What Will Drive Growth in Contract Manufacturing?

The key question often asked by {complink 7427|iSuppli Corp.} clients is, “Where will future demand come from for the outsourced manufacturing industry?”

iSuppli forecasts the global electronics outsourced manufacturing industry will grow to more than $450 billion in 2014, up from about $260 billion in 2009. That works out to roughly $40 billion per year for the next five years in incremental outsourcing revenue growth for the industry.

Up until 2008 and 2009, the industry had been able to expand simply by virtue of the continuing trend toward outsourcing, along with a healthy dose of organic growth in the global electronics market. However, future growth lies in two distinct areas: asset acquisition and organic outsourced mandates.

In the 1990s and even in the first part of the 21st century, asset acquisition represented a major component of overall industry growth, along with a well-above-average dose of end-market growth. That did not end very well. Although factory/capacity acquisitions have remained a key component of aggregate industry growth during the past 10 years, they have not played quite as large a role.

This is especially true when we look at the combined Electronic Manufacturing Services (EMS) and Original Design Manufacturing (ODM) industry. The ODM business has been able to grow dramatically during the past decade as it capitalized on the growth in notebook PCs, handheld devices, and flat-panel televisions without necessarily having to use the asset acquisition model.

We’ve now seen the entry of EMS and ODM providers into the notebook PC market, with Hon Hai or {complink 2125|Foxconn Electronics Inc.} and {complink 2085|Flextronics Corp.}, for example, engaging with a number of the major PC OEMs in either manufacturing current-year models or evaluating next year’s product offerings. This disproportionately benefits the EMS industry as these relationships grow and mature. But relative to the entire contract manufacturing industry, the PC business may not drive enough growth, because in this particular case, EMS is essentially winning business away from ODM.

So where will the growth come from? First, iSuppli expects the penetration rate of the cost of goods sold for existing customers to rise. This is the path that all companies in the industry will continue to follow. At iSuppli we believe this will be the primary driver of growth during the next five years as the penetration rate for outsourced manufacturing services rises to 35 percent in 2014, up from a low in 2009 of slightly more than 27 percent. The industries that will attain the strongest growth in penetration are the broader consumer electronics market — due to some recent asset acquisitions — as well as the industrial and automotive industries where penetration rates are much lower relative to computing and communications. (See: Home & Consumer Electronics.)

Second, services such as repair and warranty services also represent an open avenue for growth, given the segment’s fragmented supplier base. As one example, Flextronics and {complink 2862|Jabil Circuit Inc.} have reported a roughly $1 billion increase in services revenue during the past four years, but this is relative to an aggregate increase of $13 billion.

This is a nice expansion, to say the least, but such an increase alone is unlikely to provide enough growth to meet expectations.

To learn more about iSuppli’s EMS and ODM service, see my new report, entitled “EMS ODM Revenue Growth Remains Healthy as Market Continues to Improve.”

2 comments on “What Will Drive Growth in Contract Manufacturing?

  1. bolaji ojo
    October 26, 2010

    I am curious about potential growth market segments for contract manufacturers. Which product segments do you see contributing to the increase in EMS sales? Many of the top contract manufacturers are focused on the consumer electronics space serving companies like Apple, Dell and HP. Will these be the areas to watch?

  2. DataCrunch
    October 26, 2010

    I would say that definitely the traditional business model will continue to be the anchor for EMS companies for the short term.  But I would foresee new segments, such as cleantech/renewable energy and smart grid technologies as additional sources of revenue with demand increasing significantly over the next few years.  I believe Jabil is one such company that has started to embrace these new segments, but how it is impacting its profitability is yet to be determined.   It would be interesting to see which companies start branching out to new markets or if many will just hunker down and focus on what they do now and look for ways to improve and provide more value-added services on their traditional business.

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