Despite declining sales last year and sluggish growth in 2002, the electronics manufacturing services (EMS) industry is poised for another round of stellar growth as EMS sales revenue nearly double by 2005.

The weak economy will mean the industry will only grow about 3% this year to $104 billion. In 2001, EMS revenue dropped to $101 billion from $106 billion in 2000. However, the industry will resume annual double-digit growth and revenue will top $201 billion in 2005, according to market researcher Technology Forecasters Inc. (TFI). The underlying reason for that healthy growth is that the EMS industry has proven it can manufacture for less than the OEM.

But future growth won't just be due to growing demand for manufacturing services. OEMs are increasingly turning to EMS partners not just to manufacture boards and systems but for design and repair services as well.

"Customers have come to us and said 'Flex, you are vertically integrated, you have boards, plastic, you do enclosures, you have commodity management, design engineering. We are going to turn more of that activity over to you,'" says Steve Marston, vice president of supply management at Flextronics, a leading contract manufacturer.

Big OEMs came to realize that manufacturing was not a core competency of theirs as many products become commodity type products, says Marston. "PCs are a good example. You saw more and more outsourcing, not only manufacturing, but design activities with respect to desktops and notebooks. Many OEMs are moving away from the design," he says.

Consequently many EMS providers have beefed up their engineering staffs to help OEMs design products. In some cases they offer original design manufacturing (ODM) in which the EMS provider designs a product from intellectual property that they own or license and build it for the OEM. Increasingly EMS providers are handling call center and repair services for the OEMS.

In addition some OEMs are taking outsourcing to the next level and are turning to EMS providers to handle strategic sourcing of commodities especially as more OEMS and suppliers become more global and move to China and other low cost Asian countries.

The growth in the capabilities of EMS providers further enhances the EMS model and will help drive future growth. Companies that have outsourced some manufacturing to EMS providers will outsource more and OEMs who have never outsourced will turn to EMS providers for the first time.

"The EMS model has proven itself," says Eric Miscoll, chief operating officer of TFI. "Once an OEM moves in that direction, it doesn't reverse the trend. OEMs don't have the money to invest in establishing in-house manufacturing," he says.

Much future growth in the EMS industry will be driven by increased demand for box build. "With printed circuit board assemblies (PCBAs), OEMs already outsource 80-100% of their PCBAs," says Miscoll. However, OEMs outsource only about 50-70% of their box build and they say they want to outsource "a higher percentage of their system builds as soon as possible," says Miscoll. "OEMs who already outsource are looking to outsource more completely."

In the past, standard commodity products such as desktop computers, notebooks and cell phones were outsourced. High-end equipment such as semiconductor equipment was built in house.

Now even semiconductor equipment companies are starting to use EMS providers. "Because those products are complex and have low volume and a high mix of parts, the argument was those products should not be outsourced. But now those companies are looking actively at the outsourcing model to derive the benefits. Outsourcing is moving up the food chain," says Miscoll.

One of the benefits that some OEMs are looking for from EMS providers is strategic sourcing. "Increasingly OEMs are asking us what can you do for us from a sourcing point of view," says Andrew Gort, vice president of supply chain management for Canadian contract manufacturer Celestica. "They can do strategic sourcing themselves in the Americas, but not in China or Southeast Asia. OEMs will tell us 'you guys have the infrastructure can you manage this for us?'" says Gort.

He says Celestica has commodity buyers, component engineers and mechanical engineers in the Americas, Europe and Asia. "Most OEMs don't have that infrastructure that they can deploy," he says.

OEMs are looking to outsource strategic sourcing of commodity ICs, passives, interconnects and mechanicals, says Gort.

"The dividing line is something like an application specific integrated circuit (ASIC) that is core to the function of the product or a proprietary part that is designed in by the customer. They would keep that close to the vest," he says.

However, some companies don't believe they will get an edge by outsourcing strategic sourcing to their EMS partners. "Many OEMs feel they can get the same or better pricing than EMS providers which in some areas is true," says Marston. "EMS guys aren't always going to get the best prices. For custom components OEMs can get better pricing."

"The challenge we have in EMS is to show the value of global procurement that we bring to the OEM," says Marston. "We can support our customers by leveraging our volumes and our relationships with suppliers."

However, whether a company outsources strategic sourcing or manufacturing ultimately depends on whether the company views those functions as core competencies.

"The economic challenges and market downturn have opened people's minds to think more aggressively what is core to them and what is not," says Kevin Burns, chief materials officer for Solectron, the world's largest EMS provider. "With customers that haven't been vertically integrated and expect to grow, there is no question they recognize the infrastructure and robustness that exists within the EMS sector and there is no question they are going to leverage that capability," he says.

A growing number of OEMs are leveraging the design capability of their EMS partners.

"Because of market pressure, people are open minded to design for supply chain solutions that offer more cost competitiveness, " says Burns. "EMS providers overall are getting sophisticated in terms of design and design for supply chain resources. OEMs are starting to recognize that and saying they should figure out how to leverage that," he says.

Major EMS providers have large design organizations. "We have more than 1,200 design engineers today and continue to expand that," says Marston. "In some areas we are becoming an ODM (original design manufacturer). For years we worked closely with customers on design. Now we are doing original design, too." He says Flextronics has designed a cell phone and other products that it makes for customers.

To support Flextronics' design efforts, procurement is involved on design teams, he says.

"We have people on my team who are dedicated to the Flex design organization," says Marston. "We call them strategic supply chain managers ( SSCM s). They work solely with designers, going through the bill of materials and working with them on which suppliers should be qualified," he says.

Some SSCM s work with customers on pricing and driving Flextronics strategic suppliers on the approved vendor list.

As companies outsource more, EMS purchasers will be entrusted with more responsibility in the supply chain.

"We have to focus on what we can do to help the supply chain to be more effective in a number of dimensions," says Burns. "Continuity of supply and availability are important. Cost will always be important, flexibility and liability minimization is more important than it has ever been," he says.

Solectron has implemented a number of initiatives including centralized purchasing and warehousing and eliminating "touch points" in some commodities. The initiatives should help Solectron and its suppliers reduce cost. "We expect to share the benefit," says Burns. (See story pg. 31)

Besides having more supply chain responsibility, the role of EMS purchasers will also be enhanced as OEMs outsource more. "It creates an opportunity for procurement officers at EMS providers to articulate to upper management about how strategic purchasing impacts the bottom line," says Gort.

"Procurement officers have a direct influence in terms of asset management," he says. "They have influence on profit margins. Materials is a large percentage of a company's business. If you manage to get improvements in cost, that goes directly to the bottom line or enables the company to offer more competitive cost in the marketplace. If you articulate how you impact the finances, you will become a more strategic part of the corporation," says Gort.