Contract Manufacturers Face Uncertainty
As High-Tech Firms Tighten Their Budgets
By NICOLE HARRIS March 29, 2001
Staff Reporter of THE WALL STREET JOURNAL
Just last month, contract manufacturers such as Solectron Corp., were boasting that they would be able to benefit from a tightening economy by taking advantage of the trend by technology companies to outsource their manufacturing.
Now, the outlook is so uncertain that Solectron said it can't develop reliable forecasts beyond the third quarter. Competitor Jabil Circuit Inc. quickly followed with similar negative news. As their big customers got caught flat-footed by the speed and severity of the industry-wide slowdown, the contract manufacturers have struggled with a screeching halt in demand and most are coping with bloated inventories.
"The business outlook has changed," explained Tim Main, chief executive of Jabil, St. Petersburg, Fla., in a conference call with Wall Street analysts after he ratcheted down the company's financial targets for the next two quarters. "We've seen a series of order reductions and our customers have become more cautious about plans. Giving a view beyond 90 days is unreliable in today's market."
Both Jabil and Solectron punctuated their scaled-back outlook with announcements of job reductions aimed at reducing costs. Other contract manufacturers, notably Singapore's Flextronics International Ltd. and Toronto's Celestica Inc. as well as SCI Systems Inc., Huntsville, Ala., don't report quarterly results until next month. Still, given the dour news from Jabil and Solectron as well as from the tech companies they supply, most Wall Street analysts already have shaved earnings and revenue estimates across the entire sector. And shares of all companies continue to fall.
"No one is immune," says Patrick Parr, an analyst with ING Barings in New York. "When these companies announce results, time and time again we're surprised at how deep the cuts are."
If providing services to communications customers was a boon for the contract manufacturers last year, it is quickly becoming a sore spot now. On Tuesday, Nortel Networks Corp., an important customer for the likes of SCI Systems, said first-quarter results will fall well short of already-reduced estimates as the slowdown in telecommunications spending spreads beyond North America.
The doldrums for contract manufacturers follow a period of extraordinary growth. Mr. Parr says top-tier contract manufacturers saw their combined revenue grow to $55 billion last year from about $24 billion in 1998.
The companies have been riding a wave of major outsourcing deals as electronics manufacturers increasingly look to cut factory investments and get products to market faster. To keep up with their tech customers' surging demand, most contract manufacturers went on a buying binge during the last few years -- either consolidating among themselves or purchasing big customers' factories outright. Some, such as Solectron, are being hit with the slowdown just as they are trying to swallow big acquisitions.
"These guys have been swinging for the fences. They've been buying and building for a stronger environment than we're seeing for the short term, and now they'll have to drastically cut back," Mr. Parr says.
No one expects the outsourcing trend to suddenly reverse course. Industry executives point out that only 15% to 20% of the world's electronic makers outsource their manufacturing. "That leaves us with a substantial opportunity to grow," says Jabil's Mr. Main, who adds that he didn't expect Jabil to be insulated from its customers' current woes. Though Jabil gets about 55% of its revenue from the communications industry, Mr. Main says the company will continue to look at other sectors, including automotive and industrial controls.
But for now the outsourcing companies find themselves in a quandary: New contracts won't offset the downturn among existing customers.
"It's all a matter of timing," says Susan Wang, Solectron's chief financial officer. "It takes time to get these deals planned and transitioned, and given what we're experiencing with the sharp downturn, these projects won't start for some time off."
Solectron, which builds products and electronics parts for clients such as Cisco Systems Inc., Hewlett-Packard Co. and Compaq Computer Corp., expects its business to deteriorate during the next six months. Ms. Wang says the speed of the tech slowdown caught many in the industry by surprise, adding that some manufacturers may be "overreacting" and cutting back forecasts too sharply.
To further reduce costs, Solectron is considering shifting high-volume manufacturing jobs to lower-cost plants in Asia. Ms. Wang says Solectron's $2.4 billion acquisition of Singapore's NatSteel Electronics Ltd., a fellow contract manufacturer, should position it to take advantage of the outsourcing trend when new contracts kick in.
Meanwhile, executives at Flextronics are hoping the company's "cradle to grave" strategy will help distinguish it from competitors. The company, which announced it would make nearly all of Telefon AB L.M. Ericsson's cellphones, has been expanding its reach into related fields by purchasing specialists in logistics, installation and industrial design.
The goal at Flextronics isn't just to make products for its customers, but to manage the larger part of a product's life span, including helping customers design products. Flextronics also wins kudos from analysts for its "industrial park" strategy, which puts a large portion of components needed to manufacture a product in one location. "If we're making a cellphone, we're molding the plastics right next door," says Jim Sacherman, a Flextronics senior vice president. |
