Guns For Hire -- Contract Manufacturers Are Expanding
Their Scope, Services
Warren S. Hersch & Joseph F. Kovar
New York -- Call it the virtual corporation.
Spurred by intensifying competition, the need to reduce manufacturing costs
and speed product time to market, computer makers and other OEMs are
increasingly outsourcing much of what they formerly produced internally:
everything from printed circuit boards (PCBs) to motherboards and chassis.
Profiting from this hub-and-spoke strategy is a class of companies whose
fortunes and market reach have risen dramatically in recent years: contract
electronics manufacturers, or CEMs.
Industry trackers bear out the trend. Technology Forecasters Inc., Alameda,
Calif., forecasts worldwide CEM revenue will grow from $89.6 billion in
1998 to $178 billion in 2001, representing a 25 percent compounded annual
growth rate.
"The [industry's] growth is unstoppable, irreversible," said Sean Kenney,
marketing director for NatSteel Electronics Ltd., a Morgan Hill, Calif.-based
CEM.
Riding the crest of the expansion are industry behemoths generating billions of
dollars annually. In 1997, SCI Systems Inc., the largest CEM, achieved
revenue of $5.7 billion, a 27 percent increase over $4.5 billion for 1996.
Solectron Corp. garnered $3.7 billion last year, a 32 percent rise over its $2.8
billion in 1996.
Privately held Celestica Inc. attained more than $2 billion last year, while Jabil
Circuit Inc.'s 1997 total was $978.1 million, a 13 percent increase over its
$863.3 million total in 1996.
Outsourcing by computer-related OEMs contributed to an estimated 43
percent of industry revenue in 1996, according to a 1997 report of the
Assembly Marketing Research Council (AMRC), a unit of the Institute for
Interconnecting and Packaging Electronic Circuits, Northbrook, Ill. The
AMRC expects that figure to rise to 52 percent by 2000.
"Computer makers have been at the vanguard of the move to outsourcing,"
said Bob Donahue, chief financial officer and executive vice president of
Manufacturing Services Ltd., a Concord, Mass.-based CEM. "That trend will
continue."
What's more, the channel also is looking to outsourcers.
In June Ingram Micro Inc. announced a deal with Solectron Corp. to perform
final assembly of PCs, servers and related products for the distributor.
"We will see more of [such deals]," said NatSteel's Kenney. "Very definitely."
"There's a lot of copying behavior in this industry," said Charles Mullen, a
senior industry consultant at Technology Forecasters. "It wouldn't surprise me
if other large contract manufacturers and distributors pursue partnerships."
However, one CEM executive, who asked not to be named, said such
alliances lack the necessary incentives. "We've talked to a number of channel
companies," he said. "But we haven't found a way to make [such deals] work.
You can't make money doing it."
Still, outsourcing's rise is evident not only in the industry's spiraling revenue,
but also in contract manufacturers' proliferating services, industry sources said.
Starting with assembly of PCBs and other components, many of the industry's
largest players now boast whole system builds; product design, testing and
engineering; packaging; distribution; and other services.
Second- and third-tier contract manufacturers also are expanding offerings
from computer component assembly to system builds.
"We make motherboards and enclosures for desktop computers," said
NatSteel's Kenney. "The next step is to integrate all this."
CEMs have secured these new offerings, said experts, in part by building or
upgrading operations centers to add capacity and expertise. Also fueling the
growth of service-in some cases, more than half of it-is an aggressive
acquisition strategy many within the industry have adopted.
For example, Toronto-based Celestica, IBM Canada Corp.'s former
manufacturing arm, has acquired Hewlett-Packard Co.'s Embedded Systems
Operation in Chelmsford, Mass.; HP's Workstation Systems Division and
PCB assembly plant in Fort Collins, Colo.; and HP's systems assembly
operation in Exeter, N.H. Celestica also announced in July that it acquired the
Chippewa Falls, Wis., printed-circuit assembly operation of Mountain View,
Calif.-based Silicon Graphics Inc. Celestica also acquired Analytic Design
Inc., Santa Clara, Calif., in May. Analytic Design's services include
engineering design; PCB layout and documentation; Design for Manufacturing
(DFM) review, planning and purchasing; prototype and turnkey production
assembly; and test and after-sales customer service. Last week Celestica
announced it acquired Accu-Tronics Inc., Raleigh, N.C.
Solectron Corp. now owns and operates IBM Corp.'s electronic card
assembly, PCB assembly and test operations in Charlotte, N.C., and the
computer giant's electronic subassembly division in France. Jabil Circuit also
purchased the PCB assembly operations of HP's LaserJet Solutions Group
Formatter Manufacturing Organization in Boise, Idaho, and Bergamo, Italy.
"Probably 30 [percent] to 40 percent of our revenue has been achieved
through acquisitions," said Michael Marks, chairman and chief executive of
Flextronics International Ltd., San Jose, Calif. "To be a player in this industry,
you have to gain size."
Often, when a CEM purchases facilities from an OEM, that OEM
immediately becomes a customer for products manufactured on production
lines it just sold.
For instance, when Solectron purchased IBM's Charlotte facilities, the two
signed agreements for Solectron to provide PCB assembly services to IBM in
North America for the next three years. This includes logic and network
interface cards for many of IBM's high-end and midrange mainframes as well
as PCs.
Also motivating the buying spree is the desire to expand globally, observers
said. Many of the industry's key players-SCI Systems, Solectron, Flextronics,
Celestica and others-now have operations throughout the Americas, Europe
and Asia.
Along with such far-flung plants come greater economies of scale, lower costs
and the ability to balance production among varied product lines and locations
as seasonal and macroeconomic conditions require, said Flextronics' Marks
and others. That flexibility, they said, limits contract manufacturers' exposure
to potentially costly economic downturns that can leave OEM plants idle,
underused or producing insufficient quantities when there is excess demand.
"PC manufacturers want to turn production on and off as needed, but they
can't do that if they own the [manufacturing] facilities," said NatSteel's
Kenney.
"If [vendors] decide to manufacture internally, they can still use contract
manufacturers to supplement their production or to act [on] an overflow [if
orders exceed their capacity]," said Matt Knight, director of sales and
marketing for contract manufacturer Plexus Corp., Neenah, Wis.
HP's Consumer Products Group, for instance, which is responsible for digital
imaging products, uses CEMs to produce nearly all its inkjet printers
worldwide. The Palo Alto, Calif.-based company designs its inkjet printers
around a limited number of chassis. Once HP has proved they can be
produced in volume, it outsources their production to various CEMs
worldwide, depending on local market needs, said an HP spokesman.
There are other benefits. Outsourcing, industry experts said, frees computer
makers and other OEMs to cut investments in new plants and equipment and,
in turn, shift capital resources to core competencies such as marketing;
research and development; building channel relationships; and, if a
manufacturing capability is retained, narrowing it to high-end systems builds.
HP, for example, has significantly cut back or eliminated in-house
manufacturing of cases and other computer components, most notably PCBs.
This has enabled the company to refocus resources on advanced design and
manufacturing, said a company spokesman.
Despite CEMs' capabilities, resistance to outsourcing continues, particularly
among companies with a long manufacturing history, industry executives said.
Some question a CEM's ability to do anything more than component
assembly. At other vendors, assembly-line employees or managers may fear
for their jobs.
One common scenario is the OEM cuts a manufacturing plant in half, allotting
one part to a contract manufacturer for, say, PCB assembly, and reserving the
other half for high-end jobs such as assembly of workstations and servers.
Sometimes, the key issue is the volume of products to be produced, said
executives.
"Certain technologies and volumes are not good for outsourcing," said Bob
Fernander, vice president of PC products in small to medium businesses for
North America at Compaq Computer Corp., Houston. "For our Himalaya
mainframes, the volume is too small, so every system is custom-built. In other
cases, we do subassembly of boards made by us or by others.
"Manufacturing is still a core competency for us. We see no end in sight to
this," Fernander said.
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