As outsourcing grows, contract manufacturers and OEMs no longer operate at arm's length. Now they're dancing cheek to cheek
(Thanks Jim for the link).
Special Report: The Electronic Business
August 1998
By Bill Roberts
photograph by Jennifer & Company
For most of its 18 years, Micro Industries Corp. found reason to avoid becoming a contract manufacturer (CM). "It wasn't highly respected," explains CEO Michael Curran. The Westerville, OH, engineering firm was content to design circuit boards and other electronic innards for products made by General Motors, Eastman Kodak, Unisys and others, then let the original equipment manufacturers (OEMs) build the parts. Now, Micro has four circuit board assembly lines and anticipates adding a new line every nine months.
Micro illustrates just how far OEMs are stretching to outsource. With 1997 annual revenue of $30.2 million, Micro is ranked 66th on this year's Electronic Business list of Top 100 CMs (see p.70). Yet even it was pushed into manufacturing. "In the last three years our customers have wanted us to do the on-going production," says Curran. "Everybody who manufactures an end product is looking at outsourcing."
Outsourcing isn't new, but more than ever it is changing the nature of the relationship between the contract manufacturers and OEMs. Once they danced like detached partners doing the Twist, but now they do it cheek to cheek.
"It's clear that the most effective way to manage an outsourcing relationship for both the OEM and CM is to behave as a single company--truly cooperative and integrated with no redundant resources or staffing on either side," says Tom Sansone, president of Jabil Circuit Inc. Based in St. Petersburg, FL, Jabil is #6 on the Top 100 and expects to surpass $2 billion in annual revenue this year.
CMs of all sizes increasingly share sensitive information with OEMs, link IS systems to customers, join OEM design sessions and provide services throughout the supply chain, from design to box build and beyond. In a growing number of cases, CMs finish the product, slap on
the OEM logo and ship it to the user or distributor.
The simple reason is cost. "Nothing makes OEMs look at things differently more than red ink," says Olin King, CEO of SCI Systems Inc., based in Huntsville, AL. SCI, number one of the Top 100 again, expects to surpass $7 billion in revenue this year. King regards himself as the granddaddy of CM. Arguably, SCI created the industry when it began to de-emphasize government work in the 1970s and replace it with commercial contracts. "Red ink or not, almost all [OEMs] have seen their margins shrink," says King.
OEMs no longer view manufacturing as a core competency or a competitive advantage. They want to focus on technology, product innovation, brand marketing and sales. The computer systems group at Dayton, OH-based NCR Corp., for example, began outsourcing three years ago when it realized it would not be capable of both building its systems and keeping up with fast-changing circuit board technology. It struck a deal with Solectron Corp., based in Milpitas, CA, which is second in the Top 100, and expects nearly $5 billion in revenue this year, to manufacture its circuit boards. NCR recently extended that deal with Solectron to include manufacturing its computer products. "We needed to focus on our core competency, which is solving our customers' problems," explains Frank Harrell, vice president of supplier management for NCR.
Because of this trend, contract manufacturers will continue to grow. About 20% of electronics manufacturing is outsourced, but in some segments the percentages are higher. Board build may be as high as 70%. "CMs may eventually do 60% or more of all manufacturing," says Michael Marks, CEO of Flextronics International Ltd. Flextronics, incorporated in Singapore and based in San Jose, is #8 on the Top 100 and expects revenue to approach $2 billion this year.
To strengthen their relations with key OEMs, contract manufacturers have already been expanding globally, acquiring plants from customers, merging with other CMs, hiring design engineers, improving service, assuming supply-chain management, handling advanced packaging and managing order fulfillment.
Pamela Gordon, an analyst with Technology Forecasters in Alameda, CA,
expects large CMs to continue the acquisition spree and medium-sized CMs to work hard at defining their niches. "OEMs' demands for vertically integrated services and multiple geographic locations make it challenging for the small contractor, but not impossible," she notes.
Making the switch
Micro Industries' relationship with OEMs changed dramatically three years ago. Until then, it flirted with contract manufacturing just once. Micro bid unsuccessfully in 1984 to manufacture part of Apple Computer Co.'s Macintosh, which it helped design. In 1995, under pressure from customers, Micro began to make circuit boards and now builds more than 8,000 complex boards--500 to 1,500 components each--per month. It specializes in high-end products in medical electronics, office automation and industrial automation. Micro assists in designing the end product's architecture to house the electronics subsystem that Micro designs.
Large CMs might dismiss Micro as a boutique shop, but they'd love its gross margins, which run as high as 50%. "Customers are willing to pay higher margins for the intellectual property that we bring to the table," says Curran. In particular, Micro has figured out how to give an OEM a generic subsystem to use in designing an end product without waiting for Micro to design the subsystem first. Micro then tailors the generic subsystem to the specific product in parallel with overall design. For example, Micro would design the embedded PC that goes into
an industrial-strength scanner.
Most CMs hope to provide more design services to OEMs, but Curran believes he has an edge. "We can show more than 800 products we've worked on using our model," he notes. "The big guys still have to demonstrate that they're worth the higher margins," he says, adding
that Micro has learned more than a few tricks--sometimes painfully--over two decades.
The key to Micro's success is talented design engineers--30 in a 100-person workforce. It courts local university students and poaches from Silicon Valley. "Many of our engineers grew up in the Midwest, moved to the West and want to come home," says Curran. "Once they see
the kind of things we're working on, and that they can do it with a lower cost of living, then we attract high-caliber people."
For lack of design, a job is lost
Attracting talent--especially design engineers and program managers--is one challenge all contract manufacturers face as they build closer relations with OEMs. Flextronics (which beat Micro for that Macintosh contract) has 150 design engineers around the world, and can't hire them fast enough. "Every engineer in our company is fully booked," says Marks. More than 70% of customers use Flextronics for some design work, he says, yet there are cases where the company is turning away business for lack of engineers.
A table in Flextronics' main design center in Milpitas tells the story. It displays products designed by Flextronics' engineers for clients--a fertility tester, an electronic thermometer, a mouse for desktop computers and a telephone, among others.
Flextronics is also adding high-level program managers to coordinate global activities for a single OEM. These multi-talented people need plant management experience, and in some cases an engineering background. They all "need strong administrative and management skills," says Marks. He expects to have five such persons for key U.S.-based OEMs, and three for European customers.
As Flextronics has learned, managing global operations for OEMs is one of the big challenges for CMs. At Jabil, for example, each plant has a manager just responsible for keeping the factory operating. Each plant has a separate business unit for each major customer. These
business units report to one of six global business managers responsible for key customers. "It winds up being a very efficient enabler of seamless multinational production," Sansone believes.
Jabil does business in the communications, automotive and computer segments.
Jabil and Flextronics illustrate different approaches to another piece of the OEM relationship. Like many large contract manufacturers, Flextronics has been buying plants, making six acquisitions last year and 12 over the past four years. In most cases, Flextronics acquired plants from OEMs, giving it built-in customers. Marks says he's finished acquiring for a while. "We don't have any more strategic requirements globally," he says. "We're happy with what we have." He now has operations in North America, Asia, Europe and Brazil, which is the new hot market for CM expansion. (See Electronic Business, May 1998, p.42.)
Jabil, about the same size as Flextronics, chose to expand by building plants. It only recently made its first acquisition of an OEM plant--Hewlett-Packard Co.'s operations in Idaho and Italy for assembling circuit boards for laser printers. "We've been the shy player in the industry," Sansone says of his scant acquisition record. "It's probably more work to convert an OEM factory to our standards than it is to create one from scratch." Jabil wants customers to have a McDonald's hamburger kind of experience--every plant must have identical materials management systems, production control, quality systems and procedures and organizational structures completely integrated with each other.
Sansone says that OEMs once believed real men build their own circuit boards. Now, he says, the OEM "collective consciousness" has shifted to outsourcing. "OEMs are getting out of manufacturing to save money," says SCI's King. "This is a cost-driven business."
SCI designed and made just about everything for the Apollo space project, except the orange drink later known as Tang. It now has 31 plants worldwide that manufacture a variety of items for OEMs, with personal computers providing the biggest slice of its revenue. King has seen much in his long career, but, from his perspective, two new aspects of the OEM relationship are the outsourcing of more design and fulfillment. SCI recently bought a small plant in Brazil as the nucleus for a manufacturing center it is building, and the company is popping up all over Europe, most recently in Holland, Hungary and Sweden.
SCI's effort in Sweden illustrates another trend in the OEM-CM relationship. A couple of years ago, Ericsson Telecom AB, a large Swedish telecommunications OEM, decided to get out of manufacturing. It chose three large CMs for different business lines--SCI, Flextronics and Solectron.
Large OEMs have always worked with more than one CM, but it is increasingly common for competitors to find themselves in the same room with each other and the customer, sharing sensitive information. So there were SCI, Solectron and Flextronics sharing pricing details at a recent Ericsson materials conference. As awkward as this may be, "we don't think much or any of our information is proprietary anymore," says Flextronics' Marks. "Other [CMs] think certain
information is proprietary." The good news: Once established, OEMs "hardly ever tear these relationships apart," he says.
Looking for the next Cisco
There's a uniquely Silicon Valley version of building OEM-CM relationships that don't easily tear apart. Solectron and others look for start-ups that have the potential to become big companies, then build a relationship with them from the beginning, doing everything along the supply chain except product innovation and basic design.
Solectron's biggest success of this variety is Cisco Systems Inc., a San Jose-based networking hardware company. "Cisco started out very small with us," recalls Mark Holman, Solectron's director of business development. Solectron even bought a company dedicated to working with
start-ups--about 100 in all. "Maybe two of them will become future Ciscos and graduate into the Solectron machine," Holman says.
One such company is Terayon Communications Systems, a cable-modem OEM in Santa Clara. It not only designs the box that sits next to the PC, but the back-end system and the software as well. The company employs 110 workers, about 75 of them experts in fields including application-specific integrated circuit (ASIC) chips, network design, hardware and radio frequency design.
"We chose to focus on our core strengths," says company spokesman John Hamburger. "We chose not to do manufacturing, too." Solectron is Terayon's virtual manufacturing division, doing everything from procurement, design for manufacturing, assembly, final box build and shipping. Although Terayon is still small, it is delivering product globally, using Solectron plants around the world.
Solectron's success with start-ups bred one contract manufacturer whose entire strategy is the start-up niche. Founded in 1992 by six guys who left Solectron, A Plus Manufacturing Corp., based in Fremont, CA, is an $80 million, privately held company that works almost entirely with new companies in medical instruments, computer peripherals and network equipment. A Plus does a lot of box build in the low hundreds per month. "The big guys can't service it," says
Gerhard Mueller, vice president of sales and marketing.
The contract manufacturers that aren't in the top five or so are all looking to do things the big guys can't or won't do. Sanmina Corp., San Jose, for instance, avoids consumer products to concentrate on high-end networking and telecom. "We go after the products that are more difficult to manufacture internally," explains CEO Jure Sola, a Yugoslavian who immigrated to the United States at the age of 17. Sanmina is #9 of the Top 100 and expects about $730 million in revenue this year.
Other contract manufacturers are impressed with Sanmina's 15% operating margins. Sola says they're the result of the niches he chooses, good management and a long history of running a very tight ship. "We don't run any differently than we did 15 years ago" when he had almost as much debt as he did revenue, he says.
Perhaps the most intriguing approach to building tight relations with OEMs is the build-to-order strategy that Denver-based EFTC Corp. pursues using the Internet. EFTC, which is tied for #37 on the Top 100 and expects revenue this year of around $230 million, has partnered with Federal Express and Fujitsu to build notebooks on order, in small lots, on floor space provided by Federal Express at its hub in Memphis. EFTC already has warranty repair work centers for OEMs with Federal Express in Memphis and with UPS in Louisville, KY. By this fall the company will also be assembling and shipping notebook computers as they are ordered by Fujitsu customers.
The objective of the repair warranty work and the notebook assembly is to optimize the entire supply chain. Using the Internet as its IT backbone, the three partners will be able to take orders, deliver all the components to Memphis, assemble the product and ship it back out to the customer in about 48 hours. Only the inventory of parts needed for one day's production will ever be on hand at the plant.
Jack Calderon, CEO of EFTC, believes what he is doing is unique, and will also be the wave of the future for CM-OEM relations. "The others are providing solutions to build-to-order within their traditional infrastructures," he observes. "We don't have a lot of industrial-age
infrastructure. Infrastructure can be a disadvantage when change comes."
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