Can EMS/ODM companies avoid fatal pitfalls in the Mobile Handset Business?

Jeffrey Wu, senior analyst for EMS and ODM at iSuppli, sat down to talk about what some of these pitfalls are and if it is possible for contract manufacturers to avoid them in the future. iSuppli: You mention in your white paper, The Fatal Pitfalls in Wireless Handset Outsourcing, that there are seven scenarios that companies need to be extremely careful about. Are there any here that are on a grander scale than others? Meaning if you fall into one pitfall, it could mean a fatal scenario—but maybe another pitfall might just mean a bad quarter? Or are all of these potentially catastrophic? Jeffrey Wu: "Let’s look at the vertical-integration model, such as what Foxconn International Holdings (FIH) pioneered and inspired many with. When the economy is going strong and the market demand is going strong, this model—when coherently operated—will help an EMS provider grow because the economies of scale can be leveraged and the manufacturing business and the component business can subsidize each other. But when the order volume drops, this model doesn’t allow a lot of flexibility for the manufacturing arm and prevents it from sourcing to external component suppliers easily. This set-up also hinders FIH’s component businesses from approaching other customers in order to get new orders because the company is vertically oriented. In other words, the vertical integration model is like a double-edged sword. It helps an EMS provider compete better when the market grows, but makes an EMS provider suffer more when the economy stagnates." iSuppli: Is there a way that Foxconn can pull itself out of the mess? Jeffrey Wu: "The lack of flexibility in this case means that FIH’s manufacturing may not be able to go out and move beyond its model once the company is involved in this business structure. Yet I don’t believe FIH intends to discontinue the vertical-integration model because the potential for growth remains broad when the economy bounces back. Right now, what FIH is doing is trying to optimize its cost structure internally by laying people off, shutting down production lines, closing shops and moving its manufacturing bases further inland in China where the production costs may be even cheaper. In short, FIH is still trying to work itself out internally by reducing overhead and reducing its idle production lines, while retaining the vertically-integrated model." iSuppli: So do you think that contract manufacturers should avoid this kind of business model in the future? Jeffrey Wu: "It is not easy to replicate this business model to begin with. Even if EMS providers do, the lack of flexibility is a curse in the current economic climate. Should they avoid this vertical integration model? I would say definitely, at least for the time being. Don’t pursue the model unless a contract manufacturer can do better than Foxconn." iSuppli: Are we entering a phase now within the contract manufacturing industry when new business models for targeting the mobile handset segment will emerge? Jeffrey Wu: "I’m not sure if a new model will emerge soon. But there are a few competing models out there that are employed by EMS providers. Once EMS providers thought the vertically-integrated model was the way to go, but that isn’t the case right now. A number of companies were thinking about going after a vertically integrated model and now they are wiping the sweat off their brow thanking the fact that they have not gone that way. Finland-based Elcoteq would be one such company. Now a thought is maybe the EMS providers should get back to the basics and focus on what they do well. In this way, an EMS provider can achieve the greatest flexibility in procurement and sourcing, in order to move in tough times and good times." iSuppli: Given these pitfalls and some leading mobile handset OEMs pulling back on contract manufacturing, should contract manufacturers give up on mobile handsets OEMs and look to other market segments? Jeffrey Wu: "Some contract manufacturers are trying to diversify and to do so aggressively. Although the mobile handset market is going to take a hit this year, the market is where growth remains lucrative and future opportunities are huge. So the contract manufacturers are not going to just abandon this market and look at other markets. What is happening is that some EMS providers are looking at more focused market segments such as smart phones where they may be able to get additional or new business from handset OEMs as this market continues to expand. For instance, both Apple’s iPhone and RIM’s Blackberry have fueled the sustained growth of their respective EMS providers. As for ODMs, they are targeting not only the smart phone segment but also different emerging regions, such as India and China, as these are markets where demand is still growing." Author: iSuppli