Caution! Economic downturn presents new set of challenges to EMS, OEM electronics buyers
For electronics buyers, tough economic times require close scrutiny of chip, passives and other suppliers. Here's how some buyers are managing risk.
By James Carbone -- Purchasing, 1/15/2009 2:00:00 AM
The financial crisis and economic slowdown in the electronics industry will pose both challenges and opportunities for electronics industry buyers in 2009.
Perhaps the biggest challenge: managing supplier risk and guaranteeing continuity of supply for the production line.
Among the opportunities: potentially more business for those EMS providers left standing after OEMs reduce suppliers, and lower costs for the OEMs, which will see more competition from EMS providers for their business.
First, the risks. If a supplier fails, it could mean a line shutdown for an OEM or electronics manufacturing services (EMS) provider. That's why buyers need to go over their suppliers' financials with a fine-tooth comb to make sure the supplier will remain viable. Obviously if a supplier is in trouble, an alternative must be found and quickly qualified.
"There is no question that in today's environment, we have to make sure our suppliers are financially stable," says Jon Allen, director of global sourcing for EMS provider Benchmark Electronics in Angleton, Texas. "That is a challenge for any EMS provider, but especially for a high-mix, low-to-medium-volume company like us. We have several thousand suppliers."
It's not just EMS buyers who will be checking the financials of suppliers. OEM buyers also need to review the business practices and financial performance of their EMS providers to make sure they are solvent.
Buyers at OEMs and EMS providers routinely review and evaluate the performance of their suppliers during downturns and when business is booming. However, this downturn is different and requires greater supplier scrutiny.
"This is a unique slowdown. It is not a typical supply/demand situation. It involves the banking crisis," says John Boucher, executive vice president, supply chain management solutions and chief procurement officer for EMS provider Celestica in Toronto.
As a result, Celestica has changed its processes "to be more dynamic in looking at the financial health of our supply base. In the past we looked at our suppliers' financials every quarter. Now we are looking at them every month or every week," says Boucher.
He says Celestica buyers are focusing on the viability of the suppliers, making sure they are financially healthy and have a good balance sheet and "are going to be here for the long haul."
Who's yellow?
Boucher says since September a number of Celestica suppliers are having financial issues. He says Celestica has a "stoplight" ranking for suppliers. "Green-light" suppliers are healthy and Celestica awards them new business. "Yellow-light" suppliers have some problems that require involvement by purchasers. "Red-light" suppliers are in trouble and Celestica has stopped awarding business to them.
"So far we don't have any reds, but we have a whole bunch of yellows, meaning they are on watch," he says. "We have to keep an eye on them."
Boucher adds that Celestica has more yellow suppliers right now than in the past and due to the financial crisis. He says most of the suppliers are based in North America and are feeling the effect of the credit crunch.
Celestica buyers also do risk assessments on bills of materials (BOMs) to see if any suppliers listed pose a problem. Boucher adds that OEMs often ask Celestica for the results of BOM risk assessments. "They are doing that more than ever," he says.
"We are getting asked more and more to help OEM customers identify any supply exposure to risk because of the financial crisis," says Boucher.
While Celestica and other EMS providers are doing BOM risk assessments and pouring over the financials of component suppliers, OEM buyers involved in outsourcing decisions are doing the same with their EMS providers. They want to make sure their EMS suppliers will make it through the downturn.
Cutting suppliers
Now for the opportunities. OEM buyers may change or tweak their outsourcing strategy. For instance in an effort to reduce cost, some OEM buyers may consider reducing their number of EMS providers because of fewer orders for the OEM equipment. So an OEM with four EMS providers may decide to get along with three external manufacturers because it means fewer buyers will have to be dedicated to managing EMS suppliers, resulting in cost savings.
In addition, the remaining EMS providers get more business and the OEM can demand lower prices because of increased volumes award to the EMS suppliers.
"But OEM buyers need to think about flexibility in their supply base," says Charlie Barnhart, co-founder and president of Barnhart and Associates in Maui, Hawaii, a consultant to OEMs on EMS issues. Decreasing the number of EMS providers results in less flexibility, and in a downturn, flexibility is often needed.
In a downturn there is a chance that an EMS provider may fail and file for Chapter 11 bankruptcy. If that happens, the OEM may have to qualify another EMS provider, which takes time. If an OEM cuts its number of EMS providers from four to three and one of the three fails, the remaining two may not be able to handle the extra work.
Barnhart notes that OEMs tend not to have the same EMS providers build multiple product families. "They tend to break up their needs into buckets. They will give one family of product to one supplier and another family to another," he says.
Production line disruption is possible and an OEM may not be able to fulfill its orders.
One option for some OEMs will be insourcing. "That is one thing that OEMs can do if they have internal manufacturing capabilities somewhere," says Barnhart. "As demand goes down, they pull work out of the EMS industry and put it back into their own plants to keep the plant full," he says. Barnhart says Alcatel-Lucent has done that at its Shanghai facility.
Using capacity
Because of the downturn, unused capacity will likely be an issue for EMS providers over the next year or two because the global EMS market is expected to fall 3–5% in 2009, according to Barnhart.
"The industry cannot take a 3–5% decline in revenue," he says. "EMS providers already have a ton of underutilized capacity in non low-cost regions. What they are going to do is aggressively go after lower volume, high-mix business. They will go after small deals to try to backfill some capacity."
Barnhart says that's what happened in previous downturns. "EMS providers tend to go after every scrap of business that is available, no matter how small just to cover their fix overhead costs," he says.
That is another opportunity for OEM providers because it means EMS providers will be more likely to compete for their business, which could mean lower cost. Of course with less business, EMS buyers are looking to reduce cost as well.
Boucher of Celestica says there is always a "passion for cost reduction" in the EMS industry. "In good times you want additional cost reduction because you have larger volumes."
With a downturn it is more about asset management. Cash is king and the idea is to squeeze assets out of the supply pipeline and other elements of total cost of ownership, he says.
Cutting inventory
Boucher says reducing inventory is a priority right now. "I need my suppliers to help me come up with a better utilization of assets and to help drive cash requirements down to support the volume of my business today," he says.
The idea is to take overhead costs out and it is something that all EMS companies need to do, says Barnhart.
One way is through vendor managed inventory programs. "They are negotiating with distributors to do in-plant stores and kan-ban programs. It's actually not only with distributors but with individual component suppliers," says Barnhart. "Suppliers don't typically do that, but in tough times many are more receptive to it."
He adds EMS providers may do more e-auctions to buy parts in an effort to reduce price and attain some cost savings.
"Reverse auctions are a good barometer of the marketplace," says Boucher. "I'll strategically use reverse auctions as a marketplace finder to see if there are any surprises. I always try to develop long-term relationships with our suppliers, but you have to have the benchmark data out there."
Allen of Benchmark Electronics says cost reduction is always important to an EMS provider. "There is always an emphasis on cost reduction because that is how we attract new customers," he says. The reason OEMs outsource to EMS providers is to cut manufacturing cost, he notes.
Allen says, however, that at Benchmark during the downturn there is also a focus of "offering customers a supply chain that is robust and healthy and so we can assure them we will have a continuity of supply."
During the downturn, EMS providers will also seek more favorable terms from suppliers. "EMS companies are pushing out payables to the supply chain. If they pay in 60 days, they will pay in 89 days instead, paying just fast enough to keep getting materials," says Barnhart.
Barnhart says the EMS providers that are able to reduce their costs, maintain continuity of supply, retain OEM customers and attract new ones will survive the financial crisis and economic downturn. However, he believes not all will survive.
"This is going to be very tough time for the EMS industry," he says. "Some companies are going to fail and OEMs need to have alternatives because it is a long cycle to get out of one contract manufacturer and into another one."
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