The Unstoppable Growth of Electronics Manufacturing: The Assembling of Printed Circuit Boards, Electronics Subsystems, and Finished Electronics-Based Products Is a Global Market Expected to Be Worth More Than [Euro]1.2 Trillion in 2004 and Is Forecast to Grow to [Euro]1.5 Trillion by 2007
Wendin, Christine, European Business Forum
The Gulfstream G550 jet, the trendy iPod, the addictive PlayStation and the sleek Sony wall-size plasma TV all have something in common. Not the fact that they are all at the top of your wish list. Rather, each of them relies on the lowly printed circuit board (PCB), a green plastic card that houses and interconnects electronic components. PCBs, which are typically associated with computer systems, are at the heart of a diverse portfolio of products: household appliances, consumer electronics, mobile phones, toys, medical equipment, automotive sub-systems, and aerospace components.
The assembling of PCBs, electronics subsystems, and finished electronics-based products, has become a big business. These activities, collectively referred to as electronics manufacturing, have resulted in a global market that is expected to be worth more than [euro]1.2 trillion in 2004 and is forecasted to grow to [euro]1.5 trillion by 2007, according to market research firm Electronics.ca Publications.
A booming industry
Electronics manufacturing has been a growing industry since the 1950s when such consumer electronics as TVs became mainstream products. With the birth of the personal computer and the resulting high-technology revolution, the industry boomed and its dynamics also began to change. In particular, the companies that made and sold the electronics products, called original equipment manufacturers (OEMs), began to outsource some of the manufacturing processes to contract service providers in an attempt to cut costs on products that were becoming commoditised.
Today, two major trends are affecting the electronics manufacturing industry. First, pricing pressure continues to affect more and more electronics-based products as they become standards-based, from PCs and DVD players to digital cameras and mobile phones. The result is that product makers outsource additional functions in an attempt to reduce costs, capture more profit margins, and remain competitive.
Second, China and other Asian countries have emerged as crucial forces: first, as low-cost locations for manufacturing centres, which intensifies pressure on margins, and, second, as potential new market opportunities in serving the growing Asian domestic electronics market. Together, these trends are reshaping the landscape of electronics manufacturing.
Growth of outsourcing
Over the last decade, increased outsourcing by OEMs to better manage costs has already had a significant impact on the industry with the emergence of electronics manufacturing services (EMS) providers like Celestica, Flextronics, Sanmina-SCI, and Solectron. EMS comprises manufacturing of PCBs, assembly and integration of electronics systems, supply chain management of materials, and other related services. EMS emerged as a result of the increasing commoditisation of electronics-based products, which erodes OEM profit margins. These service providers differed from the first contract manufacturing service providers in that they provided higher value services than simply assembly of PCBs or subsystems.
Generally, the viability of any given electronics product is determined by the OEM's ability to maintain an adequate profit margin while selling enough unit volume to adequately fund research and development (R & D) for the next generation of products. However, as technology becomes commoditised, the intellectual property (IP) that distinguishes the product is no longer characterised by a proprietary design or components that belong to the OEM. Instead, the IP that characterises the product resides in highly engineered components like PC microprocessors.
Products once characterised by de facto or de jure architectures and interfaces become those in which the IP is subsumed into a standardised component. In this scenario, component makers are the ones that reap the largest margins, at the expense of OEMs, and as product categories become commoditised, component manufacturers are likely to see continuing growth, as they have over the past year.
When IP migrates to components that can be purchased off the shelf, new entrants face lower barriers to entry and OEM margins come under pressure. To maintain profitability, OEMs typically move more functions out of house; this is often referred to as a 'horizontally disintegrated manufacturing model.' This trend of IP migration that began in the PC industry is now reflected in other technology markets and it will continue. As a result, OEMs will continue to outsource electronics manufacturing in the future--but EMS companies will not necessarily garner the business (see chart above).
Instead, the emerging original design manufacturer (ODMs) segment, which includes Asian-based companies like Compal Electronics, Foxconn-Hon Hai, and Quanta Computers will play an increasingly important role. ODMs sell finished goods (often called white boxes) and subsystems that multiple OEMs can label and sell under their own brands. Unlike EMS companies, ODMs invest in R & D, for example to meet the unique requirements of laptop computers, to enable them to design finished products. The ODMs own all of the IP generated through these efforts. ODMs amortise their R & D investments across the many OEM customers that buy and market the ODM's finished products under their own brands.
The ODM business model for IT products originated in Taiwan to serve the laptop computer product segment. Taiwanese manufacturers invested in engineering and design R & D for the requirements of miniaturisation, power management, and durability needed to enhance laptops. As recently as 1995, Taiwan was directly responsible for a small percentage of all laptops manufactured globally. In 2004, an estimated 80 per cent of all laptops will be manufactured in Taiwan, although few end customers know the names of the ODM companies such as Compal and Quanta.
ODMs have expanded their product portfolio beyond laptops and now develop mobile phones, low-end servers, and some communication products. As they acquire more design skills, they will be able to expand into areas such as consumer electronics, low-end printers, set-top boxes, and other high-volume standardized products. The ODM business model continues to develop, and ODMs have been undertaking more contract manufacturing to take advantage of their low-cost region locations and to compete with EMS vendors on price. ODMs have also started manufacturing in regions outside of Asia, such as North America and Europe, competing directly with the EMS vendor's primary value proposition of global manufacturing and logistics.
In 2003, revenue for the contract manufacturing market, which includes EMS and ODM, was $135 billion worldwide according to market research firm Gartner, with ODMs accounting for about only 30 per cent of the total. By 2007, revenues are expected to be around $250 billion. However, PricewaterhouseCoopers forecasts that because of increased IP migration, ODMs will own nearly one half of the market. This shift has profound implications for all participants in the electronics manufacturing value chain.
For OEMs, the establishment of a mature ODM industry provides the opportunity to reduce product costs by shedding in-house design functions for low-margin product segments. OEMs could even migrate to a so-called 'no-touch' model in which their primary function is marketing and branding--the ODM or other service provider would manage design, manufacturing, distribution, and repair.
In Europe, computer maker Acer has essentially moved to such a model for its desktop computer segment by partnering with ODM Foxconn-Hon Hai. In the US, it is expected that other companies might follow a similar strategy. However, it's unlikely that an OEM would move to this model wholesale, but instead would do so for specific product segments like low-end desktops or laptops. The determination of just which product segments to design in-house and which to outsource will become of strategic importance. Likewise, brand establishment and protection will also be crucial activities.
In many new product categories, ODM outsourcing will occur earlier in the product life cycle as standardised product architectures are more quickly defined and standardised components are readily available from suppliers. Recent examples of this trend can be seen in the DVD, PDA, and MP3 portable music player products. Some product categories are being served by the ODM business model at the start of the product life cycle, as with plasma TVs.
For EMS companies, these changing dynamics will result in new business models. Some EMS vendors will implement distinct business models for serving different product segments. In moderate-volume product segments like optical switches, high-end routers, and certain medical equipment, EMS vendors will lead by service, becoming true manufacturing partners to their OEM customers. In these segments, EMS companies are also likely to extend beyond the adjacent functions of value engineering, supply chain management, procurement, and return and repair. In high-volume product segments, EMS providers will lead by design, either providing collaborative design services or functioning as an original design manufacturer.
One thing is certain, however, whether an EMS or ODM provider wins the OEM's business, more and more manufacturing and design will shift to China and other Asian countries. While software industry outsourcing has capitalised on the lower-cost regions of India and Eastern Europe, it still required a highly skilled, often English-speaking labour force. However, the electronics industry essentially needs only the lowest cost labour force, which China can provide.
China's growing role
During the last two years, China has significantly increased its electronics manufacturing capacity. In 2003, manufacturing revenues increased 34 per cent over the previous year, according to Chinese government sources. Total manufacturing in China exceeded 15 million square feet and accounted for more than 60 per cent of all production capacity in Asia, a trend that is expected to continue as the Asian electronics manufacturing market grows. Gartner forecasts a compound annual growth rate of 8 per cent through 2008, bringing Asian revenue for electronic equipment revenue production to $528 billion.
Chinese government policies have successfully encouraged significant new investment in semiconductor design and manufacturing capacity in the region. During 2002 to 2007, it is forecasted that 24 per cent of the world's new semiconductor wafer-fabrication (fab) capacity will be built in China, as will 40 per cent of new integrated circuit (IC) packaging capacity. In 2007, China could account for as much as 8 per cent of worldwide wafer-fab capacity and 22 per cent of worldwide IC packaging capacity.
Many global EMS vendors have been adding manufacturing capacity in China because of its low labour costs and OEM demand that they take advantage of the low-cost region. The presence of a large number of component suppliers also makes China a logical choice in which to aggregate manufacturing capacity, as this puts material and component suppliers in close proximity to EMS vendors. Design capability is also increasing rapidly in China. In 2004, there are approximately 400 Chinese ODMs with aggregate industry revenue of $150 million to $250 million annually.
As electronics manufacturing increases in China, developing and expanding a base of operations and acquiring the expertise for conducting business in the region will be of strategic importance to electronics manufacturing participants. Expansion into China for EMS, ODMs, and OEMs does not come without certain disadvantages. In addition to the risk of cultural differences and the native expertise required to operate a business in China, companies must contend with the increased costs of logistics, inventory management, tariffs, and other expenses. They must also balance the risk of IP theft and exposure through reverse engineering. Companies that aggregate capacity in China face the additional risk of exposing the majority of capacity to the geopolitical uncertainties of a single country.
All of these changes--the increasing use of electronics in all kinds of products, rapid commoditisation, rise of the ODM, and increased manufacturing in China--will affect all participants in the electronics manufacturing value chain. Component suppliers, EMS providers, ODMs, and OEMs will evaluate new business models as they seek to remain competitive in the dynamic industry. And for consumers eyeing all those computers, consumer electronics, and other electronics-based goods, they will likely benefit the most, with lower prices on increasingly sophisticated products.
This article is based on the GTC white paper, part of the Technology Forecast series, EMS: Electronics Manufacturing at a Crossroads. The complete paper is available at: pwc.com/techcentre
RELATED ARTICLE: Key messages
* Two major trends are affecting the electronics manufacturing industry.
* First, pricing pressure continues to affect more and more electronics products as they become standards-based. As a result product makers outsource additional functions in an attempt to reduce costs, capture more profit margins and remain competitive.
* Second, China and other Asian countries have emerged as crucial forces: providing low cost locations for manufacturing and as potential new market opportunities in serving the growing Asian domestic electronics market.
* As a result of these trends the revenue of the electronics contract manufacturing market is expected to grow to an expected $250 billion by 2007 compared to $135 billion in 2003.
* Manufacturers will need to evaluate new business models as they seek to remain competitive in the dynamic electronics industry.
Christine Wendin is an analyst and editor with the PricewaterhouseCoopers Global Technology Centre, which identifies and examines technology's impact on industries, markets, and organisations.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: The Unstoppable Growth of Electronics Manufacturing: The Assembling of Printed Circuit Boards, Electronics Subsystems, and Finished Electronics-Based Products Is a Global Market Expected to Be Worth More Than [Euro]1.2 Trillion in 2004 and Is Forecast to Grow to [Euro]1.5 Trillion by 2007. Contributors: Wendin, Christine - Author. Magazine title: European Business Forum. Issue: 20 Publication date: Winter 2005. Page number: 61+. © 2008 Caspian Publishing Ltd. COPYRIGHT 2005 Gale Group.
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