EMS/ODM a Mixed Market - Bullish for Players with a Core Strategy

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Analysts are bullish on the electronics manufacturing services (EMS) and original design manufacturer (ODM) markets’ prospects for continued year-over-year double digit growth.  This growth is based on the forecasted increase in business opportunities due to continued outsourcing by original equipment manufacturers (OEMs).  Of course, such a positive outlook for increased opportunities doesn’t guarantee the success of all players.  Analysts look for winners in the EMS and ODM markets to possess a solid core strategy and client base that the entire company is committed to.  In the event that business strategies begin to waver and flip-flop, a company in today’s mixed market may no longer be running with bulls, but be trampled by them. 

This article will offer a brief review of the EMS, ODM and OEM markets’ results for 2006 through 2Q07 as a frame for understanding financial analysts’ predictions that sustained increases in outsourcing could strengthen some companies’ 2007 performance.  Following, we will consider some key points to success from the market leaders of small and large companies, as well as pitfalls to avoid.

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The Year in Review and the One Ahead
2006 was another banner year for the EMS sector with just over 15% growth and record high sales of US$129.2bil (Manufacturing Market Insider (MMI), www.mfgmkt.com).  Similarly, the ODM market saw double digit year-over-year growth, with the top 10 companies achieving 20% growth (iSuppli Corporation, Quarterly Market Tracker, www.isuppli.com).  Yet the highest growth rates were reserved for a very small group of EMS and ODM companies whose numbers significantly boost the overall sector: Foxconn/Hon Hai, Flextronics, Jabil, Asustek and LiteOn, to name top Y2006 performers from each sector respectively.  According to iSuppli Corp., Foxconn and Asustek alone represent 57% (or US$18.5bil) of the revenue increases seen in 2006, a staggering number and a business strategy that is worth understanding (http://www.isuppli.com/news/default.asp?id=7823&m=4&y=2007).

Several key indicators provide a glimpse into analysts view of the market trajectory for a mixed 2007.  Mergers and acquisitions (M&A) are on the decline, down 15% in Y2006 over Y2005, but in line with the low end of Y2004 numbers (i.e., Y2004 saw 48 deals, Y2005 saw 55, and Y2006 saw 47) (MMI Vol.17.2:1).  In addition, geographic shifts have slowed, inventory issues continue, companies are re-organizing and reviewing strategies that will enable them to leverage existing investments, core competencies are being reaffirmed.  Presently, the most successful EMS and ODM companies have the strategic insight to focus on their most valued clients – to the point of engaging in new M&A only to enhance and entrench the client relationship while improving margins.  The enhancement of client relationships is paramount – since the prospect of a bullish Y2007 is based on increased OEM outsourcing to EMS and ODM companies, those with the best relationships and market positions will be the most likely to receive this important follow-on business.

Bullish on 2007 for OEM Outsourcing Opportunities
A major force behind the bullish outlook for 2007 and beyond is the continued opportunities in OEM outsourcing, according to financial and market analysts at Morgan Stanley, UBS, and iSuppli Corp.  The critical variable to realizing this positive growth potential, as exemplified by Foxconn/Hon Hai and Asustek, is the EMS and ODMs company’s ability to extend their reach through the supply chain, realize opportunities in non-traditional markets (e.g., industrial, medical, automotive, aerospace, and energy) and, most importantly, to increase outsourcing opportunities with existing OEM clients. 

Although there are indicators that suggest OEMs are limiting the amount of outsourcing they engage in, the average percentages still rest around 20%, leaving significant room for EMS and ODM growth despite OEM downshifts.  These opportunities are particularly significant if EMS and ODM companies offer value added services that address and contribute to OEMs’ business strategies and needs such as Lean Practices, supply chain visibility and agility, regulatory requirements, and design services.

Other Strategies for Success
Past strategies included M&A, geographic movements (high- versus low-cost regional locations) and expanding client lists.  These are no longer touted as the most successful tactics for the present market.  Today’s market requires introspection on the part of the EMS or ODM, regardless of size: identify and leverage your core customer base and assets, diversify only with strict intent.

Granted this is a simplification of the required business strategies; pricing is a real issue to OEMs and hence margins are critical to an EMS or ODM company’s ability to increase profits.  However, in order to realize higher margins, analysts counsel that EMS and ODMs must leverage what they have and know rather than continuing to buy and move to please clients and find the elusive cheaper production site.  By leveraging existing geographic locations, even in high-cost regions, to meet the needs of regionally based markets, new opportunities will arise.  For example, industrial markets with lower volume output and regional logistical requirements (e.g., medical, industrial, automotive and aerospace) may provide new opportunities to successfully utilize existing high-cost region holdings.  This approach increases margins and attracts contracts whose life cycle is counted in months and years rather than days or weeks – a win-win from a profitability perspective for the EMS or ODM company. 

Consider a company such as Kitron with a 40-year history in a high-cost region, an identified core, and a client understanding that breeds continued success (www.kitron.com).  Kitron recognizes that logistics and knowledge are critical components to achieving flexibility and quality for their client base.  As a result, they have secured follow-on and long-term contract orders while expanding their market share within their core market sectors.  Successful companies of all sizes are recognizing that niche markets are a critical variable to couple with bullish market growth strategies.  Companies such as Enics recognize their strength in industrial and medical electronics, and have become leaders in this arena while increasing holdings in their high-cost region (www.enics.com). Similarly, PartnerTech has seen its focus on core competencies, regional strengths, and client dedication pay off by doubling sales and operating profits with new orders from existing clients (www.partnertech.com).  

Competence, capability, and knowledge (IP), along with design opportunities and visibility throughout the supply chain are the current means to successful margin-building strategies.  Bringing value-adds to the table that bear higher margins and strengthen client ties is an important lesson to learn from leaders in every tier.

Pitfalls to Avoid
While today’s successful EMS/ODM strategies are different from the near past, some analysts note that too much change portends disaster in today’s market.  As we see from lessons being learned by some major players, too much change in client bases, core, or management can be harmful.  Exploring new markets may come at the cost of missed opportunities to leverage your IP as a high margin value-add.

Certainly the titans are realizing success in early-mover decisions to China and Vietnam, but leaving good assets behind in high-cost regions is myopic.  The greatest EMS and ODM mistakes seen by most analysts in today’s market are losing sight of the importance of existing client return business and the inability to recognize those client opportunities based on existing strengths and locations. 

While current market conditions may lead some observers to be bearish on aspects of the EMS and ODM market sector, the continued expansion in OEM outsourcing in 2007 presents a growth opportunity for the EMS and ODM companies with well-aligned strategies.  However, in order to not be trampled by the bulls it is imperative to keep a keen eye to the company’s core.  It is not about new geographic horizons and chasing markets, but rather about mining existing assets, opportunities, and most importantly OEM-client relationships. 

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