Indeed, after telecom spending seized up, contact manufacturers added some optical skills to their repertoires in hopes of getting more tasks from their existing customers. "In many ways our industry is countercyclical," says R. Thomas Tropea, Vice Chair of Celestica Inc.'s (NYSE, Toronto: CLS) Global Customer Units and Worldwide Marketing & Business Development, Equipment. "It becomes more important to outsource in a downturn than in an upturn."
Along with pumping out high volumes of printed circuit boards and electronic subsystems for equipment suppliers, EMS companies now offer optical networking expertise and other services. But while telecom gear makers are outsourcing more tasks to companies such as Flextronics Corp. (Nasdaq: FLEX), Jabil Circuit Inc. (NYSE: JBL), and others, the volume of products needed still isn't what it used to be.
That economic reality has been a drag on the contract manufacturers for a little while. Sanmina-SCI Corp.'s (Nasdaq: SANM) downsizing, for instance, affected about 37 facilities and some 20,000 jobs worldwide. But contract manufacturers haven't been decimated nearly as badly as their telecom equipment customers -- Nortel employs fewer than half the people it did two years ago -- particularly because more companies in other industries are looking to cut costs by outsourcing.
Table 1: EMS Snapshot
|Company||Revenues ($M) for most recent reported quarter||Revenues ($M) for year-ago quarter||Year to year change (%)||Worldwide headcount (approx.)|
|Flextronics Corp. (Nasdaq: FLEX)||$3,300||$3,100||6%||70,000|
|Solectron Corp. (NYSE: SLR)||$3,000||$4,000||-25%||50,000|
|Sanmina-SCI Corp. (Nasdaq: SANM)||$2,618||$2,842||-8%||44,700|
|Celestica Inc. (NYSE, Toronto: CLS)||$2,249||$2,700||-17%||40,000|
|Jabil Circuit Inc. (NYSE: JBL)||$851||$1,050||-19%||17,000|
|Arrow Electronics Inc.||$1,840||$2,500||-26%||12,400|
|Source: SEC filings|
* Revenues for Sanmina's 2001 quarter include SCI's revenues
Like resellers, EMS companies are important to the industry's largest telecom equipment makers (see Resellers Pick Up Some Slack). And if those companies continue to absorb more tasks, they could change how the telecom equipment makers are staffed and operated.
Just think: Two years ago equipment manufacturers wouldn't trust gnarly tasks such as fusion splicing -- a process that forms the foundation for products such as optical amplifiers and optical backplanes -- to outside contractors. Now such tasks are much more readily given to companies like Celestica.
Partly, this change is due to advances in manufacturing techniques, which makes the third-party approach less risky. Partly it's because contract manufacturers have worked hard to increase their skill sets. And partly it's because incumbent equipment vendors have no choice: They have to reduce manufacturing costs by laying off staff in order to stay in business.
"Telecom equipment makers are no longer adding value through manufacturing, they're adding it through innovation," says Tropea, a former Nortel executive. Equipment vendors should aim to save carrier operating costs, he asserts, especially with products where advanced software offers the carrier better network management. The new competencies by contract manufacturers came largely through investments and acquisitions. Last year, all the big contract manufacturers in this space either combined with competitors or bought optical assets and plant capacity from telecom equipment makers (see Contract Manufacturers Consolidate). In the past three years, Flextronics has added to its knowledge by making venture bets on telecom equipment startups such as Atoga Systems and Calix Networks.
So long as equipment makers need to cut costs, and so long as contract manufacturers keep getting smarter, the trend toward outsourcing will continue. "The key driver is that telecom equipment companies haven't found a cost model as effective as outsourcing," says Tropea. "Contract manufacturers have a global footprint, lots of purchasing leverage, and the ability to ramp [product] volumes faster."
The catch? The telecom portion of the EMS business is getting smaller as carrier spending decreases. In 2002, the telecom part of the EMS business fell to about $13.5 billion (16 percent of total EMS revenues) from $16.5 billion (18 percent), according to IDC. IDC predicts that another half billion in EMS telecom revenues will fall off during 2003.
Indeed, not all companies will see efficiencies by outsourcing. Startups like Lumentis AB say they still have more optics expertise than do the contract manufacturers; and they also want to keep tight quality control over their gear, making improvements as soon as they hear from potential customers. "Outsourcing can be really costly unless you have very high volumes and the staff to manage the process," says Ulf Persson, Director of System & Network Design at Lumentis.
Table 2: EMS Earnings Calendar
|Company||Current Quarter||Next Quarter||End of Current Fiscal Year|
|Arrow Electronics Inc.||10/23/02||2/12/03||2/12/03|
|Solectron Corp. (NYSE: SLR)||9/26/02||12/17/02||9/26/02|
|Celestica Inc. (NYSE, Toronto: CLS)||10/16/02||1/23/03||1/23/03|
|Flextronics Corp. (Nasdaq: FLEX)||10/24/02||1/15/03||4/24/03|
|Sanmina-SCI Corp. (Nasdaq: SANM)||10/23/02||1/16/03||10/23/02|
|Jabil Circuit Inc. (NYSE: JBL)||9/19/02||12/19/02||9/19/02|
— Phil Harvey, Senior Editor, Light Reading