MarketWatch Commentary

EMS companies have been faring well, relatively speaking, and the strategic moves to diversify into new markets with important core capability links has analysts and market researchers generally more bullish than conservative. 

What is particularly interesting, as we continue to watch the ongoing EMS-ODM turf war (cf. MarketWatch Quarterly Vol. 1:1, "EMS/ODM a Mixed Market;" and Vol. 2:2, "Co-Evolution and Organic Growth"), is the varied strategies EMS companies are embracing.  As well presented in the latest MMI (Vol. 20:1, pp. 1-4) report, some EMS companies are following a new, retail path (e.g., Hon Hai's retail outlets); some are expanding to sister industries (e.g., Jabil's venture into solar panels and medical disposables); some are supporting new supply chains for the still fragmented clean/smart technologies (cf. the latest MarketWatch Quarterly Vol. 3:4, now available to subscribers and next week to the public); and some are engaging in more traditional M&A deals to expand their market reach and capabilities (e.g., Celestica's acquisition of Invec Solutions, as reported in MMI Vol. 20:1, pp. 2, 7).

Among the other trends forecasted by market analysts, we should see a resumption of more normal consolidation numbers for small- to mid-sized companies, renewed momentum for regionalization/localization (cf. MarketWatch Quarterly Vol. 2:3, "An Expanding European Microcosm" for more discussions on localization), and continued distinctions between EMS and ODM businesses but with increased "credibility to a hybrid strategy" (MMI Vol. 20:1, p.4).

The next one to three years hold promise for the EMS sector, and based on early analysts' reports for 2010, the new market opportunities may provide important growth for EMS in directions beyond the past 'turf wars' with ODMs.

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As 3Q09 reports begin to trickle in there are positive indicators that indeed, the recovery is upon us, though no one is expecting a spike that is sustainable just yet. With the retrenchment of so many along the supply chain to reign in inventory numbers, protect margins and safeguard company health, there were also the opportunities for acquisition, mergers and JVs, as discussed here and here in earlier MarketWatch Commentary posts.

In sum, both the EMS and ODM sectors are down in double digits YoY, but ODMs appear to be doing better overall, as nicely summarized in Manufacturing Market Insider's recent September 2009 issue (Vol. 19:9, pp. 1-6). 'Doing better' doesn't mean positive numbers just yet, rather, not as down as EMS. "Large Taiwan-Based ODMs" are down -9.9% for 1H09, while the "largest EMS providers" were down -19.2% for the similar time period, including Hon Hai in the group (MMI 19:9 p. 3, 1); without Hon Hai, the decline would be -27.1%.

Why the difference between ODMs and EMS? One critical variable is the inventory realignments. EMS companies certainly felt considerable stress from both sides of their supply chains as inventory management issues left many EMS companies with difficult strategic decisions: working with OEMs and their downstream channel partners simultaneously, both of whom wanted inventory off of their books and docks. ODMs too felt the pinch this year, but of course with new market demands from consumers and OEMs having to reconsider margins, redesigns and innovative designs are in demand.

Those EMS companies faring the best, most notably Hon Hai, continue to do so based on "blue-chip" customers, diversification (i.e., not being a pure-play EMS) and supporting subsidiary units that can contribute and off-set other units' downturn periods. As MMI notes, though, one question about the outlier, Hon Hai, is whether it can continue to be considered an EMS or will it become more of a conglomerate? (ibid., p.3).

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MMI's numbers show that M&A, inclusive of consolidations, were down by roughly 80% YoY!  Yes, that is indeed a historic number.  To simplify, general analysts' consensus is that during economic downturns consolidations tend to rise as a result of cash-strapped corporations looking to increase margins, move capabilities back in-house, and/or simply find alternative ways to stave off insolvency or to make a market move for future expansion and market share increases by acquiring capabilities during a fire-sale.  This just didn't happen, despite what we all thought!

Interestingly, cash savings and murky outlooks seem to have been so much at the fore that even the opportunity to buy while the buying was good proved to be too risky for most.  Moreover, the historic downturn in 1H09 breaks a long-standing EMS/ODM market trend of regular M&A activity in order to increase or expand capabilities. 

As MMI notes, the lack of M&A activity in light of the EMS/ODM trend "[...] indicates that in the business climate of the first half some providers either elected to put off acquiring a new capability or decided to develop it in-house instead." (MMI, Vol.19 No.7, p. 2) 

So, what was up?  Joint ventures (JV).  Why?  Well, JVs tend to cost a lot less but come with limited risk exposure for a comparable gain in access to the desired assets or market (ibid., pp. 2-3).  Of note: MMI does not include EMS divestitures that are not retained in the EMS sector which could skew the data (ibid., p.3).

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In the middle of the month, DigiTimes 4/15/09, released some good news about 3Q09 foundry sector growth to come because of orders from netbook and 3G handset makers.  Despite Nokia and Sony-Ericsson's slumping 1Q09 earnings calls, drilling down into the MID, smartphone and 3G subsector, we come to a likely source of the mobile market driver and the better news.

A great example of such a source is the SanDisk earnings call transcript from 4/21/09.  Herein we find some important information underscoring the positive impact that MIDs and their product cousins are having along the supply chain (check out this ZDNet blog for more commentary).  According to Dr. Eli Harari, Chairman and CEO of SanDisk:

In the second half of this year, we [at SanDisk] expect demand for NAND to continue to grow particularly for mobile and portable computing platforms and this should hopefully absorb the industry supply growth projected for second half. [...]

As for demand creation, I believe that the handset business is being transformed on a scale similar to that which the web experienced in its early days and this has far-reaching implications for our mobile storage business.

That's great for the component specific side of the coin, but what about the rest of the mobile device? The mobile OEMs are also transforming, now favoring ‘insourcing' as bell weathers like Nokia reverse course to reduce cost and improve profitability.  According to a report by iSuppli's senior analyst, Jeffrey Wu, "Nokia in 2008 decreased the percentage of its outsourced manufacture volume to 17.1 percent, down from 21.5 percent in 2007.  This reflects a larger trend in the mobile-handset supply chain."

iSuppli's Wu has a new white paper that looks more closely at "the fatal pitfalls in wireless handset outsourcing."  This is an important read because the relationship between OEMs and CMs is certainly changing and the supply chains are changed by the present market forces.  These types of supply chain changes are also explored in more detail here.  Certainly, it's not business as usual - as if we didn't already know that.  But knowing why is different than knowing what.

It'll be interesting to see what the decrease in outsourcing will mean to the ODM-EMS turf wars as we continue to walk through the new territory of 2009.

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