Jeffrey Wu, senior analyst for EMS & ODM at iSuppli, talked about some of these pitfalls and if it is possible for contract manufacturers to avoid them in the future. iSuppli: How has the economic downturn affected mobile handset OEMs in terms of their dealings with contract manufacturers? Jeffrey Wu: "The downturn had a serious effect on the supply chain as a whole and OEMs are faced with reduced demand and are examining what they have done right or wrong in the last few years in terms of outsourcing. This exercise by OEMs is sending ripple effects through the mobile handset supply chain." iSuppli: Explain this ripple effect a little more. Jeffrey Wu: "The available market for contract manufacturing depends on two factors. First, the end market growth, which unfortunately is stagnant right now for mobile handsets. This situation is really making all companies operating in the mobile handset vertical market feel the hurt. But the second and more important factor is how OEMs outsource and how quickly and how much they outsource. Most companies assumed that once mobile handset OEMs began outsourcing, they would depend increasingly on contract manufacturers. Both EMS providers and ODMs were expecting these OEMs to continue to use the EMS/ODM services and not bring any of their outsourced design and manufacturing activities back internally. That didn’t happen and we see that some leading handset OEMs—Samsung and Nokia—now are holding back on outsourcing or reconfiguring the need to use contract manufacturers at all." iSuppli: Because of this, are contract manufacturers going to need to re-examine what they are currently doing in favor of adjusting to the times and rethinking this whole approach to dealing with mobile handset suppliers? Jeffrey Wu: "Actually, it is the OEMs that are rethinking the whole thing. And the contract manufacturers, inevitably, are being forced to adjust and cater to the adjustments that the OEMs are doing. If you look at the contract manufacturers in the last three to four years, they made tremendous investments in this market, thinking they would get more and more programs in this segment. But the economic downturn is forcing contract manufacturers to downscale or shift their investments and capacity, reduce their workforce and now assess how fast and to what scale new investments should be made in order to improve their cost structures." iSuppli: The theme that the mobile handset industry will always increase its dependency on contract manufacturing is an area where you say times are changing. More OEMs are turning internally again. Nokia, for instance, decreased its outsourced volume in 2008. Why is Nokia doing this? Jeffrey Wu: "Well, Nokia never really considered giving up its internal manufacturing. As Nokia’s competitors divested their manufacturing facilities and slashed their operations jobs, Nokia continued to invest in operations, identified as one of the company’s core competencies, by adding staff, expanding its manufacturing presence and further streamlining its supply chain management, instead of relinquishing more control to the hands of contract manufacturers. Why pull back outsourced production now? The pressing issue is that if Nokia doesn’t take the production in-house in the face of reduced demand in the end market, its internal capacity utilization would be lower than an optimal level, which would drive up the production costs of their mobile handsets. In a nutshell, then it would lose competitiveness in the market." iSuppli: Do you expect other OEMs to follow Nokia? Jeffrey Wu: “It really depends on the competencies possessed by the OEM. There are two companies that have been more cautious about the use of contract manufacturers: Samsung and Nokia. Samsung is one of the last mobile handset OEMs to get involved in outsourcing. While Samsung never would cease its internal manufacturing, it began to look at contract manufacturing as a possibility a couple of years ago. Now because of the tough times, I think that Samsung has put off any plans or considerations to get involved with contract manufacturers. Other handset OEMs, such as Sony-Ericsson and Motorola, on the other hand, can’t afford to pull back production on a grand scale because they use contract manufacturing as the backbone of their manufacturing. If they were to stop using outsourcing, they would not be as competitive in the market against the Samsungs and Nokias of the world. In contrast, both Nokia and Samsung still produce their products internally and may have the economies of scale so that they don’t need to move to contract manufacturers to survive." iSuppli: So bottom line, don’t expect Samsung or Nokia to plant a flag in the dirt for outsourcing, but other OEMs—Motorola and Sony-Ericsson—to continue to utilize it, or fall of the map competitively. Jeffrey Wu: "Correct." iSuppli: Is there anything that EMS/ODMs can do to encourage these companies to begin using them again? Are there package offers or incentives that could be used to encourage mobile handset OEMs to turn to outsourcing more? Jeffrey Wu: "In the short term, this is going to be a very challenging market for any contract manufacturer to win any business from these two companies, which are No.-1 and No.-2 in the market. But as the demand and the economy pick up, this is something that EMS/ODMs can look forward to, but right now the prospect is simply gloomy. Don’t get me wrong, these contract manufacturers are hungry for business and may be willing to offer something aggressive to win business. But understand they are competing against the internal production operated by Nokia and Samsung and I don’t think that under the current economic circumstances, contract manufacturers stand a good chance of winning." iSuppli: Overall, how do contract manufacturers avoid falling into this pitfall? Do they not rely on mobile handset OEMs as heavily as they do now or do they do something else? Jeffrey Wu: "For these companies, they need to strategically identify their OEM customers and establish robust relationships with them. For contract manufacturers, Nokia and Samsung really are the wild cards in the industry. Most experts thought once they start using contract manufacturing, they would never go back. That never happened. I’m not saying the EMS and ODM companies should not go after these companies with lucrative business potential, but they should determine what these two companies actually want from contract manufacturers, while continuing to expand and enhance their internal production capabilities. Now on the other hand, we should continue to see both Motorola and Sony-Ericsson utilizing contract manufacturing in the future, despite their challenges in the marketplace. So it may be best for contract manufacturers to identify the strategic fit and then pick and choose what battles they can win not just now but in the future." Author: iSuppli An additional whitepaper can be found here.