Outsourcing in a troubled economy

The global economic crisis is certain to have an impact on outsourcing in the electronics industry. What’s not certain is whether the crisis will spur a new round in outsourcing or prompt a contraction among EMS (electronic manufacturing services) companies and ODMs (original design manufacturers).
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So far, projections for 2009 show a flat year for EMS providers and ODMs. “Based on projections of a zero-growth years for the global electronics industry, it is estimated that 2009 revenue in the EMS sector will be flat to less than 1% growth,” said Charlie Barnhart, principal at Charlie Barnhart & Associates in Hawaii. Barnhart notes that even in a flat year, outsourcing market share is shifting from EMS providers or CMs (contract manufacturers) to ODMs.

Barnhart’s research projects CMs will see growth that is flat to a 3% drop in 2009, while ODMs will see flat to a 3% growth. “This is predictive of a continuation in the transfer for market share from the CM to the ODM solution,” he said. Barnhart noted the movement of market share from CMs to ODMs could be further exacerbated by particularly weak economic growth in all G7 countries.

Are recessions good for outsourcing?

Economic downturns are not necessarily bad new for EMS providers. During the 2000-2002 recession, many OEMs in the electronics industry offloaded their manufacturing to EMS providers, fueling a boom in EMS. “If you look at the EMS industry from 2001 to 2004, you’ll see an 11% compounded growth rate,” said Adam Pick, principal analyst, EMS/ODM at iSuppli Corp in El Segundo, Calif. “During that recession, OEMs looked for ways to control costs and trim their balance sheets.” To accomplish this, they turned to EMS providers.

Outsourcing has traditionally maintained a faster growth rate than the overall economy simply because a good chunk of the total manufacturing market share was being shifted to EMS providers. “If you look back 20 years, in almost every period, outsourcing outperforms total available market,” said Matt Chanoff, chief economist at Technology Forecasters Inc in Alameda, Calif.

Chanoff points to some indications, the economic troubles could continue to drive outsourcing. “Companies still want to reduce their balance sheets and get more stuff outsourced,” he said. “And they want to move their manufacturing to lower costs.”

The current economic downturn, however, may be quite different from previous recessions. For one thing, most OEMs have already offloaded their manufacturing, so there are few cuts they can take by outsourcing. “Is 2008 the same as 2001? This is a pretty mature industry now, so the growth rate of EMS isn’t going to fuel this like before,” said iSuppli’s Pick. “Consumer demand is waning, so I don’t think this is going to have the same effect this time.”

Chanoff agrees there is little room for the major OEMs to push more manufacturing out the door. “Most of the OEMs are 100% outsourced,” said Chanoff of Technology Forecasters. “So the OEMs and the outsourcing companies are going to move more or less in lock step.”

Those who shunned outsourcing may change their minds

One area of potential growth for EMS providers during this downturn is with portions of the market that have not yet adopted outsourcing. The defense industries, aerospace and medical equipment have kept their manufacturing in-house. Proprietary concerns may close the door on outsourcing for defense, but medial and aerospace are on the radar for EMS companies seeking new customers. “There has been some movement in medical equipment as EMS providers have been trying to convince medical manufacturing companies that they can meet their hybrid work and sterile environments,” said Chanoff. “But I don’t think the current economic conditions will jolt it.”

Japan is a possible outsourcing target they may be susceptible to economic jolt. While Japan likes to hold its manufacturing close to the vest, the economic benefits of outsourcing may convince these companies to finally look for cheap manufacturing. “The thing to watch is to see if Japan joins outsourcing,” said Chanoff. “Japan is 10 to 20% of the total available market. They don’t normally outsource, but if they did, that change would be huge.”

Barnhart also sees potential for Japan giving the EMS industry a boost. “Japan is a potential bright spot. OEMs tend to expand their fixed-to-variable-based cost initiatives during periods of downturns,” said Barnhart. He noted that Japan OEMs represent one third of the global TAM (total available market) and only one-eighth of global outsourcing. “They are experiencing unprecedented levels of competition from lower-cost producers in China and India. So we might see a significant up-tick in outsourcing from Japan.”

Dell of Round Rock, Texas, is also a potential newcomer to outsourcing. Last fall, Dell announced it would begin to shift its manufacturing offshore. But so far, there is little evidence that Dell has actually started the process. “Dell said they would start selling off factories, but we haven’t seen it yet,” said Chanoff from Technology Forecasters.

Meanwhile, some manufacturers may actually start taking some of their manufacturing back in-house. “There are unconfirmed reports that Alcatel [Alcatel-Lucent] is moving a billion dollars of its outsourcing back in-house,” said Chanoff. “There have also been some reports in the Chinese press about a couple ODMs that are losing business as people move things back in-house. But so far, it’s too little and too confusing to base a forecast on.”

Non-manufacturing outsourcing

Manufacturers are outsourcing more than just their manufacturing. They’re sending out engineering support, software development, and IT work. This type of outsourcing will likely increase during the economic downturn.

“For the last few years, we’ve said the services sector of outsourcing is going to grow,” said Russ Novak, director of research at ARC Advisory Group in Dedham, Mass. “Manufacturers outsourced zero of their services a few years ago. Now some are outsourcing 90% of their IT.”

Many manufacturers are already using domestic support for design engineering and engineering for manufacturing. With the pressure of the economic crunch, companies are looking into moving more of these tasks out, and much of that work may go to Asia.

“A lot of the engineering services have been moved out, and we’re seeing companies investigating India and China,” said Phil Fersht, research director for global services and outsourcing at AMR Research in Boston, Mass. “The engineering work that is getting outsourced tends to be in technical areas and software development.”

Fersht noted the interest is outsourcing engineering services has increased with the downturn. Yet he warns companies against making hasty decisions in the interest of cutting costs quickly. “We’re exceptionally busy helping clients look at these options, but we’re recommending against quick moves to save money,” said Fersht. “Companies are looking at low-hanging-fruit opportunities such as application outsourcing and transactional procurement – areas that don’t require long-term investments.”

Since the economic pressures are global, manufacturers are finding a ripe market when they look for companies to take on more of their work. Service companies in India and China have been cutting prices in order the lure services outsourcing. “We’re seeing companies vigorously seeking better deals in their outsourcing,” said Fersht. “And we’re seeing downward pressure on prices because so many companies [in India and China] are trying to get this work.”

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BY Rob Spiegel, Contributing Editor -- Electronic Business
Source：Electronics Design, Strategy, News