Changes underway at global EMS destinations

Executive Summary

Since the publication of Bear Stearns & Co.’s first report on low-cost manufacturing last year, the investment firm indicates it has seen a continued trend of acquisitions, consolidation, and restructuring by EMS providers in order to increase low-cost footprints, realign existing high-cost footprints, and diversify end-market and customer exposures. China continues to strengthen its leadership in global manufacturing, while India and Vietnam are gaining more attention from OEMs and contract manufacturers.

Meanwhile, the Ukraine, Poland, Slovakia, and other Eastern European countries remain popular as destinations for European manufacturing. In South America, Brazil has also made significant progress in shaking up bureaucracy, which should increase its likelihood of becoming another
EMS destination of choice.

Finally, Mexico is luring companies back from China as a result of its supply chain optimization, further solidifying its strategic importance in terms of manufacturing for North America.

While the continued outsourcing trend, increasingly competitive marketplace, and potential demand in many of these emerging markets remain the key drivers of low-cost manufacturing, Bear analyst Kevin Kessel feels it is important to highlight the incremental changes as well as his firm’s new findings over the past year with regard to the major topics explored in their previous reports.

China maintains low-cost manufacturing leadership

China remains the electronics industry leader in low-cost manufacturing by continuing to leverage its low-cost labor, well-established infrastructure and supply chain, and fast-growing domestic market. The country is strategically well-positioned as a manufacturing location for export to nearby countries such as Russia, Thailand, Malaysia, Indonesia, Hong Kong, and even India, to name a few, as well as some of the more expensive manufacturing locations such as the European region, Japan, Singapore, South Korea, and Taiwan. (OEM Exclusive: Request list of EMS/ODM providers anywhere in China or the greater Asia region)

Many electronics companies with manufacturing facilities located throughout China have capabilities ranging from design to manufacturing, shipping, repair, and software development, all aimed to better support the needs of OEM customers and to satisfy both local and global consumer demand.

Amid rising labor costs in the popular coastal areas of China, Bear has witnessed a growing trend of many companies moving manufacturing more inland as well as north to benefit from the tax incentives that have been established, primarily within the central and eastern parts of the region. Lower costs, as well as other favorable policies enacted by the central and local governments, continue to attract manufacturers to the area.

One well-publicized example is a string of announcements from Hon Hai / Foxconn regarding its investments to set up industrial parks in inland provinces such as Hubei and Liaoning. For instance, the Chinese-language Commercial Times reported that Hon Hai plans massive investments in China’s inland provinces in an effort to take advantage of the region’s lower costs and large labor force, including a significant inflow of funds into Shenyang, Yingkou, and Liaoning to make precision machinery; automobile components and parts, as well as printed circuit boards (PCB).

Plans also include a new industrial park in Wuhan, Hubei, to manufacture such electronics products as digital cameras and computer monitors, as well as further investment for several factories at the Qinhuangdao Economic and Technological Development Zone in Hebei province. Furthermore, in March 2007, Intel announced that it was building its first-ever wafer fab in China. The $2.5 billion it is earmarking for this facility will be the largest high-tech investment in China to date.

Indian progress comes with challenges

During the past year, numerous companies have continued to make significant investments in India. While development in India is nowhere near what is being seen in China, Bear indicated previously it believes India is the most likely country to turn into the next major manufacturing hub.

As expected, more and more EMS and OEM companies are setting up shop in the region in an effort to expand their global manufacturing footprint, with many concentrating their expansion efforts in Chennai. According to a recent article by Electronics Trends, eight EMS suppliers are expected to open up manufacturing operations in Chennai by 2008. This is partly in response to the Indian government’s offer of incentives to do business in Chennai.

Responding EMS companies have included Flextronics, Jabil, Elcoteq, Hon Hai, and its subsidiary Foxconn, while OEMs such as Ericsson, Nokia, Siemens, and Motorola have also established a presence in the region. According to research firm iSuppli, Chennai has attracted more than $1 billion in investments over the last two years, and Bear believes this number will continue to grow. (OEM Exclusive: Request list of EMS/ODM providers anywhere in India)

However, while Chennai has its advantages, such as a large labor pool of workers with engineering expertise, as well as labor rates that are among the lowest in India, challenges remain for the overall India region. Today, the key challenge and disadvantage with India remains its poor infrastructure, including its roads, ports, and airports.

These issues have not stopped the multinationals from setting up shop in the region. Nokia has announced plans to invest up to $150 million in a Chennai manufacturing facility in an effort to support the growing demand for mobile handsets and network infrastructure in the region, while Compal Communications also plans to build a handset factory in the area.

In addition, Hon Hai is expected to invest $110 million over the next five years to make handsets and components for Nokia and Motorola in the same region of Chennai, and Cisco also selected India as its globalization center, called “Cisco Globalization Center East,” from which it expects to execute its globalization vision.

Meanwhile, Bear notes Flextronics has completed the first phase of its planned eight million-square-foot industrial park in Chennai, while Jabil expanded its presence through its acquisition of Celetronix, an Indian EMS company. In addition, Jabil more than quadrupled its site in Ranjangaon, India, to 850,000-plus square feet.

While the poor infrastructure is a main impediment to rapid growth in India, a few strides have been made along the road to improvement. To help with the infrastructure crisis, work on the $12 billion Golden Quadrilateral initiative, which spans more than 3,000 miles of four and six-lane expressways connecting Mumbai, Delhi, Kolkata, and Chennai, is scheduled to be completed in 2007. In addition, the first phase of a new subway in New Delhi has been completed and new airports are under construction in Bangalore and Hyderabad, with more planned throughout the region.

The cost of Indian expansion

India’s public debt stands at 82% of GDP, the 11th-worst ranking in the world. As a result, much of the money for expansion projects must come from both public and private sources. The Indian government estimates public and private organizations will chip in $300 to $500 billion over the next five years for highways; power generation, ports, and airports.

As a result, a key to getting large expansion projects up and running in India is the ability to use the government as a willing partner rather than deal with it as a roadblock. Accordingly, numerous public-private partnerships where the government and the companies share costs, risks, and rewards have been formed, particularly since India passed a law in 2005 allowing officials to tap such partnerships for various infrastructure initiatives.

For example, the $430 million international airport currently under way in Bangalore is the result of this initiative. The new airport is designed to handle 11.5 million passengers per year, which is almost double the capacity of the overburdened existing airport. The airport will be owned by a private company and then turned over to the Karnataka state government after 60 years.

Bear learned that Siemens is helping to build the airport, while Switzerland’s Unique Ltd. will manage it. With both companies also being equity investors, the state had to contribute only 18% of the cost, and Karnataka still gets its new airport, which is scheduled to be completed in April 2008.

Corruption in India

While the new airport in Bangalore is just one example of public and private parties coming together as a way to boost improvement in infrastructure in India, progress is often hampered by the nation’s bureaucracy. For example, a BusinessWeek article noted that it takes up to ten days for Japan’s Maruti Suzuki to truck its cars 900 miles from its factory in Gurgaon to the port in Mumbai, partly due to delays at the three state borders along the way, where drivers are stalled as officials check their papers. The slowness is also attributed to the barring of big rigs from India’s congested cities during the day because they may cause major traffic jams.

Meanwhile, once at the port, the Japanese company’s autos can wait weeks for the next outbound ship due to the sparse dock space for cargo carriers to load and unload. Worsening matters is India’s corruption, spreading through nearly all sectors of officialdom, from neighborhood cops to district bureaucrats to state ministers. According to Transparency International, Indian truckers pay about $5 billion a year in bribes. While corruption delays infrastructure projects, it also raises costs for those that move forward.

The above said, Bear remains optimistic about India, especially in light of recent progress in highway and airport construction, the firm strongly believes it is imperative for the country to shake up its bureaucracy, combat corruption, and continue to make meaningful improvement in its infrastructure in order to fully realize its economic potential.

Despite the bureaucracy and corruption, both locals and foreigners have continued to forge ahead. For instance, a group of 15,000 Indian volunteers is monitoring key road projects and meeting with state officials to press for action, and Blackstone Group and Citigroup have teamed up with the Indian government and the Infrastructure Development Finance Corporation to set up a $5 billion fund for infrastructure investments in the region. These efforts are all welcome and can only help India on its path to economic prosperity.

Vietnam receives noteworthy industry endorsements

Last year, Bear Stearns & Co. singled out Vietnam as an emerging low-cost manufacturing location the firm felt had meaningful potential to grow and expand. During the past year, Bear has seen growing interest in Vietnam on the part of foreign investors.

Intel’s $605 million investment plan for a new chip assembly and testing plant is being boosted to $1 billion after getting recent government approval. This will end up being Intel’s largest assembly and test plant in the world when it is fully built out, as well as Vietnam’s first semiconductor facility. Bear believes Intel’s attraction to Vietnam was based on the region’s local talent pool, government commitment to high tech, and various intangibles (e.g., the proximity of educated workers to the government-established industrial parks, making it unnecessary to build dormitories or campuses).

Meanwhile, Hon Hai recently laid out a plan to invest $1 billion in Vietnam to build multiple industrial parks over the next three years. Before the plan could even be finalized, Hon Hai decided to up its investment to $5 billion, which includes Hon Hai getting other companies to also co-locate in Vietnam, as well as plans to build up to five industrial parks. Also, in May 2007, Samsung announced plans to build a new mobile phone plant in Vietnam that could be operational as early as the end of 2008, with an annual capacity target of 100 million units.

On May 8, 2007 Jabil announced its foray into Vietnam. The company was granted a license by the Saigon High-Tech Park (SHTP) and will develop a $100 million, 55,000-square-foot manufacturing facility. Currently, the project is expected to occur in two phases. During the first phase, Jabil will make an investment of $30 million and will begin this September to manufacture approximately 3.5 million products a year. The second phase is expected to begin after 2010 and will require an additional $70 million to essentially double the capacity of the facility to seven million products a year. Hewlett-Packard is one of the first key customers for Jabil that will benefit from the Vietnam plant, with mass produced inkjet printers expected to roll out of production.

With one of the fastest GDP growth rates in the region (~8% growth per year) and accession to the WTO in early 2007, Vietnam is becoming increasingly attractive. The country’s young population, with 60% under the age of 30, is appealing to many potential manufacturers. In addition, Vietnam has a solid educational system, strong work force, and a government that is open to foreign investment.

In the first half of 2006, Vietnam granted licenses to nearly 350 foreign direct investment (FDI) projects worth $2.84 billion, according to the Ministry of Planning and Investment, with projects focused on the industrial, construction, and service sectors in key economic zones. As a result, the region has succeeded in attracting large-scale tech projects that are needed for its economic growth, including the Intel project. In addition, the country’s recent acceptance into the WTO will likely result in the elimination and reduction of various tariffs on electronics, which will only increase its attractiveness to other companies wanting to establish a manufacturing presence in the region.

Smaller EMS companies weighing larger low-cost manufacturing footprints

During the past year, smaller EMS companies have been taking their low-cost manufacturing footprint more seriously and looking at this strategy more strategically. This has caused some companies to expand their low-cost manufacturing capacity, whether through acquisitions or organically.

Taking the organic approach, Plexus recently brought on-line a 364,000-square-foot site in Penang, Malaysia, its third site in Penang and also the largest site in the company’s overall manufacturing network. The Penang site puts Plexus’ capacity in Malaysia at 640,000 square feet. Plexus is also close to doubling its current footprint in China, from 60,000 to 120,000 square feet, which should be completed by year-end. At Benchmark Electronics, the expansion has been both through greenfield as well as acquisition. Benchmark is almost finished with another Chinese manufacturing plant that will complement its existing 115,000-square-foot manufacturing facility located in Suzhou, China.

Meanwhile, Benchmark Electronics’ Pemstar acquisition affords Plexus additional low-cost manufacturing capacity in Thailand (180,000 square feet in Bangkok), China (138,000 square feet in Shenzhen geared toward communications infrastructure), and Romania (30,000 square feet in Brasov). The acquisition of Pemstar increases Benchmark’s global scope, design engineering and systems integration capabilities, and overall low-cost footprint.

Nam Tai Electronics is also focused on increasing its low-cost footprint. The company is expanding its Shenzhen capacity and also plans to build a new low-cost site in Wuxi. Some in industry believe Nam Tai will eventually augment its low-cost Asia footprint with a presence in Eastern Europe.

Manufacturing in the US not going away, and Mexico reemerging

Bear believes U.S. electronics manufacturing is not going away. The firm cites new product introduction (NPI) and low-volume, high-mix programs should play a major role in U.S. manufacturing over the next five years given the importance of proximity to many OEMs as well as the OEM’s customers.

Additionally, Bear believes manufacturing for defense and aerospace programs will remain in the U.S. for obvious reasons, while substantial amounts of medical and industrial manufacturing will continue to be done in the U.S. as well.

Bear also notes Mexico appears to be coming back from the devastating setback caused by the exodus of many manufacturers to China a few years ago. Mexico is now becoming increasingly important as a vital manufacturing base to supply the U.S. market.

Many companies have come to realize China may not be their optimal solution for some high-mix, low-volume programs from the perspective of lowest total landed cost. Bear expects more build-to-order, configure-to-order manufacturing programs to shift from the U.S. to Mexico as a result of continued cost reduction initiatives throughout the electronics manufacturing industry.

Read about the Flextronics-Solectron acquistion.

Bear Stearns & Co., VentureOutsource.com