Flextronics Stays Hungry
Asia Week/OCTOBER 19, 2001
With tech demand sinking, aggressive expansion seems like a fast track to extinction. But Singapore's big fish of contract manufacturing is swallowing hard and swimming on
By ASSIF SHAMEEN
It's hard to imagine anyone wanting to be in tech manufacturing right now, let alone trying hard to get in even deeper. Yet that's exactly what Michael Marks is doing. As demand for electronic hardware hits rock bottom, the chairman and CEO of Singapore-based Flextronics International is doing something completely counterintuitive and adding — yes, adding — to his firm's already massive manufacturing capacity. After a string of acquisitions, Flextronics on Oct. 2 made one of its highest-profile purchases yet, paying $220 million for around half of U.S. office-equipment maker Xerox Corp.'s worldwide manufacturing operations.
At first glance, the move seems foolhardy. Many electronics plants in the region are idling, laying off workers for the first time in years. Manufacturing overcapacity in sectors such as semiconductors is at an all-time high. The Xerox deal gives Flextronics factories making low-end copiers and printed circuit boards, along with a five-year contract to produce hardware for Xerox. That's good for the venerable U.S. company — Xerox says it will save an estimated $1 billion annually in manufacturing costs. But what's in it for Flextronics?
Size. It's all part of a strategy Marks hopes will not only help his company beat the tech downturn, but cement its position as one of the world's largest contract manufacturers. Flextronics' expansion is an attempt take advantage of brand-name manufacturers' increasing reliance on outsourcing, and to achieve the internal economies of scale essential in contract manufacturing. Although you won't see the name Flextronics on gadgets at the electronics store, the company makes components and finished products for many of the best-known names in the tech world. Ericsson cellphones, HP printers and even Microsoft's new Xbox game console are built to order on Flextronics assembly lines, in a process known as electronics manufacturing services (EMS).
EMS firms are the powerhouses of I.T. hardware outsourcing, not only making vast quantities of products but running sophisticated global logistics networks. In a business in which net margins run as low as 3%, EMS firms are more profitable the bigger they are. And Flextronics, already the No. 2 manufacturer of its type behind U.S.-based Solectron, needs to keep growing. Size means it can run factories more efficiently than those it purchases them from — and buying during a profound slump allows it to acquire capacity on the cheap, at far less cost than building new lines. Its takeover of Xerox's operations was the culmination of a three-year spending binge in which it bought more than 50 plants and companies worldwide, including rival Singaporean contract manufacturers JIT Holdings and Li Xin Industries.
In a tech industry caught in a vicious slump, Flextronics' specialized brand of contract manufacturing is one of the few sectors with relatively bright prospects. "The longer and steeper the tech downturn, the more the need for companies like Hewlett-Packard to outsource and turn their fixed costs into variable costs," says David Foropolous, a tech analyst at securities brokerage SG Cowen in New York. Although there had been a trend toward contract manufacturing before this year's slump, the harsh new economic climate has made outsourcing a necessity instead of a choice for struggling tech firms, says Matthew Podrebarac, a consultant with Accenture in Hong Kong.
As an industry powerhouse, Flectronics stands to gain even more as brand-name companies consolidate. Computer and printer giant HP recently announced it will cut the number of contract manufacturers it uses. That should mean business being diverted to Flextronics, which is already HP's largest supplier and is trying to work more closely with the U.S. firm. In September it took over the running of HP's large-format printer operations in Singapore. HP's merger with Compaq will also likely bring new orders as the partners streamline procurement.
Winning more orders is only part of the plan. Expansion magnifies the benefits of high-tech supply-chain management software linking production centers worldwide. "It isn't just about size and scale," says Ash Bhardwaj, the company's Asia-Pacific president. "It's about efficiency and service." With plants in low-cost locations as diverse as Hungary, Mexico and Malaysia, Flextronics can stay close to key markets (and thus ship goods more cheaply) without losing the ability to monitor inventory and production.
To boost margins, Flextronics wants to increase the role of its logistics and fledgling product design operations — moves that could leave it resembling more closely the vertically integrated brand-name manufacturers that are now feeling the pinch. Bhardwaj isn't worried. "We are never going to be like NEC or Toshiba because we make the same thing for several brand-name makers, whereas they made things just for themselves. Our capacity utilization is much better than theirs."
Analysts and investors have questioned before whether Flextronics is acquiring too much capacity. Overestimating demand is a danger, says SG Cowen's Foropolous — though he concedes Flextronics is better positioned than its competitors to manage fluctuations in sales. Partly due to acquisitions, analysts expect the company's sales to grow 8% to $13 billion in the fiscal year ending March 2002 — a major comedown after 70%-plus growth in the past four years, but no mean feat in the current economic climate. Profit is forecast at $350 million, down from $416 million last year.
At some point, Flextronics will bump up against the law of diminishing returns when expansion no longer adds to the bottom line. Bhardwaj doesn't expect that time to come soon. He sees huge potential in Japan as ailing tech manufacturers there lay off staff and focus more on marketing. "Japan is really the last frontier," he says. "While U.S. and European companies have been outsourcing for years, Japanese companies are waking up to the fact that they would rather let someone like us make things for them more efficiently and cheaply." Amid the tech wreck, "efficiently" and "cheaply" are words that resonate. |
