More and more original equipment manufacturers (OEMs) are outsourcing assembly. They are getting leaner, eliminating plants and equipment, while contract manufacturers are becoming the new production partners for many industries. By outsourcing manufacturing, OEMs are able to deal with increasing price and profit pressures, while managing to meet changing market requirements. In addition, they are able to handle ever-shortening product lifecycles and churn out products quickly and economically. In fact, some companies operate without owning a single brick-and-mortar factory, relying solely on contract manufacturing.

As for contract manufacturers, this trend is driving significant growth. The global market for contract manufacturing is projected to increase from $103 billion in 2000 to $231 billion in 2005, says Massachusetts-based International Data Corp. In fact, in North America alone, EMS (electronics manufacturing services) providers generated $35.8 billion in sales in 2001—that's roughly 30% of the continent's total electronics assembly industry. By 2005, they are expected to take in much more—over $60 billion in sales, says Illinois-based IPC. Even IBM has gotten into the picture—offering manufacturing services to OEMs. Contract manufacturers have grown and evolved quickly, expanding from one-service shops that assembled printed circuit boards in the 1970s to supply chain specialists offering services such as product design, supply chain management, repair, and global distribution and logistics in addition to assembly and manufacturing.

The contract manufacturing phenomenon shows no signs of slowing down. In the past, electronics manufacturers in the U.S. and Europe were the main customers of contract manufacturers, but now Japanese companies are outsourcing as well. In addition, automakers are considering this solution. EMS providers are adding fiber optic component and medical device OEMs to their list of clients, which already includes manufacturers of computers, cell phones, telecommunications hardware and other electronic products. In fact, an overwhelming 87% of OEMs intend to outsource more in 2003, says a recent survey by New York-based Bear, Stearns & Co. "OEMs expect to increase their outsourcing to reduce costs and capital spending," says Thomas Hopkins, Bear Stearns managing director and EMS analyst.

Cost is a substantial part of the reason why OEMs outsource. By relying on outsourcing for most or all products, electronic product companies can attain "5% to 20% savings on material and labor costs, 10% reductions in overhead, and investor-attractive financial ratios," says Pamela Gordon, president of Technology Forecasters Inc., CA. In fact, for many OEMs, reduced cost is the EMS industry's main draw. "Cost is the biggest advantage from using contract manufacturers," says Reiko Tomasch, senior EMS analyst at Connecticut-based Gartner Dataquest Inc. "Because contract manufacturers have a lower cost structure than OEMs, they can usually reduce the cost of the product. If OEMs are divesting their manufacturing arm to these companies, they are going from fixed cost to variable cost. They only pay for what they can sell."

Contract manufacturers also keep costs down because of their sheer buying power. "A contract manufacturer can aggregate demand from a multitude of OEMs and use that clout in the marketplace to get better prices and a more stable supply of parts than any OEM could muster on its own," says Kevin Keegan, director of management consulting at PRTM, Massachusetts. "With materials accounting for up to 80% of a product's cost, small gains through materials management can have big bottom-line results." Such impressive results can be seen in the telecommunications equipment industry where increased reliance on contract manufacturing helped manufacturers reduce total supply chain costs from 11.6% to 6.1% of revenue from 1997 to 2001.

Cost is not the only dynamic. "Cost is driving demand for contract manufacturing, but there are other drivers, like time-to-market," says EMS analyst Tomasch. "As electronic product lifecycles shorten, time-to-market increasingly affects the bottom line." Contract manufacturers allow OEMs to launch their product quickly. For example, California-based Handspring Inc. enlisted the services of Flextronics and Solectron instead of building its own manufacturing facilities and was able to bring its Visor handheld computer to market just 15 months after the company's founding.

Contract manufacturers bring many other advantages such as greater efficiency, improved product quality, responsiveness, advanced production technology and increased capacity. All of these pluses allow OEMs to focus on their strengths and increase their flexibility in the market. "Leveraging the expertise of a strategic partner in the EMS industry enables Motorola to anticipate our customers' evolving needs better and speed our products to market around the world," says Christopher Galvin, chairman and CEO of Illinois-based Motorola Inc. "Motorola must remain nimble in order to stay ahead of the marketplace and grow our position as a technology leader."

Outsourcing manufacturing does have a downside, however. First of all, when they outsource, OEMs are giving up control over manufacturing. This means that extensive engineering changes can be harder to execute. Secondly, the transition from an internal manufacturing model to outsourced assembly is an arduous process and one that many companies are not prepared for. They have to manage the shift to outsourcing and later, the EMS relationship. Thirdly, many companies believe outsourcing manufacturing will hamper product differentiation. And finally, contract manufacturing is simply not a good fit for companies whose products have fluctuating demand or require complicated assembly processes or equipment. "Contract manufacturers are at their most efficient when running at high volumes, with minimal engineering changes," says Keegan from PRTM.

When considering whether to outsource manufacturing or not, keep these particular strengths and weaknesses in mind. "In general, OEMs are more likely to use contract manufacturing services for optimization of commodity products or those nearing end-of-life status," says Keegan. Furthermore, once you have chosen to outsource, work out the details such as incentives, quality assurance, legal liability and future product modifications. "Once you start transferring production lines to a contract manufacturer, there is often little or no time to respond to unforeseen issues, such as quality problems, supplier shortages or inflexible lead times around the world," says Keegan. "It is therefore crucial to have identified and worked around the rocks before the water level plunges." Foremost is communicating effectively with your EMS provider. "Remember, you are probably in it for the long-haul," says EMS analyst Tomasch.

Sources: Contract Manufacturing On the Rise
Austin Weber
Assembly Magazine, September 2002
http://www.assemblymag.com/execute-vSection-Articles-vSub-Detail-vSideBar-Active-vrID-5A33CA5B12A8421D917A67AC2EDBEF83-vDate-September+2002.htm#

IBM to Offer Contract Manufacturing
Assembly Magazine, September 2002
http://www.assemblymag.com/execute-vSection-Articles-vSub-Detail-vSideBar-Active-vrID-5ACDF9701870457F8E72B15FF917E6BB-vDate-September+2002.htm#