Food for Thought (2)
Job Shops Take Center Stage
PC makers are relying on contract manufacturers to turn out products more efficiently
Business Week
June 21, 1999
As a kid, William D. Morean thought his father's contract-manufacturing business, Jabil Circuit Inc., was one big bore. All the suburban Detroit company did was assemble computer boards each week for mainframe maker Control Data Corp. ''I didn't want anything to do with it,'' says Morean, who set out with friends for Alaska to be a bush pilot and outdoorsman. But a few years later, when his dad was on the verge of shuttering Jabil, Morean returned to lend a helping hand. After bringing in some new orders, Morean began to think that working for the company could be as exciting as flying planes across the tundra. ''I called my pals in Alaska and told them they could keep my if they promised not to kill themselves fighting over them,'' he says.
Smart choice. In the past few years, Jabil and other contract manufacturers have moved from high-tech snoozes into industry stars. As the pace of technology accelerates, companies from Silicon Valley startups to computer giants such as IBM are looking to push responsibility for nuts-and-bolts manufacturing onto no-name contractors like Jabil. That trend is expected to lift industrywide contract manufacturing revenues from $90 billion in 1998 to an expected $200 billion in 2001. Times are so good that Jabil and Flextronics International Ltd. in San Jose, Calif., are turning away low-margin business from PC makers they used to fight over. ''There's just huge demand from everywhere,'' says Michael E. Marks, chief executive of Flextronics, which has increased revenues roughly 70% a year for the past six years.
Now contract manufacturers are stealing the thunder from some of their better-known customers. In this year's BUSINESS WEEK Info Tech 100, the former ho-hum contract manufacturers are the best represented category in the top tier. Industry leader Solectron Corp. ranks No. 3, Taiwan-based Quanta Computer is No. 14, Flextronics is No. 17, and Jabil hit No. 22. ''It's been quite extraordinary. Business is amazing,'' says Solectron CEO Koichi ''Ko'' Nishimura.
Why is the industry red-hot? After their humble start making plain-vanilla products like printed circuit boards, contract manufacturers are proving that they're some of the most efficient producers of everything from PalmPilots to supercomputers. Part of the reason is that they spend almost nothing on corporate frills. Solectron's overhead is a rock-bottom 4% of sales, vs. 18% at Compaq Computer Corp. and 9% at superefficient Dell Computer Corp.
At the same time, contract manufacturers get more out of their capital investments since they handle such huge volumes. Consider, for example, a $600,000 laminography tester, which can be used to scan products for poor solder joints that can't be detected in any other way. A typical manufacturer would use the device once a day, but Solectron, because it makes products for so many customers, uses it five times a day.
Manufacturing is only part of the story. Now these companies are looking to expand their businesses by taking on more of the behind-the-scenes scut work for their clients, including purchasing, logistics, and the more mundane aspects of product design and repair. In effect, they want to become operations-for-hire for tech industry leaders. ''It's no longer about making stuff cheap,'' says Nishimura. ''Now we're doing more and more high-value things.''
Here's how. Companies such as Solectron and SCI Systems Inc. are now major buyers of parts and get volume discounts that can be passed on to big and small customers alike. Contract manufacturers also help clients get their products into global markets more quickly and cheaply because they have facilities around the world. Solectron, for example, has 21 plants scattered around the globe from Brazil to Romania. Solectron even purchased laptop-repair specialist Sequel Inc. on May 20 so that it can fix its customers' products and return them to individual or corporate buyers in one day. In the end, figures Flextronics' Marks, his customers will want to do ''only two activities--design products and create brand.''
There's no reason for anything else. Plunging prices for PCs and other gear are forcing traditional manufacturers to outsource. Not only is a maker of a $600 PC hard pressed to amortize the cost of a factory, but it can't compete with a contract manufacturer that can keep its factory lines humming 24 hours a day. And thanks to E-commerce, customers expect suppliers to deliver custom-configured products at the lowest cost in the shortest span of time. This requires build-to-order manufacturing where products are shipped directly from factories to customers. That plays right into the hands of contract manufacturers that have spent the past five years buying plants and honing back-office logistics skills.
For proof, check out how Cisco Systems Inc. has used contract manufacturers. By electronically sharing sensitive product and sales data with Jabil, Cisco is able to ship routers and other products anywhere in the world in less than two days--without ever touching the product, says Morean. One key reason: Jabil's ''dynamic replenishment system.'' Developed from years of monitoring the production of hundreds of companies, the system analyzes several types of data--ranging from basic sales forecasts to the likely impact of upcoming product promotions--to estimate how much stock it needs to have on hand at any point.
Jabil isn't the only contract manufacturer working with Cisco. The networking giant also has a remarkable setup with Flextronics. When you purchase some low-end routers on Cisco's Web site, the order zips to Flextronics, which fills it. Only then does Cisco arrange for delivery and bill the customer. And since Cisco introduces new configurations every few days, Flextronics revamps its production to accommodate the changes. ''This is the future of the business,'' says Marks.
Even telecom's old guard is scrambling to take advantage of the Solectrons of the world. Nortel Networks Corp. announced in May that it will sell or shutter 17 of its 24 factories within the next three years, a move that's expected to save up to $300 million yearly in pretax profits. The reason why it's cheaper to outsource: Nortel runs its 24 factories at 60% utilization, while contract manufacturers typically run theirs at 80% or more. ''The contract manufacturers have developed into a very major force,'' says Nortel CEO John A. Roth.
Put it all together, and top contract manufacturers are looking at a new wave of business that should help them rival their largest customers in size within the next few years. Solectron expects to boost sales from $5.3 billion in fiscal 1998 to $20 billion in fiscal 2001. ''We're going to grow at rates that no one has ever seen for a company of our size,'' vows Mark Holman, Solectron vice-president for business development. By 2001, say analysts, 30% of electronics gear could be assembled by contract manufacturers, up from 15% today. ''By then, technology companies won't have the in-house manufacturing expertise to fall back on,'' says analyst James Savage of Thomas Weisel Partners. ''So contract manufacturing will continue to outperform the overall high-tech market, with lower risk.''
Of course, there's plenty that can go wrong. The biggest risk: Contract manufacturers could get too big for their britches. Already, some customers worry that they will get distracted from basic manufacturing as they expand into new disciplines such as purchasing, logistics, and repair. And with a multiyear glut on many kinds of high-tech components winding down, contract manufacturers will have to prove they can get parts to satisfy all their customers when supplies get tight. Says one veteran chip distributor: ''They're hitting .320 for April, but we're going to have to wait until next year to see if this is a fad or a major trend.''
One looming problem: conflicts with their customers and suppliers. Solectron and Ingram Micro Inc. recently formed a venture to sell their own low-end PCs. Some in the industry think other PC makers--who also sell their machines through distributor Ingram--may perceive the move as unwelcome. ''We see that as competition,'' says Michael A. Braun, general manager of IBM's Consumer Division. While Braun is mum, analysts say PC makers may become reluctant to give Solectron business.
What's more, distributors who now provide contract manufacturers with components are trying to offer the same inventory management and logistics services to customers that contract manufacturers want to deliver. Distributors think contract manufacturers will have a hard time making progress on that turf. ''They're worse at managing inventory than their customers,'' says a distributor.
For all the risks, contract manufacturers' reign as Wall Street darlings seems far from over. The number of analysts covering the industry has doubled in the past year. And since the fortunes of the top contract manufacturers are tied to some of the most progressive, well-managed tech companies, buying their shares is like buying into a hot-growth mutual fund. Says Morgan Stanley Dean Witter analyst Shelby Fleck: ''An investment in an electronic manufacturing services company is like buying into a Who's Who in high-tech.'' Then again, maybe it's time to add the contract manufacturers themselves to that list.
By Peter Burrows in Milpitas, Calif. |
