What Happens When a Major Customer Implodes?

It seems Celestica Inc. (NYSE, Toronto: CLS) placed a large bet on the wrong horse. In the next year or so, about 20 percent of the Canadian contract manufacturer's revenues will disappear as turmoil at BlackBerry (Nasdaq: RIMM; Toronto: RIM) wreaks havoc on the extended supply chain of the BlackBerry smartphone manufacturer.

Celestica, in a recent statement, said "over the course of the next three to six months, it will wind down its manufacturing services for Research in Motion." This will result in the loss of about $1.4 billion of Celestica's annual $7.2 billion revenue.

Similar pain is being felt at hundreds of small and large companies around the world that supply components and other services to RIM, due to declining sales and eroding market share at the wireless handset vendor. As RIM's struggles intensify, the company is focusing on measures to reduce operating costs, including a reduction in the number of businesses that provide contract manufacturing services or supply components. That trend has accelerated and is spreading panic across its supply chain as sales continue to deteriorate: Analysts are projecting RIM's fiscal 2013 revenue will decline sharply to $12.85 billion in the year ending February 2013, down nearly a third from $18.5 billion in fiscal 2012.

A severe plunge in sales like this can be disastrous for supply partners and other support services providers in an OEM's manufacturing ecosystem. RIM, for instance, will require fewer dedicated contract manufacturing factory space, an ever smaller quantity of components, reduced logistics services support, and perhaps a one-third reduction in after-sales and warranty fulfillment functions. While direct services providers like Celestica will initially feel the pain, the overall effect will extend through the entire supply chain, hurting suppliers' suppliers and reverberating at non-tech companies such as retailers, real estate firms, and financial services providers.

RIM is only the latest in a growing line of high-tech companies to be hammered by a combination of economic downturn and competitive displacement by rivals. Finnish wireless handset manufacturer Nokia Corp. (NYSE: NOK) is in the same boat and may be heading down an even sharper river fall. Coming along for the disastrous ride are numerous suppliers, service providers, and support companies that Nokia estimates number in the thousands. "Our supply chain is extensive and complex and altogether we have thousands of direct and indirect suppliers," Nokia said in its 2011 annual SEC filing.

Suppliers to Nokia can expect a wild ride as its sales fall. Its annual sales fell to approximately €38.7 billion (US$50 billion) in 2011, down from €42.5 billion in 2010 and €50.7 billion in 2008. Analysts' consensus estimate is for Nokia's 2012 sales to decline more than 20 percent to $39.5 billion. Texas Instruments Inc. (NYSE: TXN), for instance, saw the problem brewing years back and began cutting back on its exposure to Nokia.

The first set of companies being hammered by events at Nokia are component suppliers, especially semiconductor vendors. Together with contract manufacturers, chipmakers, and other component manufacturers, these suppliers account for a major chunk of Nokia's €27.3 billion in cost of goods sold in 2011. As its revenue nosedives, so will the fortunes of these companies. In fact, those with a large exposure to Nokia may not recover.

Nokia acknowledged the effects of its changing business dynamics on its supplier base in a recent annual SEC filing, noting:

The intensive competition among our suppliers and the resulting pressure on their profitability, as well as negative effects from shifts in demand for components and sub-assemblies, may result in the exit of certain suppliers from our industry and decrease the ability of some suppliers to invest in the innovation that is vital for our business.

However, while component suppliers and contract manufacturers will suffer as OEM customers' fortunes ebb, the eventual loser on a longer-term basis may be the OEM itself. Companies that survive the winnowing that follows the death spiral of an OEM gravitate away from that line of business, and even those that continue to serve that sector dedicate minimal resources to it. When the affected OEMs regain their footings, they may find it difficult to get the previous level of support and may be forced to pay a higher premium for such services.

For instance, last year, after announcing it would discontinue the Symbian operating system in favor of Windows OS, Nokia faced a mini-rebellion from suppliers and vendors. In order to get their continued support for Symbian devices, the company agreed to commit to "future purchase commitments." Deals like this will dominate contract agreements in the future for troubled firms like Nokia and RIM, especially as more successful enterprises like Apple Inc. (Nasdaq: AAPL) intensify the pressure on the competition by paying ahead for guaranteed component supplies.

As for Celestica, diversification into new business ends such as the "industrial, aerospace and defense, healthcare, green technology, semiconductor capital equipment and other end markets," holds the promise of greater stability, the company said in its last annual SEC filing. Last year, it bought the manufacturing assets of Brooks Automation and raised revenue from what it described as "diversified end markets… 40 percent from 2010 to just over $1 billion in 2011."

Today, EBN will host a live chat on the implications of problems at a major OEM for the supplier base. EBN editor in chief Bolaji Ojo and Junko Yoshida, former editor in chief of EE Times, will discuss the direct effects of problems at Nokia and RIM for their contractors and component vendors. The one-hour live chat will start at noon EDT. To attend the session, click here.