skilled workers to renderquality services that can be offered to potential buyers of the manufacturers' goods.

In order to avoid over-reliance on buyers, achieve product differentiation and nurturecustomer 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 greaterprofits by building their own brand names. Inevitably, this strategy will further involvethe marketing and distribution of their own goods. So the advantages can cost quite abit - a possibly formidable barrier to most Hong Kong companies. To be sure, OBM is adifficult 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 financialresources, 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.



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All in all, in light of intensifying competition, rising product safety concerns andincreasing environmental consciousness, Hong Kong exporters and manufacturers, bethey 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 shiftmay involve offering better designs and features, enhancing product safety andreliability, using environmentally friendly materials, improving warehousing and logistics,as well as strengthening marketing and distribution. But exporters and manufacturersmust balance the higher costs required to increase the added value. In this respect, theyshould make use of new and innovative technology, including both production andinformation technology, to sharpen their efficiency in manufacturing and other value-added activities, while containing rises in costs.

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Copyright2012 Hong Kong Trade Development Council. Reproduction in whole or in part without prior permission is prohibited. While every effort has been made to ensure accuracy, the Hong Kong Trade Development Council is not responsible for any errors. Views expressed in this report are not necessarily those of the Hong Kong Trade Development Council.


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