Healthy EMS-ODM Growth Rates, But Thin Margins Persist

In its just-released Five-Year Forecast, Technology Forecasters is projecting the average compound annual growth rate (CAGR) for the next five years at 11.9% for EMS providers and 11.4% for ODMs, with computer, communications, and medical posting the strongest growth rates. In spite of continuing challenges caused by the housing/credit crunch, TFI Economist and Senior Consultant Matt Chanoff believes that high tech will offer a safe haven for investors and assured the audience at the Quarterly Forum held in Ottawa, Canada, earlier this month that corporate spending and global demand will support healthy growth in electronics. "While the soft housing market and credit crunch in the U.S. poses risks to the global economy, our verdict is that it will deal but a glancing blow to electronics, and world output will remain strong," Chanoff concluded. "That translates to good news for electronics outsourcing, although pressure on average selling prices (ASPs) will continue to challenge profitability for manufacturers." Companies attempting to improve on the industry's historically slim margins have pursued several different strategies with mixed results, according to the report: - Emulating Hon Hai (also known as Foxconn) in building a more vertically integrated model, in order to generate higher margins from component or assembly sales - Aggressively addressing segments with higher average margins, notably medical and automotive electronics, often through alliances rather than directly building capacity - Attempting to capture higher margin services in the product life cycle, such as prototyping and after-sales support - Focusing on higher margin niches within commodity segments, such as servers instead of notebooks The most important EMS driver continues to be growth in the computer systems market. Over the past year, strong unit sales in computers have combined with a customer shift toward notebook purchases that has had the effect of raising average computer selling prices. One increasingly bright spot for outsourcing is in medical electronics, which TFI forecasts at an 8.5% CAGR through 2011. Medical device outsourcing continues to gain traction as EMS companies rise to the challenges of long product development cycles coupled with strict quality standards and complex documentation requirements required by regulation. Chanoff noted another bright spot in the increasing electronics content of the automotive sector. Other highlights of the Five Year Forecast report include: - ODMs that moved into own-brand manufacturing are finding ODM business customers suspicious of this model. ODMs have responded by separating the two businesses. - ODM attempts to diversify product offerings have met with mixed success. TFI predicts that over the forecast period, spin-offs of own-brand operations, relative maturity in systems markets, mixed success in entering new product markets, and competition with Hon Hai will together retard revenue growth in this sector. - Despite the Flextronics acquisition of Solectron, TFI does not anticipate an acceleration of merger and acquisition activity in the EMS segment because there is a lack of buyers; furthermore, current volatility and de-leveraging in capital markets makes it less likely that a financial buyer such as private equity will step in. The report projects total outsourcing to grow from just over $247 billion in 2006 to nearly $429 billion by 2010. For revenue in the EMS sector this translates into 11.9% compound annual growth rate through 2011, driven by the dramatic growth of Hon Hai, (CAGR would be 6-7% without Hon Hai) and 10-11% CAGR for ODM companies over the same period. As for the regional distribution of outsourced manufacturing in 2006, TFI determined EMS production as follows: 55% in Asia, 25% in the Americas, and 20% in Europe. By 2011, this distribution will shift to approximately 69% in Asia, 17% in the Americas, and 14% in Europe. In 2006, ODM production was more concentrated in Asia, with 96% in Asia, 2% in the Americas, and 2% in Europe. TFI projects that by 2011 ODM production will become somewhat more regionally distributed, with 90% in Asia, 5% in the Americas, and 5% in Europe. TFI's Electronics Manufacturing Outsourcing Report: Five Year Forecast of EMS and ODM Industries by Market Sector and Geography is available to Quarterly Forum members. Please contact Cheryl Lund at +1-952-303-3001 or clund@techforecasters.com for more information on becoming a Quarterly Forum member.