Growth means more consolidation, more services

By By James Carbone -- Purchasing, 10/19/2000

Major contract manufacturers often tout their soup-to-nuts manufacturing services. Companies such as SCI Systems, Solectron and Celestica can build everything from a simple cable harness to a complete high-end server or workstation.

It's no secret that OEMs have recognized contract manufacturers' (CMs) capabilities and are outsourcing an increasing amount of production to contract manufacturers. Proof: Electronics contract manufacturing is forecast to grow from $78 billion in 1999 to $260 billion in 2004, a 28% compound annual growth rate (cagr), according to market researcher Technology Forecasters. During the same time, the electronics industry is expected to have a cagr of about only 8%.

That growth is having a big impact on the industry. It is resulting in more consolidation. To satisfy the growing manufacturing needs of OEMs, large CMs are acquiring smaller manufacturers as well as the manufacturing facilities of OEMs. CMs also are finding there is growing demand for them to provide supply chain management and purchasing expertise to customers in addition to leading-edge manufacturing.

The growth of the CM industry will be driven by OEMs, which currently outsource some manufacturing, using CMs even more in the next several years. For instance, a computer OEM that only outsources a printed circuit board may decide to use a CM to build the entire system. In addition, growth will be fueled by OEMs, which have never outsourced before, deciding to use contract manufacturers for the first time. Large CMs will see additional growth from acquisitions.

"I see ongoing rapid organic growth and growth through acquisitions in the top 10 and that will continue for three or four years at least," says Andrew Gort, senior vice president global supply chain management for Celestica in Toronto. He says driving the growth is the fact that more industries are using contract manufacturers. "The first wave was computer and the second wave is telecom. Other industries, perhaps medical instrumentation, will follow," says Gort. He adds that growth is spreading by geography. "First it was North America then Europe and Asia."

While the CM industry will have a 28% cagr for the next several years, there is huge potential for growth for years after that. Reason: Most manufacturing is still done internally by OEMs, says Eric Miscoll, chief operating officer for Technology Forecasters.

He estimates that the contract-manufacturing penetration rate of OEM manufacturing is only 13% this year. "We look at the total available market which we define as the total cost of goods sold by the OEM," says Miscoll. "We take the overall revenue of OEMs and the cost of goods is usually about 68%. That, in theory, is the total available market for contract manufacturers," he says. Liberal estimates say that CMs can capture up to 80% of the available market.

While computers may have been the first industry to use contract manufacturers, the computer industry still represents huge potential for the CM industry. Computer OEMs can still outsource more than they are and new products being developed can be outsourced. "What are the devices in the future that will be attached to the computer?" asks Miscoll. "That is an area where there may be a new wave of outsourcing."

Currently, wireless telecommunications equipment is fueling CM growth as many cellular phones are built by contract manufacturers. That trend will continue for years to come.

However, the industry that represents the largest growth potential for contract manufacturers is consumer electronics.

"We track 10 industrial sectors," says Miscoll. "Consumer electronics by dollar volume is the lowest in terms of using contract manufacturers, but overall worldwide production is the largest of the 10 sectors. When you look at the contract manufacturing that is done in that sector, it is tiny," he says.

As CMs grow their revenue and expand their customer base, they will offer more design services, final system integration, design and logistical support.

"The final system piece is something where the OEMs want functional testing," says Miscoll. "Whole final-system integration is something more CMs are developing because OEMs want that."

What price growth?

CM industry growth is having a major impact on contract manufacturers' operations. To satisfy OEM manufacturing requirements, CMs are expanding their manufacturing capabilities, often acquiring the facilities of OEMs, for whom they are now building products, or other contract manufacturers. In fact, while consolidation in contract manufacturing is not new, the rate of acquisition seems to have increased over the past year. For instance, Solectron has announced a number of facility acquisitions including IBM facilities in Brazil, Nortel plants in Europe, an Ericsson facility in Europe and the acquisition of Bluegum, an Australian contract manufacturer. SCI acquired contact manufacturer EOG and a manufacturing facility of ECI Telcom in Israel.

Celestica acquired Bull Electronics, a contract manufacturer, as well as NEC plants in Brazil and IBM facilities in Italy.

Wanted: experienced purchasers

While CMs are expanding their manufacturing capabilities, they are also finding they need to expand their supply chain management and purchasing expertise. As CMs handle more manufacturing for OEMs, often they are handling the purchasing of parts, commodity management, and sometimes overall supply chain management involved in the manufacturing of the product. In fact, some contract manufacturers are marketing their supply chain management prowess. Example: Solectron bills itself not as a contract manufacturer, but as a supply chain management "facilitator."

To handle purchasing, commodity management and supply chain management for OEMs, many CMs have invested in the latest and greatest software so critical information about designs, build schedules and inventory can be sent in real time among OEMs, CMs and suppliers. However, CMs are also finding that they need experienced purchasers to manage relationships with OEMs and suppliers.

"I'm finding more and more that I need seasoned purchasing professionals and not commodity gurus," says John Boucher, vice president of global supply chain management for Manufacturers Services, Concord, Mass. "We need business managers to manage across multiple companies. In contract manufacturing, we deal with suppliers, my internal manufacturing and my customer's OEM teams. The teams require a businesslike figure in purchasing commodity space. It's a broader business dynamic and we need someone with a broad perspective. The CM space is demanding that we have more experienced purchasing management-type professionals," he says.

While CMs need experienced procurement business managers, they also need buyers who handle the day-to-day purchasing as well as materials planners. In fact, many CMs have dedicated teams for OEM customers.

"The day-to-day execution, which is the accepting of orders and working with customers on their plans, the scheduling of lines, placing material orders with suppliers is done by customer-focused teams at the sites," says Gort of Celestica. "Those teams include buyers, material planners, expediters, warehousing staff, shipping and receiving. If the customer is large, there may be two or three teams for each division. For smaller customers, there may be two or three customers per team."

Celestica has also set up a global organization to handle negotiations with suppliers for customers who want the contract manufacturer to take charge of negotiations. Gort estimates that Celestica handles 80% of the part numbers for OEMs. However, OEMs often maintain control over high-dollar item parts such as asics, microprocessors and memory.

Celestica has a supplier engineering organization that does failure analysis of components. "We also have a global war room where every location every day comes in with the parts they can't get and we resolve them on a global basis," says Gort. "All of this is under the supply chain umbrella. Purchasing is part of supply chain management," he says.

Integration needed

OEMs want CMs to provide manufacturing and supply chain services globally in an integrated fashion. "OEMs are saying they don't want to deal with Celestica in three geographies as if we were three separate companies," says Gort. "OEMs say 'I don't want to deal with little fiefdoms. I want you to have an integrated process for me across the globe. I want to be able to release my product in one location and I want you to get production up and running in multiple geographies with the same standard part numbers, share the inventory planning among those locations'" says Gort.

Such an integrated process is also necessary because product life cycles are shortening and new product introductions are quickening.

There's a greater need for collaborative dynamic electronic linkages between OEMs, contract manufacturers and suppliers, says Gort. Such linkages are needed for product design and release, supply planning and configure-to-order.

The linkages communicate engineering changes that may occur with a new product or changes in build schedules so everyone in the OEM's supply chain is informed in real time.

"The idea is if an OEM customer has a major change in demand for a product, we see that change in a day as well as key suppliers and we can quickly figure out if we can support the change," says Gort. He says Celestica uses supply chain software from I2 for this.

Using Web-based product development management tools will be key to managing the supply base as contract manufacturers grow their businesses, says Boucher of Manufacturers Services. Such tools that use Web portals to gain technical and end-of-life data about parts are growing in importance because of shrinking product life cycles.

"If we get a bill of materials (BOM) with 100 items on it and 75 of them are near the end of product life cycle, those parts need some immediate attention from the buyer," says Boucher. "Ten months ago we would have to take action on a part-by-part basis. With these tools we can do it with the BOM."

PDM tools will be helpful in the quoting process. "We want to know what we are getting into before we accept an order from a customer," says Boucher. "We want to go to a customer and say 'for this bill of material, 10% is going to require a significant amount of work. We can identify those issues at the point of entry so it puts everything on the table and there are no surprises," he says. A surprise may be that a BOM part will soon be obsolete, which could result in delays in the building and shipping of a system.

More business, fewer suppliers

While enterprise software may help CMs manage their supply chain, it won't alleviate tight supply conditions that the entire supply chain faces. To guarantee a steady supply of parts, purchasers at CMs are continuing to build relationships with suppliers of key components such as memory, capacitors, logic and connectors. And while contract manufacturers use many suppliers because they often pick up the suppliers of their OEM customers, they are trying to steer more business to fewer suppliers. In other words, the 80-20 rule holds, where 80% of business is directed toward 20% of suppliers.

"We want to focus our spend with more key suppliers," says Jim Sutherland, vice president of supply management for SCI Systems. "We are seeing constraints. So far we have worked through them and have been able to keep our heads above water because of the relationships we have with suppliers," he says. SCI is consolidating more business with suppliers so it has become important to key suppliers.

Further strengthening of relationships with suppliers and building new ones will be important to support the growth the industry is seeing, according to Sutherland.

Celestica's strategy is also to concentrate more business with fewer suppliers and to sign long-term agreements with suppliers. "You can't do business with everyone in the world," says Gort. "We have preferred suppliers. We try to have long-term relationships. With high-volume commodities we might have six suppliers, somebody from Europe, Asia and North America. We try to negotiate on a global basis because customers want us to be global."

Ironically there is some vertical integration occurring in contract manufacturing because of supply concerns. Some CMs have purchased supplies of key components. Case in point: Sanmina recently bought board-maker Hadco and Flextronics purchased DII, another board manufacturer.

But not all CMs are convinced that's the way to go. "The printed circuit board industry is not known for great returns," says a purchasing executive at a major contract manufacturer. "There's a chance that the board supplier may take down your financial performance. What you can achieve through virtual integration might be better than from outright owning it," he says.

Another possible trend that buyers should keep an eye on is the investment of OEMs in contract manufacturers. Motorola has taken an equity share in Flextronics. Miscoll says this could have an impact on the supply chain. "Do other contract manufacturer have the same opportunity to get Motorola's business?" he asks. What about buying semiconductors from Motorola? The party line obviously is they treat everybody fairly, but you have invested in your partner and the relationship is now more strategic than a simple vendor relationship," says Miscoll.