MMI April 2002
Vol. 12, No. 4: April 2002
Table of Contents
Full Product Design Brings Industry More Clout
Design services have evolved such that a number of EMS providers can now design entire products from scratch. What’s more, the demand for full product design has increased over time. For some providers, this ability dates back many years; for others, it’s more recent. Either way, the ability to do full product design for OEM customers has major implications for the industry.
- Providers gain greater control over the bill of material and thus the supply chain. They can design in preferred suppliers more easily to obtain the best pricing.
- When serving as product designers, EMS providers have the power to direct design wins. As a result, IC suppliers must forge new relationships with these providers.
- These EMS companies have the inside track on manufacturing programs that follow the design project. It’s another way to find work for factories.
- Doing both product design and manufacturing guarantees like no other scenario that designs are manufacturable.
- The ability to design certain types of products allows a provider to differentiate its offering.
- This ability brings EMS providers and ODMs closer together leading to possible competition or cooperation. And full product design is a prerequisite for any provider considering the ODM model.
But the question still remains: Why would self-respecting OEMs outsource product design, commonly viewed as a core competency in the electronics industry? The ostensible answer is they wouldn’t. But in a survey of large providers, MMI found a variety of reasons why a product design would be outsourced.
- An OEM might not have the engineering resources available or might lack certain capabilities.
- Aided by DFX, OEMs believe they can shorten time to market.
- Cost can be a motivator in that OEMs avoid fixed engineering costs. Also, DFX reduces the costs of revisions and scrap.
- Outsourcing a product redesign frees up OEM engineers to work on leading-edge products.
- An OEM that differentiates its product through software may not see hardware design as core.
- Some OEMs adopt a virtual company model where design is not a core competency.
- OEMs from outside the electronics industry may not have hardware design capabilities.
Fueled by such OEM motivations, outsourcing of full product design has increased over the years. But last year proved the exception, at least for Plexus. “Historically, we saw 20% to 25% annual growth in demand through the ’90s. Starting about a year ago, we’ve seen a leveling off in demand,” said Mike Verstegen, president of Plexus Technology Group. Then September 11 created delays in decision making. “Now in this quarter, we are starting to see a healthy new business pipeline,” he added.
Jabil Circuit has a similar view of the growth of full product design. “The activity has increased over the past ten years. Recently, the growth had slowed somewhat, but the activity is increasing once again,” said Jeff Lumetta, VP, Jabil Technology Services.
Flextronics, MSL and PEMSTAR also see this activity increasing.
Start-up activity is one source of this growth. “Full-service EMS providers are exactly the partners that start-ups and their VC partners are looking for,” said Ed DeJesus, VP, MSL Design & NPI Services.
In an abbreviated survey of large providers, MMI found nine large players with the ability to do full product design from concept (see table below). Because of the survey’s limited scope, this group does not represent every provider that can design entire products.
Two companies in the survey have been developing products for 20 years or more. Branded as the product realization company, Plexus was founded in 1980 with a mission to give OEMs a full set of services for bringing products to market. That meant designing entire products as well as manufacturing them right from the start, 22 years ago.
Benchmark Electronics has a long history in product design as well. The provider has been developing products for customers for the past 20 years. “Our focus is on our customer’s time to market with the development of high-quality products that meet their requirements,” stated Benchmark in its survey response.
But other providers with shorter histories can still list a number of different products that they have designed from scratch (table).
To design from concept, a provider obviously must duplicate OEM capabilities. While each product area often demands a certain degree of engineering specialization, there is a minimum skill set required to do full product design. Capabilities include specification development; design of the electronics that may contain analog, digital and RF; component engineering; mechanical engineering; industrial design; software and firmware development; and product qualification. Products may require designing such devices as FPGAs and ASICs as well as power subsystems. Of course, a provider must also possess PCB layout and various test development capabilities.
That’s to get started. Then a provider must somehow accumulate the engineering expertise necessary for a product it wants to design. The resulting product better good and on time or else. “You have to deliver a high quality of technology and service to your customer base, or you may do yourself more harm with your customers than good,” said Plexus’ Verstegen.
“It’s a hard thing to get into. Otherwise, everyone would just have the world’s greatest products,” he added.
IC Suppliers Take Notice
The migration of EMS providers into product design has not gone unnoticed. If EMS providers take on a product design, they will be in a position to determine whose silicon is used. And IC suppliers want to work closely with whomever controls the design win, whether it be an OEM, distributor or EMS provider. As a result, IC suppliers are beginning to view providers in a new way – not as mere buyers of parts but as creators of demand.
Intel was among the first suppliers to recognize this new role of the EMS provider. Last year, the company set up its Embedded Electronics Manufacturing Services Providers program to focus on collaboration, reference design development and training for the EMS providers in the program. The initial group of four program members has been increased to six. These members also gain access to Intel’s embedded silicon roadmap.
Another IC supplier watching for design outsourcing is Analog Devices, Inc. ADI is surveying OEMs regarding the outsourcing of product design and has released some preliminary findings to MMI. “We discovered the move toward outsourcing full product design to be an evolving process and that many OEMs are choosing to keep core competencies in house and evaluate design outsourcing for less strategic projects,” said Ken Ciocco, ADI’s EMS Segment manager for North America.
As more product design outsourcing occurs, how will the relationship between EMS providers and IC suppliers change? “For technology-driven companies like ADI, we’ll have to develop a more synergistic relationship that goes beyond purchasing and customer service to design teams working with field applications engineers and marketing. A more open exchange between parties will allow the combination to develop product solutions they couldn’t have developed individually,” said Ciocco. According to Ciocco, suppliers will be forced to allocate more technical resources to meet this demand.
If EMS providers are to join distributors as creators of component demand, will providers be given incentives – monetary or otherwise – that distributors enjoy? This question is now circulating among IC suppliers.
The Intel program can certainly be viewed as offering incentives, although an Intel spokesperson said the company does not give preferred pricing to program members.
The ODM Connection
EMS providers that design products for customers and ODMs (original design manufacturers) bring the same capabilities to bear. And they both end up producing a finished product. But they get there using two different models. An ODM designs a product on spec and then tries to find customers that will source the product and its manufacturing from the ODM. When an EMS provider undertakes product design work, it does so with an order in hand. Celestica’s chairman and CEO, Eugene Polistuk, recently used the term contract design manufacturer, or CDM, to describe this activity. An ODM will own the product design, while a CDM will not.
The ODM model has recently caught on as a hot topic, especially in the financial community. One reason for the interest is that ODMs are viewed as potential competitors for outsourcing from Japan. Indeed, according to IDC’s latest quarterly report on contract manufacturing, “Taiwanese ODM vendors have had a significant head start into the Japanese marketplace.” The report also points out, “From all accounts, the design expertise of the ODM is greatly valued by the Japanese vendors.”
What’s more, IDC predicts that the ODM market, estimated at $20 billion in 2001, will outpace EMS this year. The firm is forecasting 13% growth for ODM versus 2% for EMS. Not only that, ODM margins are higher.
To gauge provider interest in the ODM model, MMI asked large providers in the survey if they intend to pursue an ODM strategy. Benchmark and Plexus gave negative responses.
Take Plexus. The company believes that the complex products it designs and builds are not a good fit for the ODM market. “Our customers’ products normally have some high level of intellectual property that makes their products unique in the marketplace, and they don’t want to buy from an ODM. Where would their market competitive advantage come from?” said Mike Verstegen.
For Celestica, ODM opportunities have not been a significant factor in its business to date. The company said it will examine the ODM strategy, if it proves the best way to provide customers with desired capabilities. But Celestica does not intend to design products that compete with its customers.
MSL is open-minded about ODM. “Should the right ODM opportunity present itself that helps fulfill a customer requirement and complements our service offerings, then we would certainly pursue it more vigorously,” stated Ed DeJesus.
Jabil and Solectron are extending the definition of ODM to fit what they already do so it is unclear what their intentions are vis-á-vis the ODM market. Solectron makes the case that it is functioning as an ODM because it offers predesigned building blocks through its Technology Solutions unit.
But one provider, PEMSTAR, has clearly signaled its entry into the ODM business. The company has come up with six reference designs that will be available soon. Two of them are computer related, two are communication related, and two are in industrial automation. This move stems from PEMSTAR’s equipment automation business, where the company has developed proprietary systems that go into customer equipment.
For PEMSTAR, an ODM business offers a number of benefits. It leverages existing design capabilities, leverages PEMSTAR’s intellectual property, adds revenue, enhances margins and helps to fill factories, according to Steve Petracca, PEMSTAR’s executive VP of business development. As for margins, the company puts ODM gross margins in the 15% range, compared with about 8% typically for EMS.
However, the ODM business is not risk-free. “We may not hit the right point in a product to get anybody interested. And if you don’t hit the right point from a specifications and timing standpoint, you may not find any buyers,” said Petracca.
Petracca sees EMS providers and the Asian ODMs beginning to encroach on each other’s space. “I certainly think we’re on a bit of a collision course. As CMs get more into the development side of things, ODM is a natural thing to follow,” he said.
“I think ODM is inevitable. I think the growth of outsourced engineering services is inevitable. And I think there will be some interesting mergers and acquisitions activity between ODMs and CMs,” added Petracca.
Partnerships between EMS providers and ODMs have been tried before. At one time, Solectron had an alliance with Taiwan’s Acer, and the former SCI Systems attempted a partnership with Uniwill, a notebook ODM from Taiwan. These relationships did not result in significant new business. Whether or not future EMS-ODM combinations will be successful is an open question, based on these examples.
Still, there are precedents for combining ODM and EMS within the same company. Two Hong Kong-based companies – Alco Electronics and Elite Industrial Group – have done it. To avoid customer conflicts, Alco said it will never make a stand-alone ODM product that would compete with one if its major customers on the EMS side.
Communications Still No. 1
Although the communications sector was hardest hit in last year’s downturn, data from 45 of the largest EMS providers show the EMS industry cannot shake its dependence on this sector.
Communications infrastructure equipment for networking and telecom went into a free fall in 2001, but the sector still emerged as the largest market segment among 45 of the MMI Top 50 EMS providers. Based on data from these 45 companies, communications infrastructure equipment represented 38% of their combined sales of $72.89 billion in 2001 (see chart). For 18 of those providers, infrastructure equipment contributed 40% or more of sales last year (see table below).
Market Mix for 45 Top 50 EMS Providers in 2001
The second largest EMS market, computers, trailed infrastructure equipment by 11 percentage points among the 45 companies. However, Foxconn (Hon Hai Precision Industry Co.), whose sales are largely derived from the computer industry, did not provide market segment data. If one were to add Foxconn’s sales to the computer segment, the margin would narrow to about 6 points. But computers would still be number two.
In third place were a group of other categories that could not be counted separately because some providers do not break them out (see table below). Included in “other” categories are industrial, medical/instrumentation, automotive and military/aerospace. Together, these other categories accounted for 15% of sales for the group of 45 providers.
The next largest segment at 11% was handheld devices, a new category for MMI and one that includes cell phones as a major component. The smallest market segments were consumer and peripherals at 5% and 4% respectively.
Assuming that mobile phones make up the majority of handheld sales, the total communications market, both infrastructure and handsets, would have amounted to 44% or more of sales among the 45 providers.
Market segment percentages were calculated from the tabular data below. Note that storage products were not specifically called out in MMI’s original survey. In at least two cases, storage products were combined with computers, but in a third case, Celestica, storage was lumped in the other category. This inconsistency may have introduced a small error. Also, the segment percentages used for Flextronics were based on nine months of sales in 2001.
Solectron Gains Lucent Work
Three-year contract at $2 billion
Lucent Technologies has made Solectron (Milpitas, CA) the primary EMS provider for advanced optical systems now being produced at Lucent’s North Andover, MA facility. At anticipated production levels, this contract would generate sales of about $2 billion for Solectron over three years.
Solectron has agreed to buy inventory and equipment related to the optical product lines for $125 million. But the provider will not acquire buildings or property under the agreement. A-Plus Manufacturing, a Solectron company, will lease space in the North Andover facility to handle initial production. A-Plus, a former EMS unit of C-MAC Industries before it was acquired by Solectron, has been recast to provide optical manufacturing and NPI services to Lucent.
Lucent and Solectron had disclosed earlier that they were in talks regarding the sale of assets and outsourcing of work from the mammoth facility in North Andover (Feb., p. 6). The cost of these assets has come down from an original estimate of about $275 million.
Solectron will provide services including enclosure design and manufacturing; optical design, manufacturing and testing; PCB and backplane assembly; repair services; and materials management. The provider will also aid in the redesign of Lucent’s optical product supply chain.
Moreover, manufacturing services will extend to the system level. Solectron will perform systems assembly, integration and testing for products before sending them to Lucent’s Northeast Systems Integration Center. To be located in the area, this center will do final customer configuration and software loading. Solectron will serve as primary manufacturer for optical systems including Lucent’s Lambda and WaveStar product families.
In conjunction with this contract, Solectron’s A-Plus has reached an agreement with the Communications Workers of America to employ members of the represented work force in North Andover. Solectron will gain 288 permanent union employees from the Lucent facility along with 250 people who will work temporarily during a transition period expected to last several months. In addition, Solectron expects to take on 80 to 100 nonunion managers, supervisors and engineers.
Permanent employees hired by Solectron will provide new product introduction services. All other manufacturing activities will be moved to other Solectron sites around the world. But work will not be sent to Solectron’s site in Westborough, MA.
The North Andover facility had about 1600 employees involved in manufacturing, of which nearly 400 were scheduled to leave on March 31. Another 500 will work at the systems integration center. Lucent expects to sell the building in North Andover.
Subject to normal closing conditions, the transaction is expected to close in Q2.
Jabil To Acquire Automotive Operations
Jabil Circuit (St. Petersburg, FL) and Valeo (Paris, France), a major automotive supplier, have announced a PCB manufacturing pact. Valeo will sell two European operations to Jabil and transfer production of two North American operations to the provider. With this deal, Jabil will get a three-year PCBA supply agreement worth an estimated $300 million a year in revenue. This is the third OEM divestiture that Jabil has landed this year and the third one involving the purchase of OEM assets in Europe (March, p. 4-5).
Jabil intends to acquire Valeo’s Meung-sur-Loire, France facility with 750 employees and the PCB manufacturing part of its Wemding, Germany facility along with 200 people. So Jabil will gain 90,000 ft2 of capacity in France and 15,000 ft2 in Germany to be dedicated to automotive electronics production. The provider will take over the employment contracts of the approximately 950 Valeo employees involved in this deal.
In addition, Valeo plans to transfer production from its Switches & Detection Systems operation in Fort Worth, TX, and the PCB part of its Electrical Systems facility in Juarez, Mexico, to the Jabil Automotive Group operations in Chihuahua, Mexico. The Electrical Systems portion is subject to court approval under a Chapter 11 restructuring.
Jabil will manufacture automotive electronics for Valeo products and systems including body controllers, sensor and switch assemblies, vehicle access and immobilizing, lighting, climate control, and wiper and cooling systems.
“This partnership represents a major milestone in our strategy to increase Jabil’s participation in the global market for automotive electronics. The acquisition of the French and German operations will significantly expand our base of manufacturing for the automotive industry in Europe,” stated Brian Althaver, Jabil Automotive Group VP.
Jabil plans to establish a regional Center for Automotive Excellence in Meung-sur-Loire.
The deal, which has been submitted for consultation to the European Works Council, is subject to employee consultation and execution of definitive agreements.
Deals done…TeligentEMS has purchased substantially all of the assets of the MercuryEMS operation in Havana, FL, from the Bank of America (Mar., p. 6). Chris Eldred serves as president of TeligentEMS. The Florida operation was formerly known as NRT Contract Manufacturing before it was acquired in 1999. Eldred was also president of NRT….Celestica (Toronto, Canada) has acquired certain NEC manufacturing operations in Miyagi and Yamanashi, Japan (Jan., p. 5)….NEC has also transferred manufacturing, fulfillment and demand forecasting in Ibaraki, Japan, to Solectron (Nov. ’01, p. 2). The provider has hired about 470 NEC employees….Sanmina-SCI (San Jose, CA) has completed the purchase of Alcatel’s manufacturing facility in Gunzenhausen, Germany, as the first phase of a divestiture that also includes facilities in Cherbourg, France, and Toledo, Spain (Feb., p. 6). Sanmina-SCI expects to complete acquisitions of these two facilities by summer of 2002.
Transaction being reconsidered… Jabil Circuit has not proceeded to acquire the German operation that was originally part of its deal with Marconi. The two parties “are currently reassessing the German portion of the acquisition in light of the current economic environment,” according to Jabil’s latest 10Q filing.
New manufacturing programs… Elcoteq (Espoo, Finland) will manufacture ISDN phones for Swissvoice, a new customer, at Elcoteq’s plant in Pécs, Hungary. Elcoteq will also provide NPI and supply chain services from Switzerland and Northern Europe. Also, Guangzhou Thinker Technology Co., a Chinese company, has chosen Elcoteq as its manufacturing partner. Under a two-year agreement, Elcoteq will manufacture PCB assemblies at its plant in Dongguan, southern China, for a Guangzhou Thinker product connecting telephone and data communications networks….Movaz Networks (Atlanta, GA), a provider of metro optical networking solutions, has chosen Flextronics (Singapore) to provide material sourcing and qualification, board assembly, integration and test in addition to logistics management and system support. Under the agreement, Flextronics will operate independently within the Movaz-owned facility in Atlanta….Sanmina-SCI will build a core optical network system and optical subsystem products for Altamar Networks (Mountain View, CA), a subsidiary of Ditech Communica-tions….BAE SYSTEMS Integrated Defense Solutions (Austin, TX) has selected Sypris Electronics (Tampa, FL) to manufacture circuit card assemblies for the Joint Chemical Agent Detector and related products. JCAD is a handheld detector used to find the presence of chemical warfare agents or toxic industrial compounds. Sypris Electronics expects to produce about 1.3 million JCAD and related assemblies valued at about $75 million over the three-year contract. Also, the Sypris unit has received a $35-million contract from Honeywell Aerospace Electronic Systems for production of card assemblies in the cockpit display of the US Apache Longbow helicopter. This contract expands Sypris Electronics’ position in the Apache avionics program. Formerly known as Group Technologies, Sypris Electronics is a subsidiary of Sypris Solutions….Coinstar has chosen DNE Manufacturing & Service Co. (Wallingford, CT) to perform manufacturing and system integration of coin counting terminals for the US and UK.
After-sales programs…Solectron has announced a number of program wins in the after-sales area. Sony Ericsson Mobile Communications has chosen Solectron to manage all of Sony Ericsson’s repair partners in North America. Information from these repair partners will funnel to Solectron, which will provide services including warranty claims processing, parts management, data warehousing, and failure analysis. In addition, Sony Ericsson has engaged Solectron to repair and refurbish mobile handsets for a certain telecom service provider in the US and Canada. Under another new program, Audiovox has picked Solectron to perform all repair, returns processing and reconditioning for Audiovox mobile handsets produced for Sprint PCS in North America. What’s more, Solectron will handle all repair and refurbishment for Microsoft’s Xbox game console in Japan and now Australia. The Japan part of this program was awarded earlier (Feb., p. 7). Finally, Solectron has added AT&T Broadband, Comcast, VeriSign and Cox as call-center customers.
ACT To Be Sold
ACT Manufacturing (Hudson, MA), ranked as the 11th largest EMS provider last year, has agreed to sell all or substantially all of its assets through a Bankruptcy Court auction process. But the company has no plans to auction off assets in a piecemeal fashion. ACT expects the sale process to be completed by the end of June.
The provider has hired Lazard Freres (New York, NY), an investment bank, to manage the sale of the company. According to ACT, Lazard has received bids from several qualified buyers. Based on the level of buyer interest, ACT continues to believe that selling the company to a buyer who will keep ACT going will maximize value for its creditors and ensure continued service for customers.
ACT filed for reorganization under Chapter 11 of the US Bankruptcy Code on Dec. 21, 2001 (Jan., p. 6). The company agreed to an auction sale of assets as part of its debtor-in-possession credit agreement.
ACT says it remains committed to continuing operations. For the period from Dec. 21, 2001 to Jan. 31, 2002, the provider recorded a net loss of $4.5 million on sales of $13.4 million. For the month of February, the net loss was $4.4 million on sales of $13.5 million. In February, ACT reported a loss of $528,000 before interest, depreciation, taxes and extraordinary expenses, compared with a loss of $1.3 million in the prior period.
IEC Reviewing Options
IEC Electronics (Newark, NY) has engaged Lincoln Partners (Chicago, IL), an investment bank, to help IEC review strategic alternatives for enhancing shareholder value. The provider has not disclosed what these alternatives are.
Last month, the company announced a work force reduction of 25% to cut costs as part of an overall restructuring plan and to match its revenue stream.
More recently, IEC has received a three-month extension to its credit agreement. Asset impairment and litigation contingency charges left the company in violation of certain financial covenants in January. This extension will run through the end of June. The company had previously received three short-term extensions.
“Our recently announced work force reductions and other cost savings are expected to lead to positive EBITDA this quarter. This extension and expected improvements in overall business performance should give us sufficient time to finalize a new credit agreement. IEC is in continuing discussions with other lending institutions and believes it will be successful in closing a new agreement,” stated Thomas Lovelock, IEC’s president and CEO.
VOGT electronic (Obernzell, Germany) has opened sales offices in five locations outside Europe and intends to step up activities in Mexico, the US and China. The new offices are located in Shanghai, China; Dallas, TX; Sunnyvale, CA; Detroit, MI; and Guadalajara, Mexico.
The new Shanghai office, supported by a plant in that city, services such customers as Osram, Philips and Shanghai Bell. The new North American offices will support customers including automotive suppliers Siemens VDO, Lear and TRW. Among other customers being serviced in North America are Efficient Networks, Celestica and Siemens in the communications sector.
The new US sales offices are attached to VOGT electronic of North America, which has an existing sales office in New York. In Mexico, another VOGT subsidiary operates one plant.
“Our objective, through this expansion, is to generate sales of 30 million euros each in Mexico, the US and China in the mid term,” said Reinhard Schülein, VOGT’s chairman.
New complex…Flextronics has broken ground on a new industrial park in the Jiading District of Shanghai, China. Construction is expected to take about three years over several phases. According to a Reuters report, the new park will eventually contain nearly 2.5 times the current capacity of its Doumen park in southern China at 1.5 million ft2. The Shanghai park will incorporate all of the components necessary to product complex infrastructure products. These components include backplanes, PCB assembly, complex cables and enclosures. Following a Flextronics formula, the new park will also house strategic suppliers.
Adding capacity in New England… NES Technologies (South Easton, MA), which offers both prototyping and production, has added an SMT line anchored by a MultiTroniks Intelliplacer 10 placement system…. Chase EMS Group (West Bridgewater, MA) has also added an SMT line, which went into its Sunburst facility in West Bridgewater, one of three Massachusetts operations in the Chase group. The new line features a Mydata MY12 autoplacer….Glynn Manufacturing Services (Middleboro, MA) has installed new SMT capability including two Juki placement machines.
Moved from Big Board…APW (Waukesha, WI), an enclosure fabricator and system integrator, and Viasystems Group (St. Louis, MO), an EMS provider with a PCB fabrication business, have been delisted from the New York Stock Exchange. The shares of both companies now trade on the OTC Bulletin Board. Hicks, Muse, Tate & Furst recently bought $232 million of Viasystems’ notes and $51 million of its bank debt. HMTF now owns 52% of Viasystems’ common stock and 55% of its unsecured debt.
Top 50 update…Based on data that came in after publication of the MMI Top 50 in March, sales and number of employees for Ionics EMS should have been listed as $257 million and 5000 respectively. As a result, the average revenue per employee changed slightly to $180,500.