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The logic behind the concept made enormous sense when OEMs first began focusing on core competencies decades ago. Manufacturing became the main function of specialized contractors such as Flextronics, Solectron, Sanmina, Jabil, Celestica and others while OEMs like IBM Corp., instead of investing in manufacturing plants, concentrated on developing technology, leaving the assembly to the experts. In IBM’s case, electronics manufacturing services (EMS) providers in the Far East were the initial beneficiaries of this initial wave of outsourcing.
What many of these EMS providers didn’t quite understand at the time was the long-term impact of razor thin profit margins on their future. Because manufacturing had already undergone mass rationalization by OEMs, EMS companies entered the market with profit margins in the low double-digits. Meanwhile, new technologies – the latest chips, for instance – can command margins of 30 percent or more.
EMS companies have never been able to increase those margins, and a recent report by IPC – Association Connecting Electronics Industries shows some sobering trends. The Global EMS Business Report, published in July, shows that first-quarter sales were down in all regions compared to last year. According to Sharon Starr, IPC’s director of market research, year-on-year sales growth for Q1 2013 was down 3.1 percent for North American EMS companies, which was the best sales performance of the three regions surveyed. Year-on-year sales decreased more in China’s and Europe’s participating EMS companies. In North America, the smallest EMS companies (those with less than $10 million in annual sales) performed best with Q1 sales up 21.6 percent over last year.
Regarding profit margins, average pre-tax earnings for the reporting companies in North America were 3.8 percent of Q1 sales, Starr said.
I’ve been talking with a number of industry sources over the past few weeks – largely distribution companies and component suppliers – and EMS is a huge part of any company’s sales plans and forecasts. Component makers, for example, need to plan for any upside or downside forecast in manufacturing, but that data doesn’t just come from OEM customers, it comes from distributors, other sources and EMS. The problem is many EMS companies send blanket orders to component makers and don’t really break out which customer is ordering what. When components are plentiful, this isn’t a huge imposition, but during times of shortages OEM visibility is crucial to end customers.
The EMS industry has been struggling with its profit-margin dilemma for a while, and it seems nearly impossible the industry will continue to grow based on margins alone. In fact, most EMS are resorting to cost cutting: my colleague Bolaji Ojo takes an in-depth look in “EMS Providers Just Can’t Stop the Cost-Cutting.” Others have been branching out into adjacent businesses, such as product design or supply chain management. Both of these services begin to infringe on the core of other businesses, though: customers, because OEMs still design products; and distributors, longtime experts on managing the supply chain. Both strategies make sense – EMS companies have to grow like any other organization – but by doing so they move farther away from pure-play manufacturing and begin to look more like an OEM.
One of the expansion models that seem to make sense right now is the after-market focus of companies such as Jabil, which is a leading service provider to Lenovo, now one of the top PC manufacturers. Jabil, through partnership with UPS Logistics, maintains caches of MRO (maintenance, repair and operations) components around the globe and deploys service technicians to repair products. Flextronics has also taken on service and support for many of its customers.
IHS iSuppli’s EMS expert, Thomas Dinges, also has a suggestion: drop the ‘E” from EMS. “Over the past few years, there have been a number of transactions by EMS companies to move into areas outside of electronics but bearing similarities along products, markets and customers,” Dinges writes. “The most recent example is Jabil’s agreement to acquire Nypro, a manufacturer of plastics manufacturing solutions that serves industries including the electronics segment. (See: Taking the “E” Out of EMS).
Another strategy is to move more into the “S in EMS”— i.e., to make a large investment in services. Such services could entail repair, logistics and field provisions,” Dinges concludes.
No one is saying that the EMS industry’s time is limited: the runaway success of Foxconn defies that argument. What I am saying is that EMS companies are going to be hard-pressed to find additional streams of business without stepping on somebody’s toes.
Barbara. This was very well written. I was wondering if that 21.6% in EMS here, might be due to quick turn prototypes engaged mostly by R&D in the US. I know that Advanced Circuits, PCB fabrication house, has branched out with their own assembly operation and I used them on my last two consulting jobs where I had the PCB fab house side of the business just forward the prototype boards to their assembly side. It is a well run company for both services and their growth has been substantial. I have always been hesitant to send low quantity, new boards overseas for assembly operations. So, is most of that 21.6 percent expansion due to an uptick in R&D here in the states? I’ll take my answer off the air.
Hi Douglas–good question. I think we might be seeing the result of re-shoring that we have been hearing about. Initially this will be the small-lot and prototyping that never really migrated, but companies are finally ramping up production onshore because they finally rationalized the costs. There are also the markets that are heavily regulated, such as medical, where onshore manufacturers have gone through the qualification process that is hard to duplicate across the globe. The question mark is mil/aero. There might not have been a dropoff because projects were already in the pipeline pre-sequestration. We might see that impact next year, but hopefully that will be offset by more re-shoring.
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