Top 10 Industry Trends

Trend #3: Outsourcing Changes the Manufacturing Alphabet
Outsourcing of hardware manufacturing has been identified as one of the top 10 paradigm shifts impacting the connector industry. It has had a profound influence on the connector market for several reasons. It has: 

• Dramatically changed the OEM/supplier relationship.

• Created a new customer base of multi-faceted contract manufacturers.

• Accelerated the trend to off-shore manufacturing.

• Forever changed—and perhaps made more complex—the traditional OEM sales channel.

• Helped reposition hardware behind mission-critical software and services.

Perhaps the most profound change in the electronics industry over the past decade has been the outsourcing of hardware manufacturing. Outsourcing is now the norm rather than the exception in this trillion-dollar industry. Fifteen years ago it wasn’t this way. There was always subcontracting, but outsourcing as a strategic business practice to replace in-house manufacturing hadn’t been invented yet.

Now most large multi-system OEMs outsource PWB assembly and/or complete system builds. They do this for economics reasons, to better manage a global supply chain, and to enable the OEM business to focus on product development, markets, and the customer. In many cases, the “M” in OEM more accurately means marketer, not manufacturer.

The full-force outsourcing trend may have started with printed circuit board manufacturing. Historically, most big OEMs produced their own PCBs. IBM was the technology leader. AT&T had huge PCB capability. Since all boards are “custom,” this was thought to be an integral part of equipment manufacturing. That began to change in the mid-80s, and eventually close to 100 percent of bare-board fabrication was outsourced—and slowly, along with it, board assembly. Companies like Sanmina, SCI, and Jabil Circuits went into high gear.
 

IBM outsourced its own PCB manufacturing, and eventually its Personal Systems’ assembly (sold to Levono in 2005). Celestica, Toronto, was originally IBM. AT&T spun-out its PCB operations into what is now Viasystems. This trend accelerated in the late 1990s. Other companies, such as Flextronics, emerged as major forces in what was beginning to be known as the EMS industry (electronic manufacturing services). What started as subcontracting became a new industry segment, and emerged as a multi-tiered outsourcing phenomenon, including: 

• Board assembly

• Subsystem build

• System build

• Turn-key design/build

• Specialist design/build in specific product areas

• Local, regional, and global CM/EMS enterprises, from small to very large

In Taiwan, companies recognized the advantage of specializing in a particular product area (e.g. notebook computers) and a new buzzword was established: ODM (original design manufacturer). Quanta, Compal, Inventec, First International Computer, and others arose in the PC industry. To the delight of Intel, some specialized in PCs, and drove costs so low that most PC OEMs went that route—following Intel’s reference designs, which also cut engineering costs.

Why Outsource?
As high-volume manufacturing went to SMT, it became highly automated. Investments in manufacturing lines were a major issue for public OEMs who have strong financial objectives. Maintaining state-of-the-art manufacturing lines was expensive and required repetitive investments to keep up, in some cases resulting in a non-competitive position.

Technology was changing, equipment had shorter product life cycles, and the manufacturing footprint was shifting to Mexico, Asia, and Eastern Europe. This resulted in precious, finite resources being devoted to developing and staying current in an essentially repetitive process—one that might be better served by a dedicated subcontractor/specialist in manufacturing. Each company’s facilitation was, in a sense, duplicative. By consolidating manufacturing resources through outsourcing, billions of dollars were saved at the OEM level. This freed up company resources to focus on the market, reduce its labor force and the messy job of managing thousands of workers offshore, eliminate legacy costs, and more easily adapt through subcontractor manufacturing in foreign lands.

Thus, the reasons for outsourcing became compelling, particularly since the EMS industry was now well underway with an increasingly large number of suppliers to choose from.

Why Not Outsource?
Basic economics might advise against outsourcing your manufacturing. Why? Because you may be teaching a future competitor to build your products, and inevitably the technologies behind them. Once they control your former manufacturing resources, you could become dependent on a potential competitor. However, most EMS firms have scrupulously avoided any hint of competition with their customers. Perhaps the greater danger might be with foreign sources, where their position in the local market could spell future problems for an OEM.

Also, lowest possible costs can theoretically be achieved via in-house manufacturing—assuming you have the accounting flexibility and resourcefulness to compartmentalize manufacturing from the rest of your business (overhead costs and allocations typically preclude this).

There is evidence, although not substantial, that some companies are rethinking their commitment to outsourcing. Reasons include: material costs, quality, control of the supply chain, and needing a company footprint in emerging markets, rather than subcontractors who establish that important foundation in countries like China and India.

Some companies have maintained their own manufacturing, but even the semiconductor industry has adopted outsourcing, with the manufacturing footprint of that important industry shifting to Asia.

Research In Motion, Motorola, IBM, and Dell, come to mind as interesting cases in the outsourcing debate. These companies have maintained company manufacturing; RIM in Canada, IBM in servers, Motorola in communications, and Dell, with a hybrid approach. Dell outsources parts and some commodity PC system assembly, but does a lot of final assembly in-house (build-to-order).

Summary of outsourcing characteristics from the OEM perspective: 

• Increased return on invested capital

• Reduced manufacturing cost

• Reduced overhead costs needed to support in-house manufacturing

• Reduced legacy costs with a large in-house manufacturing head count

• CM economies of scale reduce hardware cost and improve manufacturing technology

• OEM assets are re-focused on product development and market share

• Quality control issues, which could result in remedial costs, recalls

• Control of supply chain issues

• Markups associated with subcontract procurement

• Intellectual property protection

• Potential supply disruptions in developing countries

• Potential competitive threat, particularly in large developing countries

 Global CEMs and ODMs—2006 Sales

Impact on the Connector Industry
The rise in outsourcing has had a major impact on all electronic components. First of all, the customer who purchases the product changes from OEM to EMS. It complicates field coverage in several ways. There are now at least two customers to cover, OEM and EMS. Second, it complicates commissions, with multiple design and ship locations which are often not traceable. Third, many of the “large buys” are now global, involving an international sales and distribution team.

In general, the connector industry has adapted to this paradigm shift. It can be said that the industry has become more competitive, more global, and has experienced even more pressure to manufacture off-shore. For the connector industry, outsourcing: 

• Complicates supply chain dynamics, and can undermine preferred or sole-source positions that were rock-solid in the former OEM era.

• Has accelerated offshore manufacturing at all levels of the supply chain, as everyone seeks the lowest possible costs and localized manufacturing presence.

• Can create lower prices, and parts lists may become “bastardized,” placing additional pressure on the QSL (qualified supplier list), resulting in price competition at the lowest common denominator from knock-off suppliers.

• Creates additional pressure to specify industry standard components, or to create new defacto standards that can be supplied by third world producers.

• Creates additional responsibilities in managing inventories and providing local manufacturing support at large EMS facilities and campuses in Asia and China.

• Means that EMS providers need more technical support; their expertise is more related to assembly. There is little research and development at the EMS level. This creates both issues and opportunities for component suppliers, but in general, suppliers can be more valuable resources to the EMS.

The Future
The outsourcing phenomenon is now well proven and will continue to progress: 

• EMS providers have improved their automated manufacturing skills to where they are now world class. There is no turning back from this direction—OEMs have largely abandoned volume manufacturing facilitation.

• Notebook PC ODM success should drive new ODM market segments, such as handheld devices (cell phones, smart phones, digital cameras, GPS devices). Anticipate PC server ODMs as well.

• Former hand-assembly/bench facilities in China will automate, creating an even more formidable manufacturing capability there.

• However, those EMS/CEM suppliers who focus entirely on manufacturing are highly exposed to cyclical industry activity. The next downturn (a possible recession in 2009 to 2010, maybe sooner) will take its toll, because this industry segment has high capital costs and relatively low profitability.

• Increasing footprint of EMS providers in China (now over 50 percent of world capability) may add to the potential for instability. Rapid growth in that market is not backed by strong financial controls, or perhaps, even a placid socio-political environment.

• The idea that Western markets can retain high-mix, quick-turn manufacturing may be a fallacy, as Asia facilities become more sophisticated and obtain EDI and EDA capability.

• The rapid rise in China’s labor rates, emerging markets, and other factors will spur manufacturing startups in other areas, such as India. This will take time, as the infrastructure and spending power is not yet there.

Engineering vs. Manufacturing
A survey conducted by Bishop and Associates indicated that more and more engineering would be relocated to Asia, but not necessarily outsourced. OEMs have already outsourced engineering via the ODM route. As more manufacturing moves, so will engineering activities that are closely linked to manufacturing. Expect to see a continuing tilt in engineering to the Asia Pacific, China, and ROW regions in consumer, computer, communications, and other high-volume market segments.

What will be backfilled at Western locations? Research and development, product development, prototypes, and model shops. What will move east? Product engineering, manufacturing support, tool and die work, materials engineering, and procurement engineering.

Send your comments to outsourcing@ConnectorSupplier.com.