CBA is publishing a series of articles based on our ground-breaking study, Beyond Outsourcing, released to Outsourcing Navigator Members late last year.
The second article in the series describes the 10 global trends OEMs are currently facing as they redesign their global supply solution.
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.
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.
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 doesn’t 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.
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.
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.
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?
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.
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’ve 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.
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.
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.
EMS companies have expanded their service offerings to include such things as design services and aftermarket support in an effort to improve margins. Our next article reveals what OEMs really think about the risk to them of engaging with their EMS in these arenas.
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