JMB Communications / Jeff Berger

Writing Sample - Technology Forecasters

[NOTE: Technology Forecasters is a Bay Area market research firm. This article summarizes their research into and forecasts concerning contract electronics manufacturing. The following article appeared in Circuits Assembly magazine.]

Analysts, manufacturers, and providers of Electronic Manufacturing Services agree: EMS is growing rapidly, and that growth shows no signs of any imminent slackening.

But there is a broader question which clouds a clear understanding of the elements of the EMS equation. It’s the central question: exactly what are we talking about?

Although the acronym “EMS” is defined clearly as Electronic Manufacturing Services, and “CEMS” denotes Contract Electronic Manufacturing Services, it’s clear that any discussion of EMS may lead to confusion unless there is a clear definition.

For this article, we spoke with a number of key industry analysts to examine precisely what is growing, by how much, and where the growth is occurring, both in terms of business focus and, in some cases, geography.  

Randall Sherman: EMS is Going Up…for a While

Randall Sherman, Senior Analyst with Electronics Trends Publications, San Jose, late this summer finished an exhaustive study of the global EMS marketplace. His bottom line: things are looking up – for a while.

“There are two kinds of EMS,” Sherman says. “Contract electronic manufacturing, or CEMS, is the one we’re all interested in. It’s companies like Celestica, Solectron, Flextronics, and others. There is also a hidden outsourcing market, which is basically OEMs outsourcing to other OEMs. It is at least as large as the CEMS market, and it consists of many Taiwanese firms, qualified subcontractors, and Asian companies manufacturing for a prime contractor or OEM. They make motherboards, audio cards and other things.” 

On the other hand, contract electronic manufacturers, Sherman says, “are independent companies. They do not make their own products, they only assemble products for someone else. That’s why I don’t count companies like Acer, which manufacturers computers and motherboards for companies like Compaq and IBM. Acer also manufactures its own products. Their contract business is not in my CEMS numbers.”

In his just finished study, The Worldwide Contract Electronic Manufacturing Services Market, 7th Edition, Sherman estimates the size of the 1999 CEMS market at $58-billion. He says it consists of three components -- large, medium, and small companies. The large companies are $100-million or more, medium are $20 - $100-million, and small are less than $20-million. Others analysts, as you will see later in this article, define the “tiers” of this marketplace differently.

Sherman adds that super-large companies also come into play – those with $1-billion or more in sales. “There are about 60 large companies today,” he says, “and seven or eight that are super-large.”

The OEM market is even bigger. “I calculate that the OEM market is currently $96-billion,” Sherman says. That figure, he emphasizes, doesn’t consist of the computer industry alone. “It includes electronics manufacturers serving many industries including aerospace and automotive, but the computer industry is the largest component.”

CAGR: Sherman says the industry’s Compound Annual Growth Rate, or CAGR, has been about 26% a year for the last five years.

CEMS Market Size

Randall Sherman

“I see the market continuing to grow at this blistering pace of about 25% a year for the next five years,” Sherman says, with the highest growth occurring this year and next -- about 30% each year. After that, in the last three years of the forecast period, he says the rate of growth starts to decline. “It’s mainly an issue of saturation at that point. Most of the low-hanging fruit is being picked today.”

On the other hand, Sherman says that today, CEMS manufacturers account for only 10% of the total available market. In 2004, he estimates they will account for only 16% of total available market. “The most attractive segments that are available include the computer, communications, and the consumer marketplaces, although much of that market is dominated by Japan which isn’t interested in outsourcing.”

CEMS company size: In the future, Sherman expects CEMS to be a “large supplier” game, principally because of economies of scale realized through size. Procurement, buying power, global sourcing, distribution, and across-the-board leverage all benefit when the size of the player is larger. “Although there will always be small suppliers out there,” he says, “the large companies that have both vision and the ability to execute will be leading.”

How large will CEMS become? “Over the next few years, some contract manufacturers will exceed their customers in size, and many OEMs will lose the ability and know-how to manufacture their own products. At that point, I expect you’ll see a change in pricing as CEMS are under control.”

The entire design, assembly and distribution process is becoming transparent to OEMs and customers, Sherman says. Collaborative design, procurement (the ability to source and buy materials on behalf of the OEM), software assembly tools affecting supply and velocity, and distribution are tightly wedding OEMs and CEMS. 

North America, including Canada and Mexico, is one of the strongest markets, he notes, with Mexico especially strong because of labor costs.  

Ralph Kenton & Associates – Solid Growth

Ralph Kenton is not an analyst, but he gathers detailed information from them, draws conclusions, and uses those conclusions to advise his clients worldwide.

Kenton’s definition: “The EMS industry consists of companies specializing in procuring materials and manufacturing, assembly, and test of various products for OEMS, whose logo or trademark normally appears on the finished product.”

Kenton, who offers numerous tutorials and workshops involving contract manufacturing, says there are around 2,200 contract electronics manufacturers (CEMS) worldwide. He says revenues for CEMS in the 1995 timeframe were $30- $35-billion, and will rise to $100-billion this year or next.

CEMS Revenues

Ralph Kenton & Assoc.

Kenton divides the CEMS market into “dynamic” tiers. “Five years ago,” he explains, “we considered anyone over $1-billion to be in tier one. The tiers are constantly changing.”

“Organic” Growth:  Although Kenton says the CEMS market is currently growing at an average of 30-35% per year, he differentiates between growth among different-size manufacturers.

“If you look at the top ten,” he says, “they are growing today at 35-50% today as a group. The next tier, under $500-million in annual revenues, have a growth rate of 20-25% a year,” he says, “and smaller organizations have rates of 8% per year or less, and some are struggling to survive.”

The growth rates of CEMS and the companies they support should become equal around 2015, Kenton predicts. “The larger contract manufacturers are growing through acquisitions,” he says. There are two parts to a contract manufacturer’s growth. One is organic growth, which means they’re earning more and more business from their current customers, or they buy the business by buying entire manufacturing sites from OEMs. I’d like to see more information on just how much of that accounts for CEMS growth.”

For CEMS, there are advantages and disadvantages to acquiring former OEM manufacturing facilities. On the one hand, the OEM guarantees that the CEMS will continue to supply the company for a defined period of years. On the other hand, Kenton says, acquiring the facilities, people, intellectual property, process know-how, accounts receivable, inventory, and work in process creates liabilities if the economy goes sour, if the product becomes obsolete, of if the customer stops buying. “All the risk goes with all the assets,” Kenton says.

Not all CEMS agree with separating the two types of growth. One, in particular, Kenton says, lumps acquired manufacturing capacity into its Organic Growth numbers.

“I define ‘organic growth’ as what percentage of key customers’ TAM, or total available market, contract manufacturers have been enjoying. In 1990, HP’s total TAM to all contract manufacturers was $20-million. Today, I hear it’s around $15-billion. Organic growth is best measured by percent of TAM. A CEMS may say an OEM gave them 15% more business in a given year, but that’s not good news if the OEM’s TAM grew 25% that year. 15% would be a declining percentage of TAM. The CEMS’ slice of the pie must increase as the size of the pie increases for there to be real growth.”

Technology Forecasters:

To define the EMS industry, Bay-area headquartered Technology Forecasters, Incorporated, begins with the total electronic output from OEMs, relying on Dataquest figures, to which it applies the Cost of Goods Sold. “We usually apply an average of 68% to the Dataquest figures,” says TFI COO Dr. Eric Miscoll, “but we recently decided, within the 10 industry subsectors we define, to apply a specific percentage to each sector. The average remains 68%.”

TFI examines 10 EMS market subsectors: automotive electronics, computer peripherals, computer systems, consumer, industrial, instrumentation, medical instrumentation, military and aerospace, wired telecom, and wireless telecom. “The computer industry really fueled the growth of the EMS industry over the last many years, but growth today is being fueled by wireless telecom.”

What will fuel future EMS growth? “Consumer is the largest overall sector by dollar volume, automotive will experience some more growth, and wireless will continue for a while to fuel industry growth,” Miscoll says. 

TFI sized the market at $60-billion in 1998. “We see an annual growth rate from now through 2004 of 28%,” Miscoll says. He says TFI expects industrywide growth from 1998 to 1999 and 1999 to 2000 will be 30% when all calculations are in, with growth slowing to 28% in 2001, 27% in 2002, and down to about 25% in 2004.

Which size contract manufacturers will grow most? “The 12 top tier companies, each of which does over $1-billion in annual business, grew at 42% over the last couple of years. Mid-tier companies, which range from $100-million to about $1-billion, we tagged at about a 12% growth rate, and smaller companies are at 2% or less. The market is driven from the top, with the top-tier companies commanding close to or in excess of 50% of the total revenues for the entire industry.”

Like other companies forecasting the EMS marketplace, TFI sees the EMS companies getting bigger, with more OEMs adopting virtual manufacturing strategies. “I see contract manufacturers taking on more capabilities in the value chain, as they have been. Contract manufacturers largely began in printed circuit board assembly and have grown into design on the front end, and now do box-build and ship to final customer plus post-sale service work.” 

Miscoll described a recent agreement between Flextronics and Microsoft where Flextronics will soon apply its name to some Microsoft mice. “Nobody knows these companies,” Miscoll says, “except the analysts and the people who really know the industry. It’s an invisible industry to consumers, but as it grows that will change. It will be interesting to see the extent to which CMs will be doing ODM work, original design manufacturing, where they will design and build their own devices and let the CM private-label it. It’s infinitely easier for an OEM to manage a relationship where a CM designs and builds a product for them, than it is to manage a CM which builds the OEM’s design. That’s much more complex.”

TFI says that the war is being waged on a supply chain versus supply chain basis. “The effectiveness of a CM’s supply chain is a key differentiator, inasmuch as CMs are running on very low margins. The Internet allows the essential communication, trust, and collaboration between the CM and the OEM to happen more quickly. If the Internet is used appropriately, its effect on that relationship can be profound. The human element underlies that, and companies still absolutely require good managerial talent with the requisite skills to manage the relationship on both ends.”

Indeed, TFI says the growth of the industry is forcing change in traditional business relationships. “To get the cost efficiency advantages that the virtual manufacturing strategy offers, CMs must be allowed to do what they do best. That means allowing them to manage more of the supply chain and to take over more responsibility for the value chain. OEMs need to let them order, let them buy bulk from electronics distributors, allow them to influence design for manufacturability and selection of components to go on the board. That’s where the efficiencies will come from.”

With all this upward potential, what can go wrong? “It’s a growth thing,” Miscoll says. “The only thing that could cause them to stumble is collective stupidity on the part of the industry, but I just don’t see that happening. These are going to become huge companies, however, and I always wonder about the management talent requisite for running an enterprise like that. It’s one thing to be an engineer, to build boards and configure an assembly line and run a supply chain. It’s another to be running a multinational conglomerate that has to answer to Wall Street each quarter.”

Despite the growth of contract manufacturing, Miscoll says it accounts for only 12% of electronics manufacturing today. But by 2004, TFI predicts that figure will rise to 23%. Where will it end? Much higher, says TFI. “We think the 70% to 80% range is appropriate. That is because some OEMs always keep their most cutting edge advanced technology in house, and would be reluctant to share it.”

Dataquest

“The EMS market consists of companies which manufacture products for other companies – circuit boards, subassemblies, and kitting, and which do not have their own brand name. They take customer ideas, turn them into design prototypes, and manufacture and possibly ship them,” says Mark Giudici, Director and Principal Analyst of Dataquest’s Semiconductor Supply & Pricing Service.

Giudici notes that the EMS industry is growing at two to three times the rate of growth of the semiconductor industry, “probably at a three-plus rate over electronics, which is at 6% to 7%,” he says. That puts EMS at between 18 – 25%. Giudici says Solectron is the largest of the CEMs, having taken over that position from SCI in 1998.

Dataquest currently is quantifying EMS growth by tiers. According to Giudici, Dataquest has quantified top-tier companies as those with sales in excess of $1-billion, mid size companies from $200 or $500-million to $1-billion, plus many smaller companies serving niche markets. “There are few midsize companies,” he says, “they’re all being taken over by the top tier.” More information concerning Dataquest and the Gartner Group appears at the end of this article.

Bishop & Associates

Bishop includes OEM manufacturers in its EMS estimates – that is, companies that produce their own brands as well as products branded for others. They sized the total market at $67.8-billion in 1999, rising to $87.8-billion this year, a 29.4% growth rate. Although they predict the overall rate of growth will slow to 23.3% between now and 2004, nonetheless they predict the size of the market then will be a whopping $250.4-billion. That compares, says Bishop, with a market that was just $3.2-billion in 1985, $8.6-billion in 1990, and $28.4-billion in 1995.

Conclusion

From every perspective, several points are clear:

·       Top-tier providers of Contract Electronic Manufacturing Services continue to grow rapidly, either from additional business generated by current or new customers, from acquiring manufacturing facilities formerly owned and operated by OEMs, or from acquiring smaller CEMS providers

·        Most observers predict that robust growth will continue, although some see the rate of growth declining somewhat during the next four years

·        Most analysts we interviewed believe that top-tier contract EMS providers before too many years will rival their customers in size, giving them more power to negotiate prices and other aspects of their supplier-to-OEM relationship

·        Despite the explosive and continuing growth of the CEMS, it still serves less than 20% of the current total available market (TAM), which means substantial upward potential remains in place

·       The emergence of the World Wide Web as a tool for design collaboration, supply chain optimization, and more efficient procurement and logistics management is further helping to cement the relationship between OEMs and CEMS providers

·         Despite the growth of CEMS in North America, there has been little CEMS activity within Pacific Rim nations, except for oriental branches of U. S. CEMS providers, and Japan and Korea are still expected to be slow adopters of outsourced manufacturing; many continue to regard manufacturing as a core competency

Editor’s Note: Gartner Group was also contacted during the preparation of this story. Gartner’s Ann Cavanaugh said both Dataquest and Gartner are working on a major study which will define the market, depict its current size, and forecast its growth; the results of their study are not expected to be released until January, 2001.

Bear Stearns Equity Research and IPC declined to participate in this article.

Copyright, ©, Technology  Forecasters, 2000 . Reprinted with permission. (Written Fall, 2000.)