Outsourcers Rise Again
(Article from Upside Today)
January 11, 2000
by Robert McGarvey
Just a decade ago, outsource manufacturing was a grimy little industry where no-name shops with wallet-thin capitalizations jumped whenever brand-name OEMs called with overflow manufacturing work.
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"By 2001, to compete in this business, you'll need $10 billion in annual revenues."
But feast your eyes on the buffed up and rechristened electronic manufacturing services (EMS) companies that have become the darlings of Wall Street. In fiscal 1999, industry leader Solectron pulled in $8.4 billion in revenues, along with profits of $293.9 million - enough to command a current market cap of $23 billion. That's more than half again as great as the market caps of far more publicized media favorites such as Apple Computer (market cap, $14.5 billion) and 3Com (market cap, $14.6 billion).
But this is not a one-company category. Just about all of Solectron's major competitors, from Flextronics International to Celestica and Jabil Circuit, are riding high on billions in revenues and burly market caps. "I like all the leaders," says Roger Norberg, an analyst with US Bancorp Piper Jaffray. "This is a great growth industry."
In 1998, the global market for contract manufacturing weighed in at around $60 billion, according to figures compiled by Technology Forecasters, a firm that tracks the EMS sector. But the firm predicts growth at 20 percent annually, with the market projected to top $150 billion by 2003 - estimates that the firm's president, Pamela Gordon, characterizes as "conservative."
Richer paydays loom just around the corner, too, say industry experts. "About 15 to 20 percent of electronics manufacturing now is outsourced, but within 10 years, 50 percent will be," claims Randall Sherman, president of New Venture Consulting, a consulting company that specializes in the outsourcing industry. He estimates today's electronics manufacturing market at $425 billion, which means that if he's right, revenues for outsourcing companies are about to explode.
The sector's top guns are saying the same thing. "By 2001, to compete in this business, you'll need $10 billion in annual revenues," says Eugene Polistuk, CEO of Celestica. "Just five years ago, nobody would have thought there would be a $10 billion EMS, but soon that is going to be the minimum to be a Tier 1 company."
Riding the Wave
Why are OEMs rushing to contract out their manufacturing? "We're in the midst of an enormous shift in strategy by OEMs, where they now are embracing a virtual manufacturing strategy because it saves them money," says Jabil's president, Tim Main. "On the low side, when an OEM outsources to us, its savings will be 10 percent. It could be as high as 50 percent if they have been very sloppy."
Gordon adds, "For an OEM, the benefits of outsourcing are compelling. The OEM gets to concentrate on its core competencies - R&D and marketing - and reduces costs. And it decreases debt because manufacturing is capital-intensive and those investments are shifted to another company's books. The question shouldn't be, Why is this happening? The question should be, Why didn't this happen sooner?"
One reason it didn't happen sooner is "it had a stigma," says Gary Venner, director of consulting at Technology & Business Integrators. OEMs hadn't accepted the notion of putting their labels on products they had never touched, so many were leery about outsourcing manufacturing.
But relentless downward pressure on pricing forced OEMs to take another look at outsourcing about five years ago, and most of them liked what they saw. "Often you can get higher-quality manufacturing and lower costs by turning to a contract manufacturing solution," says Robert Freid, principal of Contract Manufacturing Consultants, a firm that advises companies seeking outsourcing solutions.
Do the OEMs lose anything by handing off manufacturing to an outside company? Probably not. "There really are few places where manufacturing makes the difference," says Bryan Stolle, CEO of Agile Software, which develops supply-chain management software. "It's all about time to market and pricing."
Accelerating time to market is where the EMSs shine. These companies have facilities scattered around the world, so time to market is almost instantaneous. In the process, costs inevitably are pared down. "Manufacturing is our business, and we're good at it," says Michael Marks, CEO of Flextronics, a Singapore-incorporated company with administrative headquarters in San Jose, Calif. "OEMs never cared about, never put their top people in, plants - but we do. And we also run our plants at much higher capacity. That's how we can cut costs and deliver quality."
Another plus for outsourcers is "substantial supply-chain efficiencies," adds Gordon. That's because a contract manufacturer places mammoth orders with its vendors, and "they get economies of scale no individual OEM could enjoy," says Barry Jaruzelski, a vice president with Booz Allen & Hamilton.
There are, however, some downsides. "Confidentiality remains an issue for some OEMs, and that's kept them from outsourcing," says Gordon. Competitive product lines often are run in the same EMS plant, and while the contract manufacturers all swear they safeguard customer secrets, the reality is that the essence of cost cutting is pooling resources to maximize capacity utilization. Yet the secrecy issue may not be as significant in practice as one might think. "Many companies have realized their manufacturing was commodity processes, not proprietary," says Freid, "and that's why they have gained more comfort with outsourcing." |
