Inventories in the EMS Industry

By Dieter Weiss, Founder in4ma

The component supply chain disruptions of the past few years have been discussed at length in EMS planning sessions, investor reports and customer calls, but I would contend that the root causes of the problem have not been well understood by the industry. My work at in4ma compiling data on the industry’s financial performance over this time period provides some important clues about what actually happened.

In most countries in Europe and globally as well, the industry experienced double digit growth in revenues in 2021 and 2022. Yet there were no signs of a sudden spike in demand from the end users. Then in the second half of 2023 and 2024, for most of the EMS industry, customer demand suddenly collapsed.

Explanations for this sudden severe softening demand were never convincing. But the financial impact was conclusive: 2024 has seen a much higher percentage of EMS companies closing, filing for insolvency, or selling the business to a competitor or private equity group. In Germany alone about 3% of EMS companies left the business. In addition, there were another 3% involved in M&A activities.

We know that the EMS industry is highly competitive; when demand is low, aggressive pricing is a common business dynamic. The availability of excess manufacturing capacity at many of the competitors creates intense pricing and competitive pressure on the EMS industry.

In such a situation, excess inventories can be very painful. In a theoretical perfect supply chain one doesn’t need any inventories; the raw goods needed would be delivered just in time. Reality is different. Especially when supply chains are disrupted for whatever reason, it can be helpful to have a certain amount of raw goods in stock to keep production running. This implies that when the supply situation eases, inventories in raw goods decrease again. But raw materials in the EMS industry are normally acquired for specific customer orders (e.g. semiconductors) and often are not interchangeable among products.

Besides raw goods which are needed for production, work in progress and finished goods are part of inventories as well and reported at least once a year in the annual report on the balance sheet on the active side.

Just in time was invented in the last half of the last century by the Japanese car manufacturers to increase efficiency, reduce inventories, and save cost. Even today, many big companies require their suppliers to deliver fixed quantities at an exact delivery date or alternatively have defined quantities on consignment either at the supplier in the finished goods store or at a store of the customer or close to the customers’ factory. This allows the customer to have a constant supply of materials required and normally they only pay for the materials when they are taken off the consignment stock. This improves the cash situation of the customer and is an additional burden to the supplier.

Within the EMS industry it is very difficult to do accurate analyses of the level of inventories considered normal or acceptable. Most companies do not have the level of vertical manufacturing and own sourcing of components needed to manufacture the customer’s product. Yet looking over a longer period, there have been times when inventories were much lower.

The first chart below shows raw material inventories of global EMS companies from 2017 to 2023. (Where 2024 numbers are already available, we are talking about fiscal years.) Note that 2017 had much lower inventory levels of raw materials than the years which followed. A minor effect in 2018 can be attributed to the MLCC allocation crisis. Now look at 2023, a time when all distributors were already suffering from low order intake due to very low demand from the EMS industry.

Inventory levels were going down again in 2023 but not reaching what could be considered normal levels. Does this mean that the industry bought far more than they needed? Were they hoarding materials and thus creating artificial demand? The short answer is ‘yes’.

These 7 global EMS had US$54.536 Billion in revenues in their year 2023 (fiscal & calendar) and US$11.930 Billion of raw goods in their warehouses. This equals 21.9% of their annual revenues. The year before it had been 23.6%. Looking back at 2017, when most of these companies had raw goods of about 12% in their warehouses, one can roughly say, that these seven companies alone had more than US$5.3 Billion of excess raw materials in their warehouses. This is still the case with most of the EMS companies.

The current situation requires strong rethinking and discussion internally of how to avoid a similar situation in the future. Rather than panicking and doubling order quantities in the false hope of getting a higher share of the allocated quantity, the industry needs to find a better logistical solution.

The situation in Europe is no different. Smaller companies often get some or all the components and/or parts for the final assembly supplied by their customers or by their mother company. This applies mainly to very expensive or long lead-time components (e.g. Semiconductors). On the balance sheet of these companies, you then find nearly no raw material inventory and such companies normally show a very low revenue per employee. In our analyses we eliminate all companies which have less than 80K Euro per employee and assume that part or all the components have been supplied from the outside.

We often see this with smaller companies in Western Europe and in Eastern Europe where subsidiaries of Western European EMS transfer labor intensive parts of production and supply all of the components from the mother company.

Bigger companies have an easier time because they are vertically integrated and even though their PCBA often are more complex, and their lot sizes are bigger, they have a better supply base, and they have more professional planning tools to plan their material supplies.

The next chart shows the full inventories (including WIP and finished goods) from 2015 to 2024 for three different revenue groups in Europe. The numbers are averages and the table above the graph shows the minimum and maximum values.

2018 shows an increase in inventories, which can be attibuted to the MLCC allocation. In 2019 and 2020, the big companies were better in reducing the excess inventories, whereas the smaller companies had more difficulties. 2021 then sees the first big jump in inventories due to the semiconductor allocation (which was panic ordering and no real material shortage from the end market). This steep rise continues in 2022 and only in 2023 did companies start to work on a reduction of inventories again. Like the MLCC allocation, bigger companies were performing better in the inventory reduction.