The Evolving EMS Industry

Estimated reading time: 7 minutes

The landscape of the EMS industry is both competitive and changing. The challenge is to develop products beyond the traditional business model. Companies that do this will take the industry to the next level.

By Bill Coker

For more than 20 years, the Electronics Manufacturing Services (EMS) industry has evolved from an assembly services industry to an end-to-end product service solutions industry. As many Original Equipment Manufacturers (OEMs) have downsized their internal operations and embraced alternative design, manufacturing and product distribution strategies, the industry has changed to accommodate this. Once exclusively a manufacturing services model, the EMS industry has evolved into a full product solutions model.

EMS market revenues for 2007 will be 45% higher than in 2004, claims Technology Forecasters. Several forces, such as continued conversion to the “outsource” business model, site and service divestitures, global/localized deployment and the increasing migration toward Original Design Manufacturer (ODM) design and product solutions are leading this growth. The penetration rate of ODM services is expected to increase from 7% in 2004 to about 10% in 2007.

It is not enough to provide traditional PCB and box-build assembly services any more. As assembly services have become ubiquitous, EMS companies struggle to differentiate themselves. The key to differentiation can be found in the concept of value engineering. There are some market trends that will have a profound influence.

Two Approaches

To create value for customers, many EMS companies have added vertically integrated capabilities, such as PCB fabrication and enclosure manufacturing. There seems to be two separate schools of thought on this. There are those companies that are increasing vertical integration strategies through acquisition of component businesses such as flexible circuits, camera modules, displays and power components. Then there are other companies that have decided to sell off their vertical integration service offerings to focus on core business competencies.

The concept of increased margin contribution drives the vertical integration decision-making process. If an EMS company can use its vertically integrated component solutions, it can keep those component margins for itself, hence offsetting the low margins associated with traditional assembly. It may sound simple, but it’s not. Some EMS companies are investing in component and technology companies that hopefully will differentiate their overall value proposition to the customer and increase the bottom line. Concurrently, other companies that had similar vertical integration goals are selling services once thought to be competitive differentiators. Regardless of which company you line up with, the question still remains: Are you adding value to both the customer and to your stockholders?

Is Vertical Integration Safe?

Some would argue that acquiring vertical integration has both risks and limitations. After all, isn’t that why the OEMs divested vertically integrated operations in the first place? Typically, EMS companies seeking to vertically integrate are venturing into uncharted territory, buying businesses where they have no previous knowledge or experience in the market. Vertical integration acquisitions tend to be the result of “fire sale” divestitures. After some restructuring and integration, what is typically left is core capability and technology. Does it really add value; and if it’s not running at optimal efficiency, does it really add to the margin contribution originally expected? In many cases, the answer is “no.” That’s why many EMS companies are selling off virtual integration solutions that are not core to their business.

Some Alternatives to Vertical Integration

There are alternatives to the vertical integration model that add value to the customer. Some companies have avoided the complete acquisition model in favor of the equity investment and strategic partnering model. This can be done for substantially different costs depending on the acquisition, but both will offer the same basic capabilities and technologies.

As another way to avoid the cost of vertical integration, some companies may adopt a collaborative design and product development initiative known as clustering. This is when a company acts much like a general contractor to manage all the key component suppliers that contribute to the end product. In doing this, the company can manage component providers that offer a higher quality product, ahead of schedule, at a cost equal to the vertically integrated model. This solution also allows the OEM to reduce the internal cost of managing both the development and supply chain during the design and product qualification phases.

How Government Legislation Fits

Another consideration is governmental legislative environmental initiatives such as RoHS and WEEE. These initiatives create more value for the customer. RoHS, for example, is driving the industry to restrict the use of certain hazardous substances, including lead and five other hazardous materials. With this directive deadline of July 1, 2006, rapidly approaching, OEMs are no longer asking, “What is it?” They are now asking, “How do we prepare?” EMS companies that have prepared and developed valued services around this initiative will benefit from greater customer visibility, loyalty and market share.

Ideally, an EMS company can provide consultative selling services to their OEM customers. They can make assessments of the OEM’s current products and provide guidance as to whether a product can continue and reach its normal end-of-life cycle, or whether it needs to be replaced with a RoHS-compliant design. These “green services” include the realignment of the bill of material (BOM) and approved vendor list (AVL) to reflect RoHS-compliant components. Companies need to manage and distinguish between lead and lead-free components by creating a database of compliant components and specifications. It’s a combination of design, component and process engineering. Lead-free manufacturing, assembly and rework processes all need to be qualified. It’s an engineering investment that needs to be made to create value for the customer. The RoHS directive ripples through the entire supply chain, driving the reduction of banned substances from the assembly process back to the leadframe and wire-bonding process at the component level. Just one non-compliant component could render an entire product non-compliant.

Price Negotiations

Another emerging trend involves the control of the BOM from a price negotiation standpoint. Increasingly, OEMs are negotiating the price and terms of condition directly with the component suppliers. What is really driving this? Is it the EMS company’s inability to drive enough on-going cost reduction, or is it the OEM’s need to retain 100% of every cost reduction? It may even be driven by the component supplier’s strategy to negotiate price and allocate components directly with the owner, rather than the EMS purchasing the components.

Regardless of the answer, there are two implications to consider. First, the OEM has to add overhead on the purchasing organization to support this activity. Secondly, the EMS company has to do the same amount of work. They have to negotiate, administer and execute on both the OEM and internal contracts with suppliers. The costs and risks of executing the business from the EMS side remain unchanged.

From a value-engineering standpoint, it reduces the amount of purchase price variance the EMS company can contribute to its bottom line. It also tends to discourage the EMS supplier from proactively working to improve and drive cost reductions. Low-cost globalization is another trend. EMS companies have provided the customer with a global manufacturing footprint since the mid-’80s. What once was considered a low-cost manufacturing and product distribution location now may not be as attractive in terms of labor costs. EMS companies need to continually reassess the value of their manufacturing and service locations to ensure that they continue to add value to their customers and generate optimal margin contribution.

From a value creation point of view, being able to provide global manufacturing capabilities in evolving new markets helps OEMs effectively penetrate those markets by manufacturing and distributing products locally, often eliminating costly import duties and tariffs. In-country manufacturing also allows OEMs to effectively compete and win new business opportunities.

Conclusion

There is no doubt that the competitive landscape of the EMS industry has changed throughout the years, and will continue to change. OEMs continue to seek opportunities to reduce the cost of new product development, manufacturing, fulfillment and after-sales support. The challenge EMS executives face is the need to innovate beyond the traditional EMS business model and execute more complex business strategies, ultimately getting customers to pay more to get more value. Differentiation is based on consultative value engineering.

A quick look at the top ten EMS companies reveals both similar and dissimilar business and execution strategies. Companies that create the best value by consultatively solving the customers’ changing range of design, supply chain and global manufacturing needs will succeed and lead the industry to the next level of being true end-to-end product service solution companies.

Bill Coker, director of sales and marketing at Elcoteq Americas, may be contacted at 6565 N. MacArthur Blvd., Suite 250, Irving, TX 75039; (972) 401-9995; e-mail: bill.coker@elcoteq.com.