Having spent time at O’Hare airport in Chicago recently, I noticed several billboards advertising Accenture consulting services. One is a photo of an elephant skillfully maneuvering a wicked wave on a surfboard. I think it might be digitally enhanced. The tagline is, “Who says you can’t be big and nimble?” This was a replacement for the Tiger Woods campaign, after Accenture dropped him due to his difficulties, so it might have been thrown together, but I don’t think it’s very effective. Consultants have been accused of not having a good handle on the basic laws of nature, and this seems to me a very good example of that weakness. Elephants can’t surf. I think there are some lessons to be learned here.

In choosing to outsource manufacturing to companies in countries with cheap labor, electronics industry decision-makers have, sometimes unwittingly, added substantial risk to their business. Now, calculating the cost and responding to the consequences of that risk is part of the job description of every OEM operations manager, even those that have no substantial operations in China.

In recent years the EMS Tier structure has changed dramatically. A few companies, with Foxconn way out in front, have gobbled up the majority of the EMS pie. Seven companies with operations in China – CBA calls them the China Syndrome Seven – have engaged in predatory pricing and thereby now dominate the majority of global outsourcing. This dominance, in turn, has enabled them to exert a stranglehold on the supply chain, which has created severe parts shortages during recent months for everyone else. Anyone having trouble getting tantalum capacitors? The China Syndrome Seven have the supply chain locked up. This stark reality is an example of how this situation impacts all electronics manufacturing in every industry.

The size and scale of these China Syndrome enterprises, especially Foxconn, is beyond the industry’s experience curve. While top line growth is seemingly unstoppable due to the global demand for electronic wizardry, the health of these companies’ bottom lines is completely dependent on artificially low labor rates and on the complex and opaque supply chain contracts they negotiate through dominance. The resulting global interconnectedness of the electronics manufacturing industry, along with the sheer size of these operations and their lack of transparency, is what creates the risk.

The conventional wisdom has always held that the supply of cheap labor in China is a bottomless reservoir, but there are signs that managing it may be far more difficult and unpredictable than most electronics manufacturers anticipated. For example, Foxconn has announced it is moving its Shenzhen factory inland in response to the global outrage over worker suicides. Imagine the logistics of completing that task on a human level, while continuing to satisfy Steve Jobs’ iPhone marketing juggernaut. It could take a few months to move or replace 300,000 workers, don’t you think? That’s like a refugee situation. Is it really possible to do that and still build millions of iPads and iPhone 4’s? The recent hardware issues in Apple products seem to indicate not. Will demand fluctuate substantially when Apple fans become dissatisfied? Will there be panic in Cupertino? Foxconn’s success surely results from military-like control over all aspects of its employees and operations. Is that sustainable in the Internet age?

So we have to ask ourselves, could Foxconn collapse? If it does, how would that impact your business?

Foxconn represents nearly US$90 billion of electronics manufacturing capacity. What if a portion of that goes completely offline, even if for only a few months? Like a sudden shortage in any part of the global marketplace, there will be some ‘scrambling’ and panic to capture capacity – both from Foxconn and its competitors. What does that mean to your product’s manufacturing schedule? There isn’t enough capacity left in the world to replace US$90 billion quickly.

Many industries are dependent on Foxconn’s customers’ products. With the global economy so fragile, what kind of ripple effect would its unraveling create?

Failure tends to happen because of small inconsequential events that cascade into catastrophe. Seldom is it one single cause, and the situation is typically fine – until it suddenly just isn’t. Industry ‘experts’ and pundits may continue to tell us that elephants can surf, but perhaps we should spend time figuring out what to do in case they can’t. An elephant falling off a surfboard can create quite a big splash. Knowledge, as always, is power.

This thoughtful article is worth a thorough read. The engineer and the guillotine story is powerful.

Haven’t we proven once and for all that manufacturing is not a commodity after all?

Issues covered: Too cheap labor, future of EMS, regionalization, and more.

Click here to listen now.

And here’s the Powerpoint,  True Cost of Outsourcing for Del Mar Show , so you can follow along.

First of all, by industry consensus, Tier 1s are defined as the top 10 EMS ranked by their annual revenues – an impressive group of companies each shipping many billions of dollars per year.

Given this scale what are their strengths?

• Purchasing power. By leveraging economies of scale, the Tier 1 can negotiate aggressively with component suppliers, passing along these savings to its OEM customers.
• Global footprint. Having manufacturing facilities in every conceivable low labor cost region, the Tier 1 can manufacture products cheaply and, again, pass along these savings to its OEM customers.
• Engineering capability. Because Tier 1 companies typically employ thousands of skilled engineers, they can bring considerable talent to a technical issue.
• Manufacturing capacity. Tier 1 companies have so many factories they should (statistically speaking) never have trouble meeting production deadlines.

All strong selling points, but there is one big caveat. The Tier 1 business model is inherently inflexible. The sheer size of these organizations requires that their facilities be kept constantly full, as to do less would mean they would experience huge unabsorbed costs and considerable financial risk. So, the best marketing solution for companies this size is to have a very few, very large account relationships. That is why they target customers who are/will be Fortune 500 electronic OEMs — what the Tier 1 industry refers to as ‘strategic accounts’.

Then why would a Tier 1 pursue a customer relationship with a company that doesn’t meet this criterion?

Primarily because there is substantial excess capacity in the EMS industry at all levels, but primarily at the Tier 1. Years of geographic migration to lower labor cost regions have left countless factories idle in regions around the world. In this imperfect system, Tier 1s have little choice but to pursue every viable piece of business in an attempt to fill these factories; and this is particularly true during recessionary times.

So what happens when you engage with a Tier 1 when you are not one of these ’strategic customers’ and then business rebounds? Does it seem likely that smaller accounts in these very big ponds will receive less attention? Wouldn’t it be reasonable to assume that ’strategic accounts’ will be given first priority during times of material allocation and shortage? In our EMS Pro Workshop we call this ‘customer relegation’ and while we do not blame Tier 1s for taking these types of actions (they are for-profit enterprises, after all), we know it causes major disruptions for many of the OEMs with whom they do business.

Fortunately, there are alternatives. One of the best is a relationship with a leading regional EMS provider who offers comparable capabilities on a scale-appropriate basis.

These companies can be found in every region, including North America, Western Europe, Australia and the Middle East. And while a thorough benefits analysis will reveal that choosing such an EMS company (instead of a Tier 1) would mean losing some top-end scalability, there will also be a substantial net gain in responsiveness, flexibility and long-term commitment (as you will be one of their strategic accounts).

An example of a company that currently provides regional flexibility and top tier capability is Inovar, located in Utah. We’ve highlighted them on our website as we’ve spoken with many of their customers, all of whom have told us that they’re receiving outstanding service at very competitive prices.

The bottom-line is clear: sometimes that XXXL shirt just doesn’t fit!

Our most recent OEM survey results revealed a level of dissatisfaction among OEMs toward their EMS providers that shocked even us. Dissatisfaction that went beyond what is normal between vendors and customers, i.e. temporary grousing arising from missed deadlines, occasional poor quality and other normal snafus.  What we saw was an almost universal level of dissatisfaction being displayed; everyone was dissatisfied about everything!

Knowing that everyone being dissatisfied about everything really isn’t possible, we sat down to figure out what we could do to help sort out this mess and you know what we came up with? Big surprise coming here… the ONLY POSSIBLE SOLUTION is to once and for all address the core elements of disconnect – the myths, misconceptions and financial gamesmanship that have plagued this industry for the past two decades.

We are not joking, either we collectively decide to do something about this or this industry will ultimately fail. Not a pleasant thought for EMS, OEM or anyone else involved or invested in this multi-billion dollar global enterprise.

Our approach (as puny as it may seem compared to the challenge) is the formation of an Outsourcing Navigator Council, a community where Outsourcing Professionals can get real answers from the industry’s leading consultancy on the cross-enterprise cost and pricing of global outsourcing. Accurate, applicable and timely data presented in a venue where rationality reigns supreme and electronics manufacturing gets down to the tough business of business!

Bottom-line, if you are an OEM and really are dissatisfied then it is time to become part of the solution!

We hope you join us in this enterprise and look forward to your help in bringing the EMS industry to its next level of evolution.  To learn more about the Outsourcing Navigator Council go to http://charliebarnhart.com/outsourcing-navigator-council/ or contact Jennifer Read at 623-293-6985 ,jennifer@charliebarnhart.com.

Hmm, given that the reader probably knew that we already knew these numbers it looks to us like their premise was that the ends (in this case Apple’s financial results) justify the means. An interesting perspective and perhaps one that’s broadly embraced in today’s secular, unrestrained business climate.

But to set the record straight and remove any ambiguity about our position we point out that the New England slave trade was also a wildly successful commercial enterprise. As historian Douglas Harper explains, “Slaves costing the equivalent of £4 or £5 in rum or bar iron in West Africa were sold in the West Indies in 1746 for £30 to £80. New England thrift made the rum cheaply — production cost was as low as 5½ pence a gallon — and the same spirit of Yankee thrift discovered that the slave ships were most economical with only 3 feet 3 inches of vertical space to a deck and 13 inches of surface area per slave, the human cargo laid in carefully like spoons in a silverware case.”

And while we have Supplier Codes of Conduct, to ensure that suppliers to electronics industry OEMs adhere to minimal standards to avoid human rights violations and that the one from Apple goes beyond enforcing local labor laws and requires its suppliers “must uphold the human rights of [workers] and treat them with dignity and respect as understood by the international community” — still, we are appalled by the news stories contained in the links included in this article and therefore re-ask our questions directly… “Does Apple really understand how important these issues are to its customer base, and its image as a hip, socially responsible leading edge company?”

We commend Apple and other Foxconn customers for conducting supplier audits. But what happens when suppliers like Foxconn, surely one of the most secretive, least transparent organizations on the planet, are caught violating the code of conduct multiple times, and efforts by OEM customers do not seem to be successful in changing long term behavior?

Should the OEM be held accountable in the Court of Public Opinion? We think this is already happening, as evidenced by articles on social media users groups, and accounts on Techie fan sites, as well as articles in the Washington Post and other national media.

Our bottom line, if Apple and other OEMs don’t have the courage to disengage with companies like Foxconn that won’t adhere to human rights standards, and move their production to companies that do (even if prices have to go up) then they deserve  to see their most valuable asset, their brand disgraced! As Warren Buffet once put it, “It takes 20 years to build a reputation and five minutes to ruin it.”

We don’t believe there are any ifs, ands, or buts about it. An OEM is either serious about Corporate Social Responsibility or they are not.

That’s our take, what do you think? Please post a comment below.

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Interesting article by one of CBA’s sponsor EMS companies. Check it out!