Original Equipment Manufacturer (OEM)

An Original Equipment Manufacturer (OEM) is a company whose goods are used as components in the products of another company, which then sells the finished item to end-users. Think of the powerful processor inside your laptop or the high-tech camera system in your smartphone. While the laptop might have a Dell or HP logo and the phone an Apple or Samsung badge, the intricate components inside are often made by specialist companies you've never heard of. These hidden-away companies are the OEMs. They operate behind the scenes, supplying the “guts” of the products we use every day. For an investor, understanding the OEM model is crucial because it represents a distinct business strategy with its own unique set of opportunities and risks. These companies don't spend fortunes on advertising to you and me; instead, their success hinges on building strong, long-term relationships with the big brands.

At its core, the OEM model is a business-to-business (B2B) relationship, which shapes its entire financial and operational reality. Unlike a company selling directly to consumers, an OEM's success isn't about catchy jingles but about mission-critical reliability and cost-effectiveness.

An OEM's customers are not individuals but other corporations. This leads to a dynamic defined by a few, very large contracts rather than millions of small sales. The relationship is often symbiotic: the brand (e.g., Ford) needs the OEM's specialized technology (e.g., a Bosch engine control unit), and the OEM needs the brand's massive distribution network and scale. These relationships are often cemented in long-term agreements, providing the OEM with a degree of revenue predictability.

OEMs often live by the mantra “make it up in volume”. Because they are selling components rather than a finished, branded product, their profit margins can be thinner than those of their well-known customers. Their path to profitability lies in producing millions of units with extreme efficiency. A key part of analyzing an OEM is understanding the balance of power with its customers. Do they have the leverage to maintain their prices, or are they constantly being squeezed?

For a value investing practitioner, OEMs can be a fascinating hunting ground. They often lack the glamour of consumer brands, causing them to be overlooked by the market, yet many possess the hallmarks of a wonderful business.

The best investors look for a durable competitive moat, and some of the strongest moats are found in the OEM world. They just look a little different.

• High switching costs: This is the OEM's crown jewel. If an OEM's component is deeply integrated into a client's product design, it can be incredibly expensive, risky, and time-consuming for that client to switch to a new supplier. This “stickiness” creates highly reliable, recurring revenue streams—music to a value investor's ears.
• Technological Edge: Some OEMs possess patents or proprietary know-how that makes them the only game in town for a specific, crucial component. This technological superiority gives them pricing power and protects them from competition.

Many of the world's best-run OEMs are “Hidden Champions”—dominant global leaders in a niche industry but completely unknown to the public. Because they don't have a flashy consumer brand, they often fly under the radar of many analysts and investors. This lack of attention can sometimes lead to the company's shares being undervalued, creating a potential opportunity for diligent investors willing to look under the hood of the economy's most popular products.

Investing in OEMs is not without its perils. Before committing capital, you must rigorously assess the following risks:

• Customer Concentration: The biggest danger is often customer concentration risk. If an OEM generates 70% of its revenue from a single client, any bad news for that client—or a decision to switch suppliers—can crush the OEM's business almost overnight.
• Margin Squeeze: Powerful customers constantly push for lower prices. An OEM that lacks a strong technological advantage or high switching costs can see its profitability slowly eroded over time.
• Technological Disruption: The tech world is unforgiving. A competitor with a better, cheaper, or smaller component can render an OEM's product obsolete, wiping out its competitive advantage.