Contract manufacturers handle the inventory hot potato
By Claire Serant / EBN (electronic buyers news)
(01/08/01, 04:09:08 PM EST)
The responsibility for carrying inventory in the past decade has been passed around the electronics industry like a hot potato, often burning component suppliers and OEMs that have held on for too long.
Contract electronics manufacturers may be next in line, at least going by the rising volume of inventory that the top-tier players have accumulated in recent quarters. Through their belief that they are in the best position to handle excess raw materials, work-in-progress, and even finished goods, CEMs have been winning new business.
The sector is expected to make 34% of OEM electronic goods in 2004, up from 20% this year, but industry watchers contend contract manufacturers may be setting themselves up for a severe headache if they're caught holding large inventories during an economic or industry downturn.
In the third quarter of 2000, for instance, inventory for the top 10 CEMs should have been $3 billion lower, said Roger Norberg, an analyst at Chase H&Q in Minneapolis. Many of these CEMs have bulked up even more since then. When Solectron Corp. report-ed first-quarter fiscal 2001 earn-ings last month, the Milpitas, Calif., CEM revealed that inventory reached a whopping $4.58 billion, up from approximately $3.8 billion in the previous quarter.
“Solectron is carrying $1 billion more in inventory [mostly in raw materials] than they need,” Norberg said.
As the buildup of raw materials and finished goods mushroomed across most market segments during the past two quarters, OEMs and component suppliers began to blame their contractors for not bringing some products to market faster, according to analysts.
“There's a lot of pressure to hold a large inventory of raw materials because of component shortages,” said Shawn Severson, an analyst at Raymond James & Associates Inc. in St. Petersburg, Fla. “Solectron had too much raw materials and screwed up the supply base. And Jabil [Circuit]'s customers carried too high an amount of finished goods, which hurt Jabil's recent quarter.”
CEMs also stung While OEMs and suppliers were the primary victims of the last component crisis that hit the electronics industry in mid-2000, CEMs can also be hurt by an inventory imbalance, industry executives acknowledged. Bulging finished-goods inventories can hinder production flows, while excess raw-material holdings-particularly in a tight component market-can wreak havoc on business forecasts, according to analysts.
“Unanticipated component shortages can result in the delay of scheduled shipments, higher component costs, and an increase in inventory levels-all of which could negatively impact operating results,” said David Parrish, an analyst at Dain Rauscher Inc., Minneapolis. The CEM-or electronic manufacturing services (EMS) provider-has assumed a greater role in the electronics supply chain in recent years, aggregating costly OEM manufacturing operations into megaproducers that benefit from economies of scale.
In addition to their traditional manufacturing services, CEMs are also making inroads into the design process at component suppliers, according to Joe King, Molex Inc.'s chief executive designate in Lisle, Ill.
“The influence of CEMs on the design phase has been increasing and will continue to increase,” King said during a recent interview. “They work directly now with maybe 15% of OEMs' approved vendors. That's going up to 30%.”
Theoretically, the exposure to a broader swath of the manufacturing base should enable CEMs to gain greater visibility into demand and improve the industry's forecasting ability. But that's not necessarily proving true, according to observers. Anecdotal evidence suggests OEMs and their CEM partners in some cases are competing for the same components used in different product categories-in the worst-case scenario, leaving goods partially finished for want of parts.
In other cases, CEMs' tendency toward massive inventory buildups has tied up capital and created artificial demand. When the inventory glut peaks, CEMs must burn off the excess, which in the latest instance has stalled cyclical ordering patterns and reaped misery for component suppliers and distributors.
“The problem is [that] not all the demand materialized,” Severson said. “It's taken longer to work off this inventory than it would if the demand picture had remained as it was originally forecast.”
Profiting by taking risks
Not that carrying inventory is entirely without its incentives. Just as electronic-component distributors are paid for each transaction, many CEMs receive a fee for carrying excess parts. ACT Manufacturing Inc., Hudson, Mass., accepted a $50 million advance from Dallas-based Efficient Networks Inc. last year to offset any problems associated with catering to the company's future inventory needs.
While popular during the past 12 months, deals like ACT's are on the decline because component markets have loosened, according to observers. “Now customers tell CEMs to hold off and that they don't need the inventory right away,” said Herve Francois, an analyst at Credit Suisse First Boston Corp. in New York.
Indeed, inventory management tends to be easier when supplies are plentiful and more challenging-even for large aggregators-than when shortages stretch lead times too far into the future.
“Inventory is still a four-letter word,” Francois said. And once lead times stretch from 10 to 35 weeks, CEMs will have difficulty managing the supply chain, which in the latest instance has led OEMs and component makers to blame them for the industry's inventory overhang, according to Francois.
In some cases, this had prompted CEMs to address their holdings, observers said. “They've been pushing back for four months now,” said Jerry Labowitz, an analyst at Merrill Lynch & Co. Inc. in New York. “We saw that occurring in the fourth calendar quarter and accelerating as the quarter progressed.”
However, other CEMs are moving ahead with aplomb, as recently as late in the fourth quarter snatching up components even before customer orders were placed.
Solectron's inventory strategy, for example, includes buying certain high-volume, multicustomer components in bulk even before manufacturing orders are received from OEMs, according to Susan Wang, Solectron's chief financial officer, during a recent investor conference. The goal is to become an integral and crucial part of the OEM's operation, industry executives said.
“My strategy is to take over my customers' supply chain,” said John Boucher, vice president of global supply-chain services at Manufacturers' Services Ltd., a Concord, Mass., CEM. Whatever strategy is used, CEMs are showing their determination to provide OEMs with valued-added supply-chain services by signing long-term agreements that maintain a fluid product flow and at least aim to improve forecasts.
Plexus Corp., a Neenah, Wis., CEM, is not heavily exposed to the PC or wireless businesses that recently led to the industry's inventory troubles. But the company said it tries to take an even-handed approach nevertheless.
“We strive to have appropriate inventory turns built into our contracts with customers,” said Tom Sabol, Plexus' chief financial officer. “We want to keep our customers happy, but we're running a business as well. We want to be covered for debt-carrying costs, like asset holding.”
As the electronics sector digs out from under its inventory avalanche, such moderation may become more apparent, at least among second-tier CEMs, according to some analysts. Others predict that valuable lessons will be learned as the industry gears up for renewed growth and stronger order cycles.
“This should lead to greater efficiencies, which help widen margins and, of course, provide the necessary components to ship more products,” Merrill Lynch's Labowitz said.
Additional reporting by Bolaji Ojo |
