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The Rise of the Mega-Vertical Supplier (August 2007)

    In the outsourcing space for mobile phones, a new class of providers is emerging. Nokia calls them mega-vertical suppliers. These are companies that offer in addition to design and manufacturing an integrated supply chain of internally supplied components. Two companies, Flextronics and Foxconn International Holdings, have been following this paradigm for some time. Developments at other suppliers indicate that the mega-vertical concept is catching on in the mobile phone space. Indeed, Nokia tells MMI that the company definitely recognizes an industry trend toward mega-vertical suppliers that have the capability of providing a wider portfolio of components to Nokia. What’s more, Nokia expects to see that kind of consolidation in the future.
     It could be argued that the future is now because supplier consolidation in the outsourced mobile phone space has already begun. In three cases, an EMS provider or ODM has made or announced one or more deals to build a vertically integrated supply chain for mobile phones, while a fourth company has pledged to put together a vertically integrated solution through arrangements that will include M&A. Consider the following.
    • Lite-On Technology, a Taiwan-based ODM and components supplier, intends to make a tender offer for Perlos, a producer of handset mechanics with headquarters in Finland. According to a statement from Perlos, this deal, when closed, will form “a new powerhouse” in the handset supply chain. The product offerings of the two companies are described as complementary. For handset customers, Lite-On provides phone camera modules, LEDs, keypads, GPS, and various types of sensors. Perlos’ capabilities are listed as handset mechanics, plastics, sheet metals, light guide applications, assemblies and antennas. But the combined offering will not include software or final assembly, according to a Perlos presentation.
    • EMS provider Jurong Technologies (Singapore) has announced three investments that will enable it to act as a vertically integrated ODM for mobile phones (July, p. 5). In its most recent move, the company plans to add cell-phone design capabilities by acquiring a controlling interest in i-Sirius Pte Ltd., which develops and sells GSM modules and designs handsets based on these modules. On the mechanics side of the supply chain, Jurong acquired plastics supplier Amould Plastic Industries this year and entered into an agreement to purchase a majority interest in SEB, which engages in both plastics injection molding and metal stamping.
    • Perhaps the most visible example of the mega-vertical trend in action is Jabil Circuit’s acquisition of Taiwan Green Point Enterprises, a plastics supplier, early this year (Nov. 2006, p. 1-2; Jan. 2007, p. 6). This deal gave Jabil a vertical capability in electromechanical parts for mobile phones and other consumer products. The acquisition addressed the handset supply chain in particular, since when the deal was announced, Green Point had a 12% market share in handset casings.
     Green Point is part of Jabil’s newly formed Consumer Division, which goes into effect Sept. 1. The division will combine dedicated design resources with vertically integrated supply chain solutions and certain existing and planned manufacturing operations to provide low-cost solutions for mobile phone and other consumer electronics customers. Jabil sees the needs of its consumer products customers as distinct from those of its other customers, who will be served by a separate EMS Division.
    • Elcoteq, a top-ten EMS provider, is working on broadening its offering for terminal products customers, especially mobile phone manufacturers. Under its Integrated EMS strategy, Elcoteq is striving to add mechanics expertise and services as well as combine electronics and mechanics capabilities for product development (July, p. 4). Besides developing existing operating models, the company has said that certain M&A arrangements will be needed to carry out this plan. Another option is to look at various forms of collaboration with other companies operating in the same field.
     According to Elcoteq, mobile phone manufacturers need partners to independently manage a wider range of services because of more complex product structures and shorter product lifecycles.
     Jouni Hartikainen, Elcoteq’s president and CEO, told analysts in July he believes that the company can stop the trend in declining sales to Nokia with what is contained in Elcoteq’s Integrated EMS plan. (Together, the Nokia and Ericsson groups accounted for 53% of Elcoteq’s sales in Q2 2007.)
     Nokia finds that several benefits accrue from utilizing a mega-vertical supplier. The company informs MMI that a consolidated supply chain adds some cost effectiveness, provides flexibility, and leads to smaller overhead costs for Nokia.
     With Nokia’s blessing, this mega-vertical trend is here to stay.

Labor Quest (Editor's Last Word, October 2007)

    The EMS industry has a history of looking for places that would reduce labor costs. Today is no different. Providers are expanding into Eastern Europe because wages in Central Europe’s Hungary, Poland and the Czech Republic are higher by comparison. Vietnam offers lower labor costs than in China, and the flood gates are beginning to open for EMS investment in Vietnam. However, to say that the industry is merely chasing low-cost labor around the globe misses the point. What providers are seeking is the lowest delivered cost of customer product. Harnessing a low-cost labor pool is only the first step toward this goal.
     In a typical scenario for a new low-cost location, a provider would line up one or two customers who would commit production to the new facility when built. There is an unwritten industry rule that says EMS providers don’t build plants on spec. When the new facility goes live, it would usually start with products that are high enough in labor content that the customer would see a net cost reduction. But the vast majority of products where labor content is low would not be good candidates for this plant. That’s because, as the EMS world knows all too well, the cost of a customer’s product in most cases is largely driven by the materials content of the BOM. Unless the new location would result in a lower cost BOM, the provider would have a hard time selling many customers on this location. That’s where a local supply base comes in.
     More than once, MMI has presented the need to develop a local supply base for such low-cost locations. China is now so dominant in the EMS business because it combines low labor and material costs. But building up a local supply base can take years.
     In the case of Vietnam, the typical playbook for low-cost greenfield operations is being tossed aside by Hon Hai Precision Industry. For one thing, Hon Hai is not starting with a modest investment in one site. Reportedly, the company intends to invest in five or six different locations in Vietnam under a $5-billion plan to single-handedly develop Vietnam into a major center for EMS in Asia. Hon Hai is also departing from the norm by planning this huge investment ahead of customer demand. It would be far fetched to assume that Hon Hai has customers lined up already to justify its investment in five or six industrial parks and associated amenities.
     Because of the scale of this development, Hon Hai will need to create a local supply base to feed its manufacturing sites. This is no small task, but Hon Hai has supplier clout and affiliated companies to bring to bear. What’s more, these sites must be able to demonstrate fairly quickly that customer quality levels won’t suffer. Vietnam could be Hon Hai’s biggest challenge yet.
     The quest for low-cost labor continues, while Hon Hai makes its own rules for the pursuit.

Copyright 2007 JBT Communications. Copying, posting, publishing or distributing these articles without permission is prohibited.

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