Five Sources of Risk in 2011

The Charlie Barnhart & Associates Composite Risk Index continues to climb, indicating accelerating risk for the electronics manufacturing industry. However, with the announcements of a return to growth, and most analysts saying there's no danger of a double-dip recession, where does the risk come from? Our latest analysis indicates these five sources of risk:

1. Cost of labor. Prices for both EMS and ODM services in China have increased and are forecast to continue to increase at a rate of approximately 1 percent per month for at least the next six quarters for an aggregate of at least 20 percent. This is without taking into account Foxconn Electronics Inc. 's announced raises (unlikely) and the Chinese government agreeing to ease currency protections (also unlikely).

2. Risk of failure in Tier 1 EMS. Recent actions at the Tier 1 EMS level have virtually guaranteed some type of catastrophic event at the "Goliath fringe." In the 1990s and early 2000s, Solectron Corp.'s strategy of top-line growth at the expense of profits led to its eventual demise and acquisition by Flextronics Corp. (Nasdaq: FLEX); we see similar behavior among Tier 1 EMS and global OEM customers. A failure at this level will have repercussions throughout the supply base.
3. Abrupt slowdown in government spending. Companies selling to the military and government markets are facing uncertainty as stimulus money runs out and austerity measures kick in across the developed economies. In the US, the day of reckoning for state budgets, combined with eventual defense budget cuts, will bring many programs to a halt, sometimes without warning. This is already reflected in some earnings guidance. For instance, Cisco Systems Inc. (Nasdaq: CSCO)'s surprising announcement of a lower than expected annual sales forecast are attributed by TheStreet.com in part to cuts in capital spending by state governments.
4. Global market rebalancing. Lip service is being paid to the need for emerging economies to open their markets to slower-growth, developed economies. Overall, this is good for everybody, because emerging markets need to become less export dependent and their citizens need access to the world's goods and services. Developed economies, on the other hand, need to find new markets for their products. However, making this happen will require a level of global cooperation that seems unlikely.
5. Global complexity beyond the ken of C-suite decision-makers. Currency and tax issues, the challenges of global emerging markets, the unique history and challenge of outsourcing electronics manufacturing, and rapid changes in technology have created a perfect storm situation for C-level executives in OEM corporate boardrooms. Engineering and technology are no longer the main drivers for strategic planning, and the potholes and pitfalls are much more difficult to navigate than they were in the past. Operations and supply chain managers are cautioned to manage this carefully, as they will see potential supply disruptions before the top executives do.

Note: The CBA Composite Business Risk indicator is an estimate of the overall supply risk in the global EMS sector and is related to the Geographic Constant in the Global Risk Module (GRM) tool of the Outsourcing Navigator Series. It also includes factors related to monetary exchange, economic forecasts, infrastructure scalability, cost and availability of resources (including energy), outstanding regulatory and geo-political issues, status of down-slope supply-chain, availability of up-slope services, cost and availability of capital, fixed asset utilization rates, book-to-bill ratios, current delivery trends, lead-time projections, and a quality rating factor.