Is There Trouble on the Horizon for Contract Manufacturers?

The 2012 growth outlook for the outsourced manufacturing industry has vacillated since the year began. Earlier in the year, business activity was upbeat and companies were generally optimistic about growth prospects for the second half. While IHS Corp. still forecasts the industry will post modest growth by year-end, the outlook for outsourced manufacturers has changed dramatically.

All the strength in the market now is concentrated among a small number of leading outsourced manufacturers, which are showing most of their growth with an even smaller number of major customers. For much of the rest of the industry, business is actually contracting as global growth has slowed amid a host of unfavorable elements, including the sovereign debt crisis in Europe, slowing expansion in China, and a near stall in the US economy.

IHS now estimates global outsourced manufacturing revenue will rise to $389 billion in 2012, up 5.4 percent from $369 billion in 2011. This represents a downgrade from our most recent forecast issued in June 2012 of nearly 10 percent growth in 2012.

On the positive side, new business activity is generally higher as OEM customers look to outsourcing in order to reduce costs as well as to accelerate their supply chains. Even so, in numerous conference calls over the past few months in which trends in the underlying electronics business were discussed, companies have sounded a cautious note. The phrases “stable,” “modest,” and “hopefully it gets better in the second half” were often heard.

Global economic weakness remains the major stumbling block for the electronics industry. In fact, many of the companies that IHS has spoken with recently have shifted their outlook from stable to lower. In many cases, future sales prospects are contracting as overall global growth has slowed amid economic challenges in Europe, China, and the United States. And with economic growth slowing, most outsourced manufacturers may lower their earnings expectations for the rest of 2012.

Much of the strong industry growth in the first half was highly geared to one company: Hon Hai, a.k.a. {complink 2125|Foxconn Electronics Inc.}, which owes a significant portion of its growth to just a small number of customers, including its largest client, {complink 379|Apple Inc.}. As Hon Hai is now the largest outsourced manufacturing provider by a factor of nearly four compared to its closest competitor, the direction of the IHS outsourced manufacturing industry forecast is highly correlated to Hon Hai and to its largest customers such as Apple. Aside from the key customers that are still reporting very strong growth, there’s a high likelihood the market is entering a slowdown.

In the face of economic headwinds and concerns about overdependence on a limited number of large customers to drive growth, IHS advises outsourced manufacturers to take three courses of action. First, sharpen the focus on winning new sales as well as accelerating the time-to-volume for previously won business.

Second, get the financial house in order, as low rates make it both accretive to rework the capital structure as well as easier to negotiate better inventory terms with customers. Finally, prepare for an upcoming decrease in demand and a protracted period of very modest sales. Outsourced manufacturers should work to control whatever factors they can, including expenses, hiring, and capital spending.

Many companies are already addressing this slowdown head-on by undertaking such actions. Because of this, as well as the memories from the Great Recession fresh in the minds of companies across the industry, IHS believes the industry will likely exit this period of sluggish growth in better shape.

6 comments on “Is There Trouble on the Horizon for Contract Manufacturers?

  1. bolaji ojo
    October 31, 2012

    The Apple-Foxconn partnership has benefitted both parties immensely but one of the two parties is more dependent on the other. What is Foxconn without Apple? Another piddling EMS provider!

  2. _hm
    October 31, 2012

    Does Apple has new CM in Taiwan? Foxconn should be careful of this. Also, Apple may have downturn in near future and it will have significant affect on Foxconn.

  3. itguyphil
    October 31, 2012

    Why do you think they will experience a downturn??

  4. ITempire
    October 31, 2012

    All these economic slow down factors are equally applicable on normal manufacturers therefore I don't feel that in particular contract manufacturing industry is likely to suffer. Despite that, concentration of contract manufacturing in the hands of few big players is not a positive.sign.

  5. ITempire
    October 31, 2012

    @ Bolaji True. Foxconn might be vulnerable without Apple's contract. It is the nature of this contract manufacturing industry that they have to be dependant on the decisions of their clients far more than a manufacturer is dependant on its clients.

  6. rohscompliant
    November 1, 2012

    The old 80/20 rule applies here…but in the apple/ foxconn case it is more like a 99/1 rule…………..that is foxconn gets 99% of their biz from 1 client; apple…… would hurt them if apple went elsewhere…..

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