From the Publisher

eric

Eric Miscoll

As we end what has been a tumultuous and challenging year and look forward and ponder what the next decade might have in store for the outsourced electronics manufacturing industry, I was reminded of an industry research report from 2012 that has proved to be quite prescient.

EMSNOW Editor Jennifer Read and I had the privilege of working for many years with one of the smartest men I have ever met, who spent far too much time than was probably healthy thinking long and hard about the electronics manufacturing services (EMS) industry.  While he has now moved on to other adventures, many might remember Charlie Barnhart as a sometimes irascible EMS industry veteran, who had a long history working as a senior executive for global EMS companies SCI Systems and then Sanmina-SCI.  After “retiring” from the EMS industry he founded his own consulting firm, Charlie Barnhart & Associates LLC (CBA), where Jennifer and I were proud associates. Charlie is a passionate and data-driven truth-teller, and his insights are always worth considering.

In September of 2012, CBA released a special report titled – Beyond Outsourcing: The Future Landscape of Electronics Manufacturing.  The intended audience for this report were mid-market OEMs who were, along with EMS companies, the firm’s clientele.  In the Executive Summary to that report, Charlie described the Top 10 Macro Trends he believed were driving the next evolution of outsourcing.  I wish to share those with this audience now, eight years later, as I believe they are issues with which the industry arguably still contends today.

(I share these with the permission of Charlie Barnhart, who is now retired from the industry and hopefully not thinking deeply about this industry anymore.)

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From Beyond Outsourcing (2012)

By any measure, the EMS industry has for the past two decades supported business practices that have significantly benefited their OEM customers. Driving these practices has been a relatively short-list of factors:

  • The broad-based commoditization and outsourcing of electronics hardware in the (but not limited to) Computing, Communications and Consumer market segments by primarily Western and European OEMs.
  • The OEM community’s on-going demand for progressively lower prices for EMS services as a means of preserving their product contribution margins.
  • The wholesale transfer of electronics manufacturing (and in many cases design via the ODM solution) to China and other low cost, cross-hemispheric, regions.

charlie barnhart logoThe ultimate result of these trends has been the consumers of outsourcing services (i.e., OEMs) have lost touch with the true costs associated with electronic manufacturing. These customers have embraced and become dependent upon a supply solution that is unsustainable, which they are now incapable of recognizing by virtue of this very reality (i.e., having lost touch with actual cost). The situation is further compounded by an escalating level of supply risk and an unknowable timeline for when the EMS industry will ultimately morph into a solution incongruent with the OEM communities’ on-going dependence.

Given these observations and the inevitability of this sea-level change, CBA initiated this research to provide both detailed insight and actionable intelligence to the mid-market OEM membership of its Outsourcing Navigator Council. And even more importantly, to answer their question “What should we be doing NOW and in the future to once again gain competitive advantage from electronics manufacturing.”

The following Top 10 Macro Trends are driving this next evolution of outsourcing. These are the leading indicators; the beacons, if you will. A careful exploration of these trends, their implications, and their underlying metrics is a useful exercise as we shine light on the future of electronics manufacturing.

  1. EMS/ODM Prices Are Converging.

For the OEM, using an Original Design Manufacturer (ODM) model historically delivered a cost benefit over an EMS because ODMs provided an off-the-shelf design and fewer ancillary services. OEMs that used the ODM approach gained something in time to market, but arguably lost something in competitive advantage due to innovation. However, the cost advantage for OEMs who use this approach is disappearing as ODM costs have been driven up by the OEM community’s expectations over the past decade (especially from the supply-chain and SG&A perspective.)

IMPLICATION: If you are depending on an ODM model you should be actively exploring other options.

  1. Regionalization Is Gaining Momentum.

What started as a trickle has become a stream. It is not a torrential river yet, but substantially more than a trickle and momentum is building. With rising transportation and global labor costs, combined with increasing global risk, OEMs in the midmarket have come to understand that a cross-hemispheric supply solution is not cost effective.

IMPLICATION: More OEMs are designing a supply solution where they build in the region for the region.

  1. Global Capacity Utilization Is Increasing

While outsourcing began as a way for OEMs to convert fixed cost (e.g., plant equipment, buildings, etc.) to a variable basis, as EMS capacity increased, OEMs became focused on securing continuous cost reductions. Today, hardware manufacturing has become a commodity and OEMs rely on continuous cost reductions for manufacturing to stay competitive.

EMS companies were able to accommodate ongoing cost reductions for many years as they had underutilized factories they needed to fill (including over a hundred OEM divestitures). That reality is changing. In short, perhaps the biggest risk facing OEMs is the fact that available global capacity is now reaching full utilization and prices are not likely to continue on their downward trajectory.

Our data shows a significant reduction in the supply of EMS capacity and we have forecasted that if additional capacity does not come on-line within the next two-three years demand will exceed supply.

IMPLICATION: While overall capacity may not change, more of the available capacity may be going offline due to changing business models and other trends. With demand exceeding supply, prices must rise for EMS services.

  1. Labor Costs in China Are Rising Far Faster than Anyone Predicted.

Our data indicates that for electronics manufacturing, there is not an unlimited supply of low-cost labor in China, in spite of the huge population. Pressure from human rights organizations; rising middle class expectations, and government regulation to avoid social unrest have contributed to the rapid rise in wages. CBA forecasts that labor costs will continue to rise for at least the next two to three years.

IMPLICATION: Does this mean OEMs should exit China immediately? Probably not, but a thoughtful well-developed alternative solution that is fully congruent with an OEM’s immediate and long-term needs should already be in development.

  1. Slower Rate of Growth of Electronics Outsourcing

The EMS penetration rate is the percentage of electronics total available market (TAM) that has taken the plunge to outsourcing to an outside entity for manufacturing services. This measure is the baseline upon which the industry has historically based its growth forecasts. CBA has watched the rate of growth of the EMS industry slow.

IMPLICATION: Finally, the industry is realizing that outsourcing is not one size fits all and the heady days of double digit, year-on-year sequential growth in outsourcing are behind this industry.

  1. Risk in the Supply-chain Has Reached Unprecedented Levels

The risks involved in global electronics hardware manufacturing are increasing. Few would argue that statement. Yet many would argue that these risks, including geopolitical instability, turmoil in the financial system, and certainly natural disasters, are beyond the control of most strategic planners, so why even worry about them? Thankfully most front-line managers understand that even in the best of times outsourcing is an inherently risky proposition best controlled with careful planning and thoughtful execution; unfortunately, this insight seldom reaches the C-Suite.

IMPLICATION: Many OEMs are reconsidering their entire supply solution to mitigate risk and thereby reduce their true costs. The question is whether or not these insights will be embraced by executive management in time?

  1. The Demand Cycle Has Shortened

Most OEMs simply don’t know what they need until something is sold; and then they need it from their manufacturers within days not weeks. And further complicating the situation, most refuse to maintain finished goods inventories or operate in-house manufacturing capabilities in parallel to their outsourcing suppliers which would dramatically improve their response times.

For a few years, ‘Lean Manufacturing’ looked like it would provide an answer, but Western industry simply could not bring itself to fully embrace the approach with its many operational disciplines.

What we are left with is a dysfunctional system where OEMs refuse to place firm commitments, where forecasts are meaningless, where the outsourcing industry is afraid to order anything until the last possible minute and the downstream supply chain routinely labels everything as non-cancelable/non-returnable. Meanwhile the ‘express delivery’ service industry reaps the rewards of the industry being behind the demand curve.

IMPLICATION: The expectation is that, just like in the virtual world, an almost infinite array of choices of physical products should be available instantly. This trend is unlikely to reverse.

  1. Fewer Resources at OEMs

As the so-called ‘outsourcing dividend’ has finally begun to dry up, OEM top-level executives have begun squeezing every internal element of their own enterprises in an attempt to preserve profits.

Beyond general cost-cutting in travel, internal support activities and miscellaneous expenses/benefits we have also noticed an even more unsettling trend: elimination of the outsourcers themselves. These are the operations managers and supply chain specialists who understand manufacturing well enough to manage a complex cross-enterprise supply solution.

IMPLICATION: There are far too few people within most OEM organizations with ‘tribal knowledge’ about manufacturing; almost no one is left that truly understands the real risks and costs, or appreciates the value.

  1. EMS Are Trying to Diversify Their Revenue Streams

The EMS industry has been actively expanding their services offering deeper into the product lifecycle as a means of diversifying their revenue stream in pursuit of margin improvement. In spite of a significant effort on the part of the EMS community, during the past decade the acceptance rate for these life-cycle services has not been particularly high. The most probable reason that OEMs haven’t embraced these new services is they’ve become so conditioned to commodity-based pricing for PCB & Box Build that they don’t want to pay for the actual costs of these extras. In fact, many OEMs have started moving in the other direction, exerting more control internally over several stages of the product lifecycle.

IMPLICATION: The EMS industry’s efforts to improve financial performance are not working.

  1. The Global Market Is Not What Was Expected

Capturing global demand is a potential opportunity for nearly any type of business, electronics being no exception. With demand in the developed world slackening due to the continuing hangover from years of excess spending on both the public and private level, emerging markets have become nearly everyone’s best hope for growth. Yet demand for OEM products in emerging markets for the most part requires a middle class willing and able to spend on imports. Simply manufacturing a product in an emerging market is not a guarantee that local buyers for that product will magically appear, contrary to what many OEMs believed.

IMPLICATION: The opportunities of a truly global marketplace have proven irresistible, yet elusive.

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I think most readers will agree that this list, and the stated implications, were representative of the challenges the outsourcing industry faced in 2012.

Was Charlie right on all these issues?  Maybe not.  But a baseball player who hits only 4 out of 10 pitches for a career will still be considered a superstar and elected to the Hall of Fame.

The EMS industry needs more people like Charlie thinking, caring, and challenging this industry.

What do you think are the current trends are driving the next evolution of outsourcing? Share them with me (emiscoll@emsnow.com) and I will compile and share a list of the top issues.