'OEM Services' and Chinese EMS and ODM

"When major US electronics OEM's feel pressure on profits, they outsource. When Chinese electronics giants run onto a rough patch, they tend to 'take in work.' "   --  Old Chinese proverb

It's easy to get confused when Chinese electronics OEM's refer to their "OEM services." These are manufacturing services provided by the Chinese OEMs to other, usually foreign OEMs. So we are not talking here of anything resembling the moves of western electronics OEMs into "services." This is contract electronics manufacturing, parallel to and competitive with stand-alone EMS and ODM. We've coined the term electronics manufacturing and design (EMD) services to apply to both these Chinese OEM services and the more classic EMS and ODM operations.*

As the "proverb" at the head of this article suggests, there is evidence Chinese electronics OEM services march to the beat of a different drummer. For one thing, profits may be subordinate to other social objectives, such as providing employment by keeping the shop doors open, or utilizing available capacity. Yet these companies do a lot of business - more than half the estimated $38.3 billion in Chinese electronics manufacturing and design (EMD) services in 2005. And, many Chinese electronics companies that offer OEM services are leaders in their product lines - usually home appliances or consumer electronics like TVs, LCD monitors, and DVD players. Chinese electronics OEMs also can draw on significant design resources, as well as specialized intellectual property (IP) in their areas of core competence.

This article provides a quick look at some players in the Chinese EMD space, including providers of electronics OEM services and their counterparts - the classic or stand-alone Chinese EMS and ODM. The article compares and contrasts these major segments of Chinese EMD and presents forecasts and evaluations of future direction.

Companies
Table 1 presents a selection of the larger "Classic" Chinese EMS and ODM providers, based on surveys and related research. Many companies in this category originated in Hong Kong, moving their manufacturing to mainland China in the last 10 to 20 years

EMS, in this context, is product assembly, usually with front and back end services including prototyping and test. ODM involves 'design for manufacturing,' if not full-scale design of new products, with manufacturing services included.

The first column lists the 2004 sales of the company, including revenues from OBM or own brand manufacturing. The second column lists total EMS and ODM revenues of the unit. Overall, the 50 companies intensively surveyed and documented in this research reported 10 percent of their revenues originating from ODM operations.

Table 2 provides similar information about several of the larger providers of OEM services in the companies surveyed. Note that OBM or own brand manufacturing takes a bigger share of total sales. Many of these companies have brands that are well-known in China and some other Asian markets. Frequently, their OEM services manufacture products for sale (under other brand names) in the US, Europe, or Japan. Assorted ODM revenue information is supplied in column 3 of Table 2, based on survey responses.

OEM services are variously structured in these companies. An "Overseas or International Marketing Division or Subsidiary" may manage or coordinate OEM services throughout the OEM organization. Frequently, however, subsidiaries or major manufacturing divisions have their own (possibly non-communicating) OEM services operations. The asterisks in Table 2 indicate only partial OEM services data on BOE and Panda was available.

Comparisons
How do the OEM services compare and contrast with the more classic, stand-alone EMS and ODM operations in China?

Some differentiators include:

• "Classic" EMS/ODM services tend to have higher, more stable profits

For 2004, profit margins on sales ranged from 28.6% to a minus (-) 36%, averaging 1.5% for companies reporting on this category. Profit margins narrowed from 2003, especially for OEM services.

• "Classic" EMS/ODM services often are more transparent from an accounting and managerial perspective, especially for companies originating in Hong Kong

Shocking accounting abuses can occur in Chinese companies; a recent example involved Kelon, a Shenzhen-listed company and one of China's largest producers of electrical appliances. Some Chinese managers acknowledge this problem and make special efforts to supply information in excess of local accounting requirements. Ultimately, however, the only protection to a prospective customer or buyer of the company is diligence in checking out business associates, company performance, and company capabilities.

• Chinese OEM Services have higher product concentration in consumer products

Several large Chinese television, appliance, and 'white goods' manufacturers, such as Galanz, Hisense, and Skyworth, have active electronics divisions and own special intellectual property (IP) in their core product areas. These companies may have advantages in lower cost design and manufacturing in the areas of their core competence.

• The role of the Chinese government is potentially significant for many providers of Chinese OEM services

Chinese providers of electronics OEM services are usually linked to the Chinese government, via complicated stockholding arrangements. Most Chinese electronics OEM's started as State Owned Enterprises (SOE's). These relics of socialist planning were transformed through stock issuance in the 1990's or later. However, the Chinese state is the majority owner of stock in most of these companies.

This means two things: (1) favorable access to bank financing, and (2) direct control of mergers and other developments by Chinese asset management groups representing the interests of the State.

This is a very different system than we are accustomed to in the West (see the discussion in Chinese Electronics Manufacturing and Design Services: Company Profiles and Market Forces, Chapter 2). On the one hand, Chinese OEM's and OEM services might have greater staying power in the event of a significant slowdown in global IT growth. They could have greater access to finance.

Also, the company landscape can change rapidly. For example, the Chinese Electronics Corporation (CEC) and Great Wall of China, both major players in electronics OEM services through their myriad subsidiaries, recently were merged, creating a mega-company with on the order of $10 billion in sales.

What does this mean for the future?
Overall, Chinese electronics manufacturing and design (EMD) services are forecast to grow from an estimated US$38.3 billion in 2005 to a total of US$74.7 billion in 2010. This implies a CAGR or compound annual growth rate of 14.3 percent.

By comparison, combined global EMS and ODM revenue is expected to grow from US$202.4 billion in 2005 to around US$370 billion in 2010. This extrapolation derives from Technology Forecasters' Electronics Manufacturing Outsourcing Report  (Third Quarter 2005). Total available market (TAM) for electronics hardware will go from US$1 trillion to over US$1.5 trillion over the same period.

Electronics manufacturing in China generally is expected to rise perhaps 30-40 percent of total global electronics hardware production by 2010.

Chinese electronics manufacturing and design services - the indigenous operations owned by Chinese and located in China - are anticipated to show more modest growth. The scale of electronics manufacturing by foreign owned electronics manufacturing, including global EMS and ODM, will probably increase more rapidly.
 
The attraction of Chinese EMS and ODM and Chinese electronics OEM services, however, is probably for the smaller contract. US, European, and Japanese companies will consider indigenous Chinese contract manufacturing because of perceived lower costs of production coming with Chinese assembly labor, Chinese management and engineering, as well as the cost advantages of increased local sourcing in China.

What's especially interesting about Chinese OEM services in this context is the presence and depth of collateral engineering and design resources in many of the giant Chinese concerns.

Clive Jones is a consultant and senior analyst with Technology Forecasters Inc. and Managing Director of Economic Data Resources LLC. Contact him at cjones@economicdataresources.com.

__________________________________________________________________
*See Chinese Electronics Manufacturing and Design Services: Company Profiles and Market Forces, released November 2005 (http://www.emsnow.com/spps2/sitepage2.cfm?catid=45) with 50 company profiles, information on the business environment, and product information.
___________________________________________________________________