Dueling Swords in EMS market

The financial stats alone make it abundantly clear electronics manufacturing services (EMS) providers are among the most endangered species in the electronics industry. They are also among the industry's most adaptive enterprises, constantly tacking on new services and forever restructuring and readjusting operations to fit equally fast-changing revenue models.

EMS providers started out as junior partners to OEMs in a supply chain where players talk about partnerships, but which is governed in reality by how much power an enterprise has over its extended supplier base. With no natural base, restricted interactions with end-customers -- beyond what the OEM permits -- and limited influence over component suppliers and distributors, EMS providers were not natural power brokers in the electronics industry.

That situation has changed little despite strong efforts on the part of senior executives to raise the profile of EMS companies. Even companies like Foxconn, the world's mega-EMS provider, is severely limited by what its equally mega-OEM customers like Apple, HP, and Dell permit. Rather than butt heads with customers, but still conscious of the need to improve margins and profitability, EMS companies in more recent times have resorted to a strategy that's best described as "thrust and parry."

Errol Flynn: EMS pioneer

En garde!
The "thrust" (offense) gets them involved in new business opportunities, while the "parry" is defensive. If you are a senior executive with an OEM that has an engagement with a contract manufacturer, then you should familiarize yourself quickly with the full range of the contractor's "thrust" and "parry" activities, as some of these will have an impact on your company's operations. In other words, add actions being taken by EMS providers to accelerate margin growth or exit lower profit operations to your must-watch list.

Margins are so slim in the contract manufacturing industry that companies must constantly ensure they can justify the huge capital investments required. Like a malnourished child suffering an acute case of Kwashiorkor, EMS revenues can be bloated while everything else on the income statement is all bones and rags: The gross profit and operating margins are paltry, while net incomes -- when they post a gain -- are often so measly you wonder why anyone would want to be in the business at all.

To the numbers
Let's take a look at numbers from a publicly traded EMS provider. Flextronics Corp. (Nasdaq: FLEX), one of the largest in the industry -- possibly second to Foxconn Electronics Inc. -- in the fiscal year ended March 31, 2012, posted sales of $29.4 billion and gross profit margin of 5.2 percent, which represents about the average for the industry; 7 percent is considered great while 9 percent is simply insanely fabulous.

Rivals Jabil Circuit, Plexus, and Sanmina are in some ways only slightly better positioned. Their sales are also much smaller; in this industry companies are often forced to choose between higher revenue and/or fatter margins, an unpalatable option whichever way you cut it, since both choices are loaded with dangers. Market leader Foxconn, for example, has chosen higher sales but sweats bullets just to extract a fraction of the profits recorded by its biggest customer (Apple). The Taiwanese EMS provider, I predict, will eventually have to review and most likely change that strategy, but that's material for another blog.

This is why change is a constant for the industry. After years of pandering to OEMs' desire to have "low-cost" operations and competing with each other to drive down costs for customers, the EMS market is trying to move in a different direction. At the very least, these companies are experimenting with a revenue model that puts the emphasis on quality rather than volume. In doing so, they are also indirectly lending credence to the belief that Western countries still have a role in electronics design and manufacturing.

Stepped-up investment
Two recent developments support this view. Last week, Flextronics announced it would invest a total of $32 million in a new product innovation center in Milpitas, Calif. It backs up the company's long-term commitment to higher-end prototyping services in a Western location. Jabil Circuit also has reported it would be partnering with UPS to offer "reverse logistics solutions for return and repair programs to high-tech original equipment manufacturers, service providers and enterprises on a global scale."

That's the "thrust." The "parry" comes when the EMS provider turns down that huge-volume, high-sales, but lower-margin business for lower revenue but healthier margin contracts.

Related posts:

• Who's at the Heart of the Supply Chain?
• Contract Manufacturers Eye Unsexy 2013
• 6 Criteria for Choosing an EMS Provider, Part 1
• 6 Criteria for Choosing an EMS Provider, Part 2