Electronics industry eyes Eastern Europe
Despite the lack of a viable local supply base, Eastern Europe is becoming an important source for low-cost electronics manufacturing services. One strategy: bring suppliers with you.
By James Carbone -- Purchasing, 2/16/2006
Eastern europe is emerging as an alternative to China for electronics manufacturing. And, as electronics manufacturing services providers (EMS) build a supply base there, OEM buyers may soon follow.
Labor rates in Eastern Europe may not be as low as China, but the distances electronics equipment needs to be shipped to Western Europe are shorter, resulting in less freight cost and a lower total landed cost. Many EMS companies have operated in countries like Poland, the Czech Republic and Hungary for a number of years. Like a magnet, though, lower costs are drawing many EMS providers further east into Romania, Ukraine, Bulgaria and Russia. In those countries labor rates can be 70% less than other European countries. But the move east poses challenges for buyers: finding reliable suppliers that can deliver quality components on time. Often, those suppliers are not in place, so manufacturers take steps to bring them with them. To solve the supplier problem, EMS providers are deploying supplier campuses where global suppliers set up operations near an EMS provider facility. Often an indigenous supply base springs up around those global suppliers—offering sourcing opportunities for the EMS tier-one suppliers and other manufacturers. Case in point: Celestica. The EMS company is developing a supplier campus at its new facility in Romania which will be similar to the one it set up in Suzhou, China, says Art Cimento, senior vice president for corporate strategies for Celestica in Toronto. Suppliers who are in the campus service Celestica, but can sell parts to other companies as well. At the industrial park in China, there are suppliers of raw boards, connectors, cables, injection molded plastics and stampings. "That’s what we are building out in Romania. It is in a growth phase. It’s not fully deployed yet," says Cimento. Evolving suppliers Solectron is also developing a supply base in Romania as it has done in other regions of the world such as Malaysia. Bud Mathisel, senior vice president and chief information officer for Solectron, says development of a supply base is an evolutionary process. "It is like watching a biological organization develop. The first elements are the transplants from more developed areas. Familiar international names like Intel, Siemens, Philips and Motorola. Over time what happens is those companies spawn new life forms that are more local," he says. Mathisel says Solectron’s Penang, Malaysia facility is an example. The plant opened in 1991 and was Solectron’s first international site. “The facility was built on a former coconut palm oil plantation,” says Mathisel. “People who visited it then said it was a virtual jungle. Today when you arrive there it looks like a version of Silicon Valley,” he says.Surrounding the plant are facilities of big-name electronics suppliers such as Intel and Motorola. In addition, there are many local suppliers. “Over the past 14 years that we have been there, we have developed a supply base that provides us with almost everything we need to do manufacturing within a short distance,” he says. Having a local supply base is important to cut down on transportation and inventory costs, he says. Such costs can eat up any savings a company may get from low labor rates because materials represent about 85% of a product’s cost, while labor is about 8%. He says what happened in Penang is similar to what happens in other low-cost areas that Solectron and other EMS providers move to. It will likely happen in Eastern Europe. “In Romania, the supply base is coming along nicely,” says Mathisel. “It’s a chicken or egg thing. As our operations expand in these areas, so will the local supply base.” Make no mistake: EMS providers will further expand in those areas because of pressure from their OEM customers. "Eastern Europe is the next frontier for the EMS industry and people keep pushing that frontier further to the east," says Celestica’s Cimento. Of course, chief procurement officers at major OEMs say they aren’t necessarily telling EMS providers to locate in any particular country. "We give them the cost targets we need to achieve or maintain our competitive position and they decide what their strategies are," says Greg Shoemaker, chief procurement officer for Hewlett Packard, in Palo Alto, Calif. Be responsive
Ian Crawford, vice president of global sourcing for IBM, says IBM doesn’t make its decision on which EMS providers to use based on labor cost or unit cost that an EMS provider quotes. Rather it is based on total landed cost and the ability of the provider to respond to IBM customer needs. That means IBM wants its EMS providers to get products to its customers in Western Europe as soon as possible after an order is placed and to adjust its schedule when demand changes. "Cost is one thing, but you have to be responsive to customers," says Crawford. "It is easier to do when you are in Hungary than the Far East. The big advantage of Eastern Europe is the physical proximity to Western Europe, which means supply lines are shorter." Cimento agrees. Celestica manufactures for a major consumer electronics company in Eastern Europe for products sold throughout Europe. 'The company basically needs to meet market demand for the European market and can’t take the delay time of manufacturing someplace cheaper like China and having the distance to cover," he says. China may have lower labor rates, "but low labor costs can be offset by freight or inventory or mismatch of product vs. market channel demand," he says. Celestica and Solectron aren’t the only companies that see Eastern Europe as a manufacturing alternative to China for the European market. Foxcon, a Taiwanese EMS provider, has opened a large facility in Romania to service European customers. "Foxcon has recognized how important Eastern Europe is going to be because of the geographic proximity to European markets," says Crawford. Flextronics, Sanmina-SCI, Celestica and Solectron all do work for IBM in Central and Eastern Europe. Crawford says that countries that used to be described as Eastern European, IBM and other companies now describe as Central European. Those countries include Hungary, Czech Republic, Slovakia, and Poland. "When we talk about Eastern Europe we talk about Romania, Bulgaria, Russia, Ukraine," says Crawford. Shoemaker says HP has been using EMS providers in Hungary and the Czech Republic since the 1990s. "They do subassemblies, final assembly, and configuration for us," he says. Need to compete Manufacturing in Europe is moving farther east, Shoemaker says, because EMS providers have to "compete vigorously with Asia and some of the advantages in Central Europe are starting to erode vigorously. There are shortages of labor in Hungary and the Czech Republic that has tended to drive up the labor rates," he says. Even non-EMS companies are moving further east to save on labor. Eric Miscoll, chief operating officer for researcher Technology Forecasters, says Delphi has shifted some manufacturing from the Czech Republic to Ukraine for labor savings. "They were paying $5-6 an hour. The rate is $1.50 in the Ukraine," he says. But there are problems as EMS and other providers move east into Ukraine, Romania and Russia, although labor costs are lower. Besides the weaker infrastructure and relatively undeveloped local supply base, there are problems at border crossings. However, those problems will be worked out as time goes by, and EMS providers are taking a long-term approach, according to HP’s Shoemaker. "If they move east and provide manufacturing services, they will develop that local content and get support from government to improve the infrastructure," he says. "The big EMS companies have a lot of experience doing this." And what about that local content? Showmaker says HP equipment built in Eastern and Central Europe "is not product that requires significant investment. It’s things like packaging, sheet metal and plastics," he says. Darragh Knox, manager of regional materials, Flextronics Europe, says while the number of products produced by local suppliers is limited, the quality of those products is high. "In addition, those suppliers that we engage with show a strong customer satisfaction focus and willingness to participate in our supplier programs," he says. For the supply base to develop, Eastern Europe has to do what China did: increase its investment in infrastructure. "China invested billions of dollars in infrastructure improvements to enable movement of goods," says Knox. In the short term, the strategy for many EMS providers is to develop a supply base for low-tech items. "They are looking to source locally things that would be prohibitively expensive to ship," says Joe Carson, chief procurement officer for Lucent Technologies. Items include cable assemblies, racks and enclosures. "You can bend metal in Romania as easy as anywhere else." Carson adds that while Lucent uses EMS providers in Central and Eastern Europe, it also needs sources of supply for software and professional service to support its equipment. It takes time
The supply base for production materials such as semiconductors, liquid crystal displays and other electronic components will take a while to develop. Some analysts think the supply base in Eastern Europe will take a long time to develop because there are sourcing alternatives in Western Europe. "The supply base in Eastern Europe at this stage is immature at best right now," says Jeffrey Wu, an analyst with researcher iSuppli. "There are many mature and highly sophisticated component suppliers in Western Europe who are in close proximity to EMS providers in Eastern Europe." Those 'financially justifiable alternatives" in Western Europe preclude the need for immediate development of component suppliers in Eastern Europe, according to Wu. Many buyers will be content to purchase components from electronics distributors serving Eastern Europe. He says distributors are growing their business 20-40% per year. "With their warehousing presence, distributors have a good chance of aggregating demand and do well with logistics support and shipment fulfillment," he says. Crawford says for an indigenous supply base to develop, it has to be cost competitive, produce the same quality as global suppliers and in the volumes that OEMs and EMS companies need. If a supplier can’t do that, why would an OEM and EMS provider use those suppliers, he asks. "In the end we have to see how the supply base develops," he says. "It may be that the continuing influx of global suppliers will form the basis of a supply base in these countries." While OEMs see Eastern Europe as a viable low-cost manufacturing location, they also view it as a growing market for their products, including appliances, computers, cellular phones and other consumer high-tech gear, says Wu. The Eastern European population isn’t as large as China or India, but it is still sizeable and represents a major market that is currently underserved. "Take wireless handsets," Wu says. "If you look at the market for Eastern Europe, the penetration is still low. It’s about 30% compared to 90% in Western Europe. There is a lot of potential for growth and is another reason driving OEMs and EMS providers to boot up their presence in Ukraine, Russia and Romania."
Pros and Cons of SOURCING in Eastern Europe Pros:
* Low-cost labor. Labor can be 70% less than Western Europe.
* Close to Western Europe markets compared to China.
* Access to growing market for equipment. Cons:
* Immature supply base. Most production components, other production material need to be imported.
* Infrastructure is not as developed as Western Europe.
* Labor costs, while significantly lower than Western Europe, are higher than China’s.
Who’s Where in Eastern Europe
Here’s a short list of major electronics manufacturing services providers with manufacturing, design or software development facilities in Eastern and Central Europe. * Flextronics: Operates in Poland, Czech Republic and Hungary
* Solectron: Facilities in Hungary, Romania
* Celestica: Operating in Romania, Czech Republic
* Samina: Facility in Hungary
* Kimball: Operates in Poland
It's not just EMS
Tyco has facilities in Eastern Europe and is spending about $50-60 million sourcing there. It’s looking at sourcing injection-molded parts, tooling and machining, and plans to grow its business in that part of the world. Here is why the company is looking toward Eastern Europe, according to Sharad Bohra, who has overall responsibility for emerging-markets sourcing:
1. It’s in part a risk-management strategy. The company is diversifying its low-cost country sourcing regions.
2. Tyco has several factories in Europe, and it may be more economical to develop local suppliers to serve those factories. The company is exploring possibilities in still-developing Romania, Bulgaria and Ukraine vs. the Czech Republic, Hungary and Poland.
3. It’s sometimes easier to convince facilities in Western Europe to accept supplies and components from Eastern Europe than from low-cost Asian countries.
Bohra’s advice to others considering sourcing in Eastern Europe: Pick the right suppliers and the right components and materials to source; understand that they need to make a strong investment, as they would when developing suppliers anywhere; and put staff on the ground to develop suppliers there and train them.
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