Expect double-digit growth — again

The links between OEMs and electronics manufacturing services providers are tighter than ever.

Staff -- Purchasing, 1/13/2005

Despite slower growth rates in end-equipment markets and competition from original design manufacturers (ODMs), the electronics manufacturing services (EMS) industry will grow 13% to $123 billion in 2005.

That's a lower growth rate than the 20% dollar volume growth in 2004, but still a healthy increase in view of last year's high rate. The drivers: more outsourcing by OEMs of their manufacturing and a growing number of end-market segments—which have not previously done much outsourcing—turning to EMS providers to handle more manufacturing.

One reason why buyers are continuing to shift more and more manufacturing to EMS providers is that more EMS providers are moving closer toward the ODM model by offering more design services and being more flexible in the types of services they provide. Buyers can also expect EMS providers to handle more post-manufacturing services such as repair, recycling and reclamation services.

"OEM customer expectations are continuing to get significantly more demanding," says Kevin Sachs, vice president of strategic marketing for Solectron. "They don't look to their EMS partner just to do manufacturing. They want us to provide more value-added [services such as] design and customized supply chain solutions to make sure that material and information flow processes are in place and [that they] meet the OEM's customer requirements."

To address the need for design, Solectron uses a collaborative design approach in which Solectron designers work with the OEM design engineers in developing a new product. "We focus on relatively rich intellectual property (IP) products [because] we need to have a design capability that is as good as or better than the OEM's and [have it done in a way that] we are not looking at owning the IP or looking to compete with customers."

While there is growth in demand for design services, there is also a huge demand for post-manufacturing services such as repair and reclamation because OEMs want their EMS partners to handle repair center operations. And, if a product can't be repaired, OEMs want EMS providers to both recycle materials and arrange the disposal of materials that can't be recycled.

"We will need to understand what's [inside] many products and the logistics of moving [those materials] from point A to point B," says Dan Shea, chief technology officer for Celestica.

That greater dependence on EMS providers will translate into strong growth in 2005. "We are expecting 12% to 15% growth in 2005," says Sachs. "It will be slow in the first half of the year, but we expect a strong rebound in the back half of the year," with demand the strongest for mobile handsets, computers and communications equipment.

"In the outsourcing business you get growth because end-market segments are growing and because companies are increasing their rates of outsourcing," says Sachs. "We expect the underlying market to grow by 5% to 7% and the rest of the growth [to] come from increased rates of outsourcing" from traditional EMS users such as computers and communications and industries such as industrial, medical, automotive segments, which are beginning to use EMS providers more.

To identify what OEM customers truly want, some EMS providers are offering consultative services. "EMS companies have traditionally tried to sell OEM customers services that EMS companies had versus what the OEM customers needed," says Celestica's Shea. "[With] consultative services, you go in and try to understand the problems that customers are trying to solve, put in place the capabilities that are needed," and work collaboratively with the OEM on solutions.

The initial engagement, he says, is more consultative in nature with "C" level senior executives such as chief operating officers and often reveals that an OEM is looking to lower their supply chain cycle time, reduce product costs or to increase flexibility in the supply chain. After the initial consultation, Celestica works with functions such as engineering or supply chain management on a potential solution.

Just one example: To help reduce product cost, Celestica recommended the OEM change a raw board manufacturer and that it re-lay out a board making it smaller. By doing so the board could be used in other products and the OEM could reduce cost.

Because OEM customers are demanding more from their outsourcing partners, more EMS providers are beefing up their design capabilities and taking a close look at the ODM industry because ODMs are strong in design and, in many instances, take away EMS business.

(EMS providers have traditionally built a product for an OEM and assisted them in enhancing the product so it can be manufactured cost effectively.)

By contrast, ODMs—which are mostly in Asia and typically build cell phones, low-end computers and some consumer electronics equipment—will design a product (using its own design or intellectual property (IP) that it has licensed), manufacture the product, label it with the OEM's name and ship it to the OEM's customers.

Sometimes, they sell the same product to multiple OEMs; other times, they will build a product using an OEM's design or licensed IP. They will also just design a product with the manufacturing done by an OEM or an EMS provider.

"You can go to an ODM, just buy their design services and have it manufactured somewhere else," says Eric Miscoll, chief operating officer for market researcher and consultant Technology Forecasters. ODMs will also offer EMS-type services in that they will just manufacture and not do any design work on the product if that's what the customer wants.

Although the ODM market is smaller than the EMS market, its growth rate is higher. For instance in 2004, the EMS industry grew 20% to $109 billon. ODM revenue grew 25% to $59 billion. For 2003 to 2008, ODM is projected to have a compound annual growth rate of 19.5%, compared to the 14.6% projected compound annual growth for EMS providers over the same timeframe.

A lot of ODM growth today comes from high volume low-cost products such as low-end cell phones. However, in the future ODMs may move up the electronics food chain.

"ODM business is the low-hanging fruit," says Miscoll, who points out that 80% of its cell phone handset revenue, for example, comes from "dumb" (low-end) cell phones. High end equipment and industries such as medical, military and aerospace, says Driscoll, favor EMS providers and don't use ODMs.

But OEM buyers need to stay alert to a growing trend for ODMs to move into "brand manufacturing, says Miscoll. "It's really OEM, but they don't want to call it that because they are competing with OEMs." An example: Ben Q, an ODM based in Taiwan, was # 2 in cell phones in Taiwan with their own brand and Motorola—which Ben Q makes—was #1.

Miscoll, however, thinks it is unlikely that EMS companies will ever compete with OEM customers. For example, he says, Flextronics, the top global EMS provider, has an ODM program in which it has designed and manufactured a cell phone that can be sold to multiple OEMs. "But [it] won't come out with a Flextronics phone and compete with its cell phone customers."

"The next year will be interesting," adds Miscoll. "Outsourcing is going through a change. EMS and ODMs are converging. To ODMs, it doesn't matter if I am building to your design or to mine. Money is money and they'll do the deal either way."

The bottom line is while the two industries may be converging, OEMs don't necessarily want EMS providers to morph into ODMs, but they do want them to have strong design capabilities.