The EMS business forecast – A tale of two scenarios

IDC recently published its latest forecast for the electronics manufacturing services industry (Worldwide IDC Electronics Manufacturing Services Market Forecast, 2008-2012, March 2008). In this article for VentureOutsource.com, I expand some thoughts on our EMS industry forecast as we examine the state of the U.S. economy. As shown in the table below, we estimated the EMS industry (including EMS firms and ODMs) grew 17% in 2007, mostly due to the strength of the computer and the consumer device segments. Looking forward, these sectors will likely continue to drive the EMS market, leading us to believe the EMS industry will continue to outperform the broader IT market in terms of top-line revenue growth, reaching a compound annual growth rate of 10%. In the short-term, we also expect to see strong revenue growth of 14% in 2008 and 12% in 2009.   Worldwide EMS Industry Revenue Forecast (US$B)

Source: IDC, 2008
	2005	2006	2007	2008	2009	2010	2011	2012
Worldwide EMS sector	121.7	144.6	162.7	183.4	204.5	225.3	243.6	260.6
Worldwide ODM sector	70.3	85.0	105.7	122.3	139.0	152.6	165.1	176.9
Worldwide Total EMS business	192.0	229.6	268.4	305.7	343.5	377.9	408.7	437.5

  This outlook is based in part on the macroeconomic forecast data available through mid-February, which formed our most likely scenario: the U.S. would not move into recession, though there would be a significant slowdown in GDP growth. Combined with a continued strong outlook in the near-term for computers and mobile phones, especially outside the U.S., we still maintain strong expectations for the EMS industry. Deciding that this was the most likely scenario was difficult given the recent economic news, but structural factors seem to reinforce this scenario. Outsourcing remains a core element of the IT industry, which may increase during tough economic times. The total available market (TAM) for the EMS industry should continue to grow, especially for the emerging sectors. Finally, the industry is dependent on Asian manufacturing for more than half of all revenues and, since labor costs are rising in the region, and with margins already thin, outsourcing costs will likely also increase. This is exacerbated by the falling value of the dollar, further increasing costs for OEMs, increasing revenues. These and other factors mean that even in a recessionary period, there are strong arguments in favor of continued top line growth in the EMS industry -- if not profits. Like any forecast, however, this one is based on the most likely scenario at the time it was generated, and decision-makers need to be aware of the alternative scenarios. In 2008, we face a situation where strong forces are feeding into these other scenarios, which may likely bring about another set of outcomes. Where do the threats to our forecast come from? The most immediate threat to the forecast remains the credit crunch in U.S. financial markets. Which path the U.S. economy takes is still muddled. Will attempts to address the current credit issues be successful or is there a more underlying problem at play remains to be seen. IDC's January 2008 Future Scan survey of CIOs and line of business managers showed that spending intentions for the coming year, which had fallen significantly during the second half of 2007, had rebounded in December and in January of 2008. Yet, we are starting to see first quarter retail sales below expectations; the health of financial institutions being increasingly questioned; and continued instability in credit markets. In a reverse from its previous survey, Wall Street Journal's March 13th economist survey shows most respondents feel the U.S. has slipped into recession. For EMS firms, the most immediate risk is consumer spending on computers and consumer electronics since these two segments represent roughly two-thirds of the market. Capital spending is also at risk, from both the credit crunch and a slowing economy. Enterprises were already looking at decreased spending on servers, but now spending on networking and telecommunications is under threat. On the other hand, OEMs in the emerging segments may be spurred to increase their outsourcing rates to eliminate costs from their business models. If the U.S. does move into a recession, how fast and far will it spread? European IT spending is at risk because of their exposure to the credit crunch underway in the U.S. Recession in the Euro zone means the two largest regional consumers of technology and other capital goods will be suffering. Such a disruption would then place many emerging economies at risk. These nations are dependent on exporting manufactured goods. If these economies slow, their consumption and capital spending for IT would also be undermined. China, especially, has based its economic model on exporting goods to the US. For EMS / ODMs, not only would their top line results suffer, but also the geographies where they have located the majority of their operations will undergo severe economic and social stresses, endangering their investments. Growth in the EMS industry over the next couple of years could be cut by as much as fifty percent, resulting in mid-single digit growth through 2012, if our primary scenario is discarded due to a worsening economy. For decision-makers, the key issues to monitor include how the PC market performs over the next two quarters. This will likely be the key harbinger for EMS / ODMs. If shipments surge in the third quarter with the arrival of new components plus the start of traditional shopping periods, outsourcers will likely weather the current economic storms. How the stock market performs will also be a good indicator for enterprise spending in the short-term and for an overall view of the credit market. In any case, EMS / ODMs need to carefully watch how the U.S. economy progresses to better understand the near- and long-term impact on their business.