The scope of electronics outsourcing in China
By Clive Jones and Eric Miscoll
Jun 01, 2005
According to the Chinese Ministry of Information Industry (MII), contract manufacturing is the "basic character" of electronics production in the Yangtze and Pearl River Deltas of China. This character is reflected in the surge in EMS revenues from these areas of China in 2004 and even larger ODM numbers from mainland China. China also has other large, diverse electronics outsourcing operations. In addition to manufacturing, many of these operations offer design services.
The scale of electronics outsourcing in China may have exceeded $150 billion in 2004. This number would include $30 to $40 billion in EMS, dominated by the global players, and perhaps another $50 billion by ODM. Additional electronics outsourcing originates from Chinese joint ventures, directly from Chinese OEMs, and from Chinese state-owned enterprises (SOEs).
The size and technical sophistication of Chinese electronics outsourcing makes it important to the dynamics of the global EMS industry. There is probably as much electronics outsourcing in China not counted in the EMS or ODM figures, as there are EMS or ODM operations in the rest of the world. These Chinese companies have growing access to technology, and, under certain scenarios, could mount a formidable competitive challenge to the EMS industry. Probably more importantly, they also represent a unique opportunity for acquisitions.
The accompanying Figure presents a chart that suggests the contrasts between segments of EMS, as conventionally defined, and China-based electronics outsourcing.
Figure 1: EMS revenues (by category) and China electronics outsourcing revenues for 2004
The tiny yellow block in the chart represents "indigenous" Chinese EMS/ODM companies.
The maroon bar in the chart is an estimate of China-based EMS revenues. A significant portion of this total is accounted for by Tier 1 EMS companies, such as Flextronics.
The dark blue bar in the chart shows the Technology Forecasters Incorporated (TFI) tabulation of global EMS revenues for 2004 - approximately $109 billion.
For purposes of comparison, the red block in the chart represents 2004 electronics sales in China, based on Chinese Ministry of Information Industry numbers.
Finally, the lighter blue bar shows electronics outsourcing revenues in China for 2004 and includes the revenues from the yellow column. These numbers are estimates. The basis is described below and will be amplified in a forthcoming Report.*
A key point is that Chinese electronics outsourcing is significantly larger than China-based EMS. In addition, China's electronics outsourcing exceeds total global EMS activity, as strictly defined.
[* China Electronics Manufacturing and Design Services: Company Profiles and Market Forces (Technology Forecasters Incorporated), Fall 2005. ]
China's Electronics Outsourcing - Segments
Our research has identified 50 "indigenous" Chinese EMS/ODM operations with revenues totaling approximately $15 billion. For the most part, these companies service smaller contracts than their global EMS counterparts do. Several of the larger, more well-known companies originated in Hong Kong and moved manufacturing operations to the mainland in the 1990s. EMS investments of other offshore Chinese, originating, for example, from Singapore, also have thrived. In addition, literally hundreds of Chinese EMS companies have revenues in the $10- to $60-million-dollar range. Typically, these companies were centers for consignment or semi-knocked down (SKD) and completely knocked down (CKD) assembly, and now they offer prototyping, testing, and product forwarding.
A loosely defined set of companies also comprises potential candidates for inclusion. In this set are Chinese joint ventures (JVs), state-owned enterprises, and foreign-owned enterprises that provide manufacturing services for global OEMs. Many of these companies are among China's leading electronics exporters. We provisionally estimate total 2004 revenues for the contract manufacturing companies in this list at around $30 billion.
Finally, Chinese OEMs are rapidly developing design services in handsets, television, consumer appliances, and industrial electronics, and already they have a track record in manufacturing for global OEMs. As a benchmark, the top 100 Chinese electronics OEMs realized an estimated $110 billion in revenues last year, through a bewildering variety of subsidiaries, joint ventures, and other alliances. A significant percentage came either from expanded offerings of design services, or from contracts to manufacture for other global entities.
Rush to Design Services
There is a rush to provide design services throughout the Chinese electronics industry. This pursuit of higher profits signifies growing technical sophistication. Chinese companies are moving up the value chain in product design, and their subsidiaries and JVs share these technical advances.
Mobile communications is a big area for design services, since China is the largest cell phone market in the world. Hitting the price zone for Chinese consumers and rapidly offering new services in Chinese built into the handset - these business imperatives have opened huge opportunities in China.
Chinese manufacturers, however, also are pressured by a worrisome tendency to over-produce, once the basics of a product line are mastered. This is true for Chinese television OEMs and large Chinese OEMs manufacturing "white goods" or consumer appliances with electronic controls. A major reason for the increased use of design services is to expand the product mix to higher value products. According to Michael Liu of China Outlook, China's domestic markets are, in some cases, over-supplied with the basic product lines, and Chinese companies can face allegations of "dumping" when excess inventories are disposed of in global markets. The solution is contracting design and manufacturing services with Japanese, European, and U.S. OEMs as well as with direct consumer outlets.
Chinese JVs benefit from technical advances in Chinese electronics manufacturing, and, in some cases, may be good candidates for acquisition by a global EMS.
Until the 1990s, the "joint venture" was the only way a foreign manufacturer could set up shop in China. The idea was that foreign companies would provide technology and know-how, and Chinese partners would manage production. The resulting operation would speed "technology transfer." The early takers read like a roll call of the world's leading electronics corporations - OEMs such as Motorola, IBM, Hewlett Packard, Compaq, Phillips, Alcatel, Lucent, Samsung, Sanyo, Seagate, and Sharp.
Recent years have seen big changes in Chinese regulations and in the strategies of the global electronics giants. Restrictions have been relaxed and acquisitions of Chinese companies have become easier to carry out. At the same time, many of the world's largest electronics OEMs have announced plans to expand IT services, moving away from manufacturing hardware per se. Recent initiatives in outsourcing new product design suggest a related question. Will OEMs supply as many contracts to their long-time JVs, when more and more of their product portfolio is outsourced to ODMs? These developments seem to create opportunities for buying a stake in Chinese JVs - taking over a global OEM's share. Two examples are Elcoteq's acquisition of IBM's holdings in Shenzhen GKI Electronics Company, Ltd. and Beijing GKI Electronics Co., Ltd. in late 2002.
Beyond extending the scope for acquisitions, the issue is whether China's electronics outsourcing poses a challenge to global EMS. Opinions differ widely. Some, skeptical of the technological base and managerial skills of Chinese companies, argue that any real challenge is remote. Others point to scenarios in which Chinese outsourcing companies might compete directly with global EMS providers.
On the skeptical side, Cambridge University studies confirm that indigenous China EMS operations can score high for cost, quality, and dependability. At the same, the Institute for Manufacturing (IMI) research rates global EMS higher in almost every other area - such as design capabilities, record processes, and after-sale service. And it is telling that Chinese OEMs, as a whole, lost market share to their global counterparts last year, despite more than 20-percent year-over-year growth in the Chinese companies' sales.
Any threat, then, is probably more potential than actual. Some would say it is just a matter of time. China decisively trumps the United States, Japan, and Europe in annual numbers of new engineers and trained technicians. More immediately, a slowdown in electronics markets could give an edge to China's electronics outsourcing. Cost is king in a slowdown, and innovation tends to slow. Furthermore, a sales slowdown could impair global EMS companies with razor-thin margins, while Chinese operations might expand, through "innovative" financial tactics.
Many observers sense major changes in electronics manufacturing in the works - more EMS consolidation as well as restructuring of relationships between EMS, ODMs, and OEMs. In considering these transformations, Chinese electronics outsourcing probably will be a significant part of the action.
This research and the report it is derived from will be featured at the December meeting of Technology Forecasters' Quarterly Forum for Electronics Outsourcing and Supply Chain program. For more information on how to join this fast growing industry association go to http://www.emsnow.com/spps2/sitepage2.cfm?catid=49
Clive Jones is a consultant and senior analyst with Technology Forecasters Inc. and Managing Director of Economic Data Resources LLC.
Eric Miscoll is a senior consultant and Chief Operating Officer with Technology Forecasters, Inc.