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Electronics Production | January 05, 2010

Can the EMS-Industry get healthy in 2010?

The years of high growth for the maturing EMS industry are over. Based on the forecasts of leading research groups, the five year compound annual growth rate (CAGR) for the EMS industry from 2008 to 2013 will be 7.8% according to Electronic Trends Publications, 1.8% according to International Data Corp or 0.0% according to InForum.
A blending of these three forecasts yields a CAGR of only 4.0%. This is a far cry from the rock and roll years of the late 1990s when EMS was the darling of Wall Street and industry forecasts were routinely in the double digits.

The reason for this slow-down goes beyond our global economic woes. The current EMS model has realized its potential. As Charlie Barnhart expresses the concept, "The outsourcing dividend has been spent." OEMs that do not outsource have judged it an unappealing solution for them, while other OEMs have begun a return to self-build. This latter issue, while not yet a significant trend, does mean that some OEMs are judging the EMS industry as inadequate for their manufacturing needs, for whatever reason.

The reality is that most electronics manufacturing has and probably will always be done internally by OEMs. This is apparent when you consider the penetration rate, a measure tracked by industry watchers for nearly 20 years. The penetration rate is a comparison of EMS revenues with OEM Cost of Goods Sold (COGS) and it grew to around 20% but seems to have leveled off, regardless of EMS expansion into other services to capture more.

What OEMs primarily outsource is the commoditized part of the process - the printed circuit board assembly (PCBA). The more desirable (to the EMS) box build work has been harder to come by, and the original design manufacturing (ODM) industry proved to be a strong competitor for this level of work, especially for commoditized products.

Both EMS and ODM will continue to serve a purpose in the electronics industry, but their penetration of overall OEM COGS has reached a plateau at what is likely to be its saturation point unless some things change in the industry.

As I see it, there are essentially three events that would help improve the health of the EMS industry, as defined by higher profitability: a new “killer app”, a drastic reduction in available capacity, and/or a change in the fundamental practice of outsourcing.

New electronic products tend to be good for the EMS industry. The industry’s growth was fueled by computers, cell phones, networking equipment, and game consoles. The EMS industry benefits when OEMs bring new products to market, especially when the OEM’s desire is to maintain IP ownership. The benefits of new products can be significant, but also only offer a short term benefit to the industry.

The electronics manufacturing industry, inclusive of both EMS and ODM, is plagued by too much available capacity. Based on CBA’s assessment, there is approximately 450-500 Million square feet of global capacity (being used or not), including EMS and ODM, but excluding India. Using a baseline metric of $1M per annum per 1K square foot, the industry is geared up to produce $450-500B per year, but last year the combined industry only generated about $230B, according to InForum.

This glut in capacity allows OEMs to apply pricing pressure on the industry, and there will always be someone willing to low-ball the market. This is the primary issue that challenges the industry, and a drastic reduction in capacity is necessary if the industry is to improve its profitability. This can occur through a combination of consolidations and business failures.

A change in the OEM practice of outsourcing provides the most promise for the EMS industry. OEMs need to focus more on a proper Total Cost of Ownership (TCO) analysis than on just finding the lowest available labor rate. CBA has been advocating this approach for many years, and thankfully people are starting to heed this call, but more need to do so. Most OEMs spend far too much internally overseeing their outsourced manufacturing and very few are taking the steps necessary to do something about it.

Compounding this incongruence is the practice of EMS companies trying to differentiate themselves from other EMS companies by spending more time tweaking the ‘definition’ of their value proposition than actually implementing systemic innovations in their approaches and/or service offerings. In our experience, almost all EMS value propositions now say essentially some combination of the following obvious attributes:

- Customer focused/centric
- Proactive
- Quality operations
- Reduce costs
- Improve time to market

These traits are not game-changing differentiators, but rather the least common denominators of being in business in any industry. I recall an old Far Side cartoon that captured this challenge perfectly. It showed a herd of penguins all looking the same, and one lone penguin in the middle of the pack was singing “I gotta be me, oh I just gotta be me….”

The reality is, there are many EMS companies that are very good at manufacturing, and many innovative OEMs in all industry sectors. The challenge lies in the intersection between these entities. CBA would challenge the industry to take the outsourcing business model to the next level. To forge, invest-in and nurture long-term, mutually profitable business relationships founded on real-life cross-enterprise, market-sector specific data.

Author: Eric Miscoll; Charlie Barnhart & Associates

Image source: BMS

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