Electronics Production | January 26, 2010
5Q/5A: CEO of Riverwood Solutions answers our EMS questions
Five questions on the EMS Industry with Riverwood Solutions’ CEO Ron Keith.
Q: Where do you see the European EMS-industry in the next 2-3 years? Today roughly 22% of the world's electronics manufacturing by dollar value is located in the 40 plus countries of the broader European region. Although eastern Europe continues to get the vast majority of manufacturing press attention and direct manufacturing investment, more than 75% of Europe’s electronics are still produced in a handful of large, mostly western European countries, including Germany, France, Italy, UK, Sweden and a few others (including Finland which is not exactly western Europe). Production of electronic products in Europe is forecasted by some to decline by approximately 0.5% per year for the next several years - with much of this decline being accounted for by the simple mathematics of the differential in value-add between western and eastern European-based production models. That is not to say that the Euro zone is not seeing tremendous pressure to move production of many types of electronics to even lower cost locales in Asia - but rather that the total supply chain economics of Asian production is somewhat less compelling for European OEMs than for many of their American counterparts. This is due as much to the higher level of end market fragmentation in Europe as it is to logistics costs, increased managerial complexity, and to a lesser extent, a slightly more socialistic view of outsourcing within Europe as opposed to outsourcing far offshore. While increasing cost pressures will continue to drive an exodus of certain types of electronics production from Western Europe to places further east, some sectors will continue to flourish in region. Industry sectors where products are sold to businesses rather than consumers and where those products compete in the marketplace based on performance and innovation will continue to do well. Consumer products, white goods, and lower-end telecom production that drove much of the outsourcing growth in the past decade will be replaced by new growth drivers, including medical devices, industrial products, control systems, and to a lesser extent, aerospace. The nature of both the production and marketing of these types of products provides some level of immunity to the pressures to move manufacturing offshore. Q: Which segment provides the highest growth potential for you? Riverwood Solutions is not a manufacturer. Our company provides advisory, implementation, and management services to OEMs looking to improve their operations, manufacturing, outsourcing and overall supply chain. Given the nature of our business, the areas that represent the greatest growth potential for us are generally industries and geographies where the outsourcing of manufacturing is either under-penetrated, or is relatively new. Specifically, we see a lot of opportunity in medical devices, alternative energy, green tech, and complex industrial electronics. We are currently investing heavily in medical products and devices and think this area will be a significant growth driver for us over the next 5 to 7 years. The medical device segment has a number of specific requirements for supply chain partners which are not well understood by most EMS providers. Today the options available to device companies is more or less bifurcated into two options: (1) small, specialized EMS providers that work almost exclusively in medical; and (2) large EMS providers that have specialized groups or segments for servicing the medical segment. Each of these options provides a different set of challenges for outsourcing OEMs, who then turn to Riverwood for help. For the most part our company does very little work in consumer electronic products or any form of super high volume, commoditized production unless we are approached by a well established company looking to penetrate a new product segment. Q: Is becoming an ODM-company the way to go for EMS-providers? This is a loaded question and quite frankly one that I am considering writing a book about, and which I’m sure would sell dozens of copies (mostly to my family and employees.) There is no simple response to this question, but I’ll try to break it down into when becoming an ODM might make sense, and when it does not. The rapid growth of the ODM industry in the late 1990s through to the present was much needed and quite a predictable evolution for many Asian-based EMS providers. A natural extension of the ability to leverage low cost labor and low cost facilities was the ability to leverage low cost engineering resources. This was a great strategy for EMS providers in very fast-paced, short lifecycle industry segments such as motherboards, lap tops, handheld devices and other consumer products. But becoming an ODM is not a panacea and in fact would be a terrible strategy for most EMS providers. As a general rule, the move from pure EMS to ODM only makes sense for EMS providers under the following set of criteria: 1) If the company has the ability, via its geographic footprint or other means, to leverage design and engineering resources at costs that are at least 75% less than the same resources employed by its OEM customers. 2) If the design of products in the industry segments they serve is identified by all three of the following specific characteristics: i. Incredibly fast product lifecycles that are primarily a function of a repetitive set of engineering challenges, such as adding a faster processor, repackaging a newer chip-set, or generally executing a design process that is evolutionary and based upon engineering – not one that is revolutionary and dependent upon true innovation. ii. The “packaging” of specific electronic functionality provides a considerable amount of the total product differentiation in the markets served. Cell phone handsets are an excellent example of this type of product where the industrial design, i.look, feel and user interface provides a large portion of the product’s differentiation. In reality, most handsets produced in the world in 2010 will be based on less than a dozen basic chip-set architectures with a great deal of the actual “innovation” being provided to ODMs and OEMs via reference designs from the likes of TI and Qualcomm. iii. The development of truly new and truly novel intellectual property – as opposed to the incremental advancement of an existing art, process, packaging, or function – is NOT fundamental to the competitive positioning of the OEM clients in the segment. True innovation is not something that can be outsourced, and companies seeking to compete on product innovation outsourced to a supply chain that is readily accessible by their competitors are doomed to failure over a fairly short number of product cycles. 3)The decoupling of design and production is either very difficult, or very costly in terms of either time or money. Although this third criteria applies to many industry segments, the test of whether an EMS provider should become an ODM lies in meeting all three criteria as well as other strategic, financial, and competitive considerations. I can say categorically that EMS providers that do not meet all three of the criteria above generally have no business moving into the true ODM space. However, for some of these EMS providers, some level of CDM offering may be appropriate. Q: How would you define the relationship of EMS-provider and OEM customer? That of course depends on which EMS providers and which OEMs you are referring to; but in general the relationship between OEMs and their EMS providers is one that is all too often characterized by mistrust, animosity, and a tremendous lack of understanding. Over the last few years, probably 35% of customer inquiries that Riverwood has received are from OEMs that are unhappy with their EMS provider and that are looking to switch providers. Although we have seen numerous instances where an EMS provider was truly doing a poor job, more times than not the problems being reported by the OEM are ones of their own making. The most frequent complaint we hear from OEMs is lead time: “Why can’t my EMS provider give me a two week lead time on this product?” When we dig into the root cause of the problem we typically find a manufacturing services agreement (contract) between the parties that makes achieving a two week lead time either (a) impossible, or (b) an uncompensated service that puts 100% of the potential material liability associated with achieving that lead time squarely on the EMS provider. In an industry characterized by 3% net margins, why would an EMS provider risk millions of dollars of their own money and 4 years worth of account profits to dramatically reduce product lead times when the OEM is clearly unwilling to risk any of their own money on the same objective? When OEMs built their own products, the internal team understood all too well what it took to reduce lead times and where that potentially added cost or liability to the system. But now that production is outsourced, lead time reductions are expected to defy the general rules of supply chain behavior and be free of both cost and material liability. Calibrating these expectations is a big part of what we do in cases where the OEM is unhappy with their EMS provider. Designing a supply chain with two week lead times is not overly problematic. But rarely is the issue the design of a supply chain that can provide this level of responsiveness – the issue inevitably becomes who should pay for the costs and why doesn’t the EMS provider just give me two weeks on everything as a matter of course? The companies that have very good relationships with their EMS providers are always those who recognize that the relationship is a long term partnership and that each company in the partnership has a uniquely different business model that they operate. When we are able to move our clients from confrontational accusations towards cooperative solutions, both their satisfaction level and supply chain performance improve significantly. Q: Which new market segments do you want to enter? As I mentioned before, we are making a pretty significant investment in medical right now. Because good supply chain design and supplier management practices are pretty transportable across market segments, expanding our efforts in certain segments is not particularly difficult for us. We would, however, like to enter some new geographies. I think Japan continues to be a very attractive market for us and for EMS companies, although one that remains perpetually under-penetrated. Riverwood Solutions’ approach to operations management, sourcing, and supply chain management would resonate well with the Japanese, and the market opportunity for us there is virtually limitless. I would like to think that Riverwood would be able to establish a presence in Japan in 2010, but given how rapidly our business is growing everywhere else, I think Japan will have to wait until at least 2011.