MMI June 1998

Front-End Centers Moving Into OEM Backyards

As a time-to-market strategy, concurrent engineering has been around so long and cited so often that it no longer commands the attention it once had. But the strategy is no less valid today than when it was introduced in the '80s. What's more, the EMS industry is about to put con-current engineering back into the limelight.

In the past year, some EMS providers have begun to offer local centers to support customers nearby during new product development (see table on p. 2). By providing front-end services locally, EMS companies ensure that they're directly involved with OEM engineering teams during product development. Time and distance are no longer barriers to DFM (design for manufacturability) and DFT (design for testability).

In addition, the number of these front-end service centers is increasing rapidly and will continue to do so (table). Here's why.

# Time-to-market pressures compel OEMs to bring their volume providers on board during the design phase. And it's easier to do that locally.

# Front-end centers provide a contractor with a local presence for developing new business. Doing front-end work gives the CM a "heads-up" on new programs and the opportunity to transfer them to a remote facility for volume production later on.

# A network of front-end centers can provide geographic coverage in key areas that might not be served by a contractor's volume facilities.

# OEMs typically seek front-end support from local operations, especially when it comes to prototypes. Volume providers are questioning the wisdom of letting someone else do this work before it reaches their facility.

# With qualified engineers and designers in short supply, OEMs are finding it harder to design everything in house as fast as they need to. Front-end centers can be in a position to handle outsourced design work

# When successful, front-end services can provide a growing profit center.

# If an OEM decentralizes its development efforts, its EMS suppliers may be encouraged to support multiple design centers. Take the case of AVEX Electronics, a top-10 EMS provider. One of its customers went from operating a few large centers for design and R&D to smaller, localized centers for launching products. In the process of this reorganization, the customer determined that it would need partners to help with product design in those locations. For OEMs, a large, centralized development site "does not always coincide with what the market needs...in terms of product design cycle times," says Todd Westbrook, AVEX VP of business development and technology. "So it's about getting more autonomy, getting faster, trying to cut down on the cost of your internal infrastructure from a customer standpoint, outsourcing what makes sense, and getting the product to market faster."

In the accompanying table, MMI has listed EMS providers it knows to be marketing front-end centers. Celestica, which is in the quiet period prior to an IPO, may deserve to be on this list. The company recently made three acquisitions in the front-end area, including a new product introduction center (see News p. 7).

Off To a Good Start

Creating a network of centers to support customers' product introduction efforts is a concept still in its early stages. But some initial results are promising.

Let's start with Flextronics International, which takes credit for originating this front-end concept about a year ago. "I feel better about this today than when we started. And I felt pretty good about it when we started," comments Nicholas Brathwaite, Flextronics VP of advanced technology and engineering services.

The EMS provider reports success in being able to sell customers on its Product Introduction Centers (PICs). "In the U.S., we've probably done 50 projects so far. There are probably only a couple of customers that we haven't been able to convince this is the right way to do it," says Brathwaite. Those that said no understood the benefits of PICs, he reports, even though company politics prevented them from taking advantage.

There's another good sign. "Customers in PICs look very much like our production customers," notes Brathwaite. "A lot of our larger production customers are starting to use these services."

PICs are now an important part of Flextronics' sales strategy. These centers are "one of the big differentiators for us today," he declares.

Front-end services also play a strategic role at Plexus, and always have. From day one, the company has operated a separate engineering organization, Plexus Technology Group. "Our concept is to offer services to help OEMs to get products into the marketplace, not just manufacturing services," says Michael Verstegen, VP of Plexus Technology Group. "It's an 18-year strategy."

Now Plexus is taking that strategy on the road with its ProtoCenters and design centers. These centers "are a key element of our continued growth strategy," says Verstegen.

EA Industries, on the other hand, recently began a front-end effort, yet is already getting results. Earlier this year, the company acquired Service Assembly Inc. of Wareham, MA, which became the first Tanon Express location to offer quick-turn prototype services. After bringing on the Wareham site, volumes there went up dramatically. "We have seen a step function [increase] of about 30%," reports Frank Brandenberg, EAI president and CEO. The company is beginning to route one or more volume customers into the Wareham operation, while bidding on volume work from Wareham customers. "We expect to win some of those bids," says Brandenberg. Adding the Express capability has also made EAI more attractive to companies that had not been doing business with it or the Wareham operation.

"The success of the Wareham acquisition and the whole concept has caused us to accelerate our deployment," says Brandenberg. Originally, EAI had planned three Express sites for this year. The target for 1998 is now six.

Strategic Differences

EMS providers are far from uniform in their approach to front-end services. A common strategy is to use front-end centers to feed volume plants in other locations. But front-end centers do not always operate at a distance from volume facilities. Both Elcoteq and Solectron will locate new centers on manufacturing sites, not apart from them.

Solectron stresses that many of its sites already provide services for new product introduction. "Solectron Texas has been offering NPI services for many years and is extremely successful," notes Sean Tzou, Solectron's VP of new product introduction. The Charlotte, NC, site offers another example. "Charlotte where we added capabilities from IBM will also play a very important role," says Tzou. He also points to sites in Massachusetts and France as further examples of NPI activity.

But Solectron wants NPI services to be recognized in their own right. "Customers are looking at it as an extension of the existing operation's services. We're trying to provide a different look," explains Tzou. How that look will take shape in form of new NPI centers has yet to be announced. But Solectron expects to say more about its NPI strategy soon.

Another distinction arises in way design services are treated via-á-vis prototyping. While it is common to combine prototyping with some level of design service, Plexus organizes design and prototyping as separate entities.

Then there's EFTC. For the time being, this EMS company is sidestepping design services in favor of EFTC Express locations focused on prototype, quick-turn and ultralow-volume manufacturing. The company's recent acquisition of Personal Electronics in Manchester, NH, gave EFTC its first Express site. Jack Calderon, EFTC's CEO, president and now chairman, believes he has found a front-end niche that does not suit large contract manufacturers. What these shops do well, says Calderon, "is preproduction at the manufacturing center. The other thing traditional contract manufacturers do well is get involved early in the design process and work with the OEM in launching products. What these large contract manufacturers don't do well is dealing with these short-run situations, ultralow volume and very quick-turn reactive type prototypes as opposed to a new product launch."

Small shops providing OEM engineering centers with reactive services are flourishing, Calderon points out. EFTC aims to get a share of that business with independent centers that can stay nimble. The company will introduce design centers in the future.

I-PAC Manufacturing, now merged with scanner maker Photomatrix, has adopted a vertical integration strategy for its prototyping centers, the first of which is I-PAC Express Assembly in Carlsbad, CA. Rather than source bare boards for prototyping, I-PAC intends to bring that capability in house. "We believe if we can add the bare board fabrication to our quick-turn prototype business, then we have a true competitive edge...," says Patrick Moore, the new CEO and president of Photomatrix.

What's more, I-PAC plans to extend vertical integration to other areas. "We are looking at acquisition of bare board fabrication, plastic injection molding and metal stamping capabilities to complement the prototyping of the electronic assembly," says Moore. Vertical integration will also be applied to production.

The DII Group is also setting up a network of regional centers, but these operations, called Dii Technology Centers, are intended to provide more than front-end support. They will serve as the integration point for DII company services from design and prototype development through production. Still, DII's Design Solutions subsidiary is expected to play a key role, offering engineering support, PCB design and layout, and other front-end services. Dii Technology Centers will be located where at least two DII companies already have operations.

Front-end services can also vary from center to center within the same company. When an EMS provider picks a center location with a few customers in mind, services offered there typically reflect the needs of those customers.

An Impact on Small Shops?

Will front-end centers hurt small shops that already service OEM design groups? The answer depends on whom you ask. AVEX's Todd Westbrook believes that his company doesn't really compete with small shops because they cannot provide the type of service that AVEX can. "Just because you can lay out a printed circuit board, does not mean you can lay it out with the intent of high-volume production," he asserts. Volume buying and component selection may also put the small house at a disadvantage.

Still, if a customer can get such design and component services as well as prototypes from a contractor like AVEX, why would the customer go to a small house for prototypes? Westbrook agrees, "We compete in a larger sense."

For Agility, a smallish regional provider in Ayer, MA, there is no doubt about competition. In the past, the company enjoyed a modest market in beginning-of-life and end-of-life products from some large OEMs in New England. "Now with the introduction of these centers, I think that is drying up that kind of business," remarks Mark Hashem, Agility VP of operations. "It's really pushing us back in dealing with companies of our size and smaller OEMs."

He offers a case in point. A certain OEM in New England had been a substantial customer of Agility, says Hashem, while another contract manufacturer handled the high volume. Agility is now seeing less of that business with the introduction of a local center by the other contractor. But Hashem can understand why. "The OEM can go to one supplier and get it all done," he admits. "If some of their products take off, these can go to volume faster from their perspective. Time to market is better. They already have their volume supplier tooled up."

Not an Universal Trend

While one can cite plenty of reasons why front-end centers make sense, they are not everyone's cup of tea. Take MATCO Electronics, which operates a group of EMS companies. Rather than maintain design centers in three locations, MATCO is centralizing its MATCO Design Group into one facility in Binghamton, NY.

NatSteel Electronics also favors serving customer R&D activities in the U.S. from one location, Silicon Valley. The company says building prototypes there becomes an advantage because everything you need can be sourced there. "By trying to have one [center] everywhere, you're diluting your know-how," contends Sean Kenny, GM of NatSteel's U.S. operations.

In addition, design and prototype operations become cost centers if they're not well utilized. That is a no-no in the overhead-limited world of contract manufacturing and remains a concern in some quarters of the EMS industry.

But for AVEX, this concern is no longer valid. "We could have put a design center in Dallas five years ago. But if our customers were not of a mind that these services add value, then you're going to sit there with a cost center instead of an engineering center," AVEX's Westbrook points out. "Now I think that there's a lot more willingness on the part of customers to view better ways for getting better products to the market."

EAI takes a similar view with regard to its Express centers. "These shops are not loss leaders. They're profit centers in themselves," declares EAI's Brandenberg.

Still, the profits won't come if customers won't pay for these services. "The big challenge comes from many customers who believe a lot of these services are bundled in overhead and provided 'free,'" says Brathwaite of Flextronics. "They say, 'I'm not used to paying for this up front or purchasing [it] for a separate amount.'" But he points out, "The strategy where you separate the two makes a lot of sense. Any time you start bundling things you pay for them whether you use them or not."

Flextronics reports that customers have been convinced to pay for front-end services separately. This is good news for other providers that have just started to open front-end centers.

If customers are willing to pay for these services, you can't beat them for convenience.

New Spin on Global Manufacturing

low-cost sites fit regional supply chains

Up to about a year ago, an EMS provider could call itself global if it operated manufacturing facilities in the world's three major markets. But for some OEMs, that definition of global is no longer good enough. Not only do they want products manufactured in Asia, Europe and North America; they are also pushing for production at low-cost sites in each region. For example, Cisco Systems has confirmed that low-cost manufacturing in the three regions is part of its sourcing strategy.

This new requirement, of course, has not escaped the largest EMS providers (first table). Having expanded into Central Europe, Flextronics International and SCI Systems are offering low labor costs in the three world markets, while Solectron expects to add the Central European leg of its low-cost offerings this summer. The three providers will have this global position to themselves, but not for long. Eight other EMS providers have confirmed their intention to offer low-cost manufacturing in the three regions (2nd table).

The rise of regional sites offering low-cost labor reflects a larger trend -- the formation of regional supply chains. OEM operations such as Hewlett-Packard's Consumer Products Group want to supply a region with products that come from that region (May, p. 8). The idea is to shorten the supply chain, saving inventory and logistics costs. With a price-sensitive product in particular, the OEM will also look for the lowest manufacturing costs in each region. Perhaps latest example of this strategy can be seen in HP's selection of Flextronics to manufacture inkjet printers at Flextronics' campus in Hungary (see News, p. 7).

But the most conspicuous example of a regional supply chain has formed in North America. More and more, OEMs seeking the lowest manufacturing costs in the region are outsourcing work to Mexico, where EMS capacity has soared (April, p. 1). What's more, the influx of EMS companies to Mexico has not ended.

Cent. Europe Completes Triad

Still, it is the recent activity in Central Europe that has put low-labor-cost manufacturing into a global context. EMS providers seeking low-cost manufacturing work typically operate in emerging Asian countries or Mexico or both geographies. To offer a low-cost manufacturing solution in each of the world's major markets, therefore, these providers need a Cen-tral or Eastern Europe site (2nd table).

Of the EMS providers intending to offer low-cost sites globally, two besides Solectron have Central European projects underway. On the outskirts of Budapest, Hungary, NatSteel Electronics has acquired a building of about 70,000 ft2 on a much larger site. Over the next few months the EMS company will refurbish the building and expects to have it on line toward the end of this year. The company is planning to use the facility for regional support of customers in Europe.

Another EMS plant is also going into Hungary. Finland-based Elcoteq Network Corp. is building a 11,000-m2 (118,000-ft2) plant in the town of Pécs in southern Hungary. The company expects start-up to occur in November and says the site will employ about 1000 people when in full production.

Although Elcoteq manufactures in Finland as well as in St. Petersburg, Russia, where it started up a pilot plant late last year, and in Tallinn, Estonia, a high-volume site, the company's aspirations extend well beyond Europe. After opening a customer service center in Dallas, TX, earlier this year, the Finnish provider just started building a facility in Monterrey, Mexico. This first-phase project will occupy about 8000 m2 (86,000 ft2). Dallas will also serve as the headquarters for Elcoteq's operations in the Americas.

Elcoteq is expanding into Asia too with an aftermarketing services unit to start up in Johor Baharu, Malaysia, during the summer of 1998. This first-phase unit will be followed by a second manufacturing phase, which could take place in Malaysia or another country that company is looking at -- China.

The example of Elcoteq shows that the large, U.S.-based multinationals do not have a lock on a regional strategy for low-cost manufacturing. Asia-based provid-ers, namely GET Manufacturing and NatSteel Electronics, also want in on this strategy, as does IMS, which manufacturers primarily in Asia. OEMs that formerly would have sent cost-sensitive products to Asia for manufacturing now have regional alternatives.

Not Reserved for the Top 10

Nor is this strategy confined to top-10 EMS providers. Of the 11 EMS companies covered here, four were not large enough to make the top 10 in 1997. And one, Pemstar, is just now coming up on industry radar screens.

After only four years in the EMS business, Minnesota-based Pemstar operates a Mexico facility in Guadalajara and holds 45% ownership of a joint venture in Thailand with Italade Technology (Thailand) Ltd. Employing 1000 people, the joint venture ships over one million disk drive components per month from a 90,000-ft2 factory. Not only that, Pemstar has selected Tianjin, China, for a 30,000-ft2 leased facility, slated to be in production by July 1. The company already has a program lined up for the China site. In addition, Pemstar is waiting for approval of a second joint venture, this one in Singapore.

Pemstar also has its sights set on Europe. The company is looking at putting a facility in each of two European locations. Hungary would serve as a site for low labor costs, while Ireland would act as more of a technology center. The target for both is Q1 or Q2 1999. (See May, p. 8.)

With fiscal 1998 sales of $164.7 million, Pemstar offers precision electromechanical assembly and test, microcomponent assembly and test including component placement and wire bonding, and turnkey engineering. An estimated 50% of Pemstar's business comes from box build.

Low Cost, But Not Low Tech

Gone are the days when manufacturing in emerging markets was reserved for manual assembly and through-hole technology. Take Guadalajara, Mexico. It has some of the most modern EMS plants in the world. These days high-volume SMT can be done as easily in emerging markets as in high tech centers. In fact, high-volume programs, where products tend to be commodity-like and designs are stable, are made to order for the low-cost sites that companies like Solectron operate.

Despite the fact that materials dominate the cost of turnkey programs, labor costs, both direct and indirect, remain a variable that the EMS provider can control. The attraction of low labor costs becomes apparent when one compares rates in Germany, Belgium, Finland and France, for example, with those in Poland, Hungary, the Czech Republic, and Romania (table). Dovatron estimates labor rates in Central Europe average $200 to $250 per month fully burdened for all social costs.

Will Central/Eastern Europe develop in the same way that Mexico has? Probably not. Contract manufacturers in Mexico have made Guadalajara an EMS center and are beginning to congregate in Monterrey. But no such center appears to be forming in Central or Eastern Europe. In Hungary where most of the current site selections have been made, each EMS provider is located in a different town or city. According to Flextronics, towns in the countryside can only supply so many people.

Michael Hannon, whose company MHM (Ayr, Scotland) has studied Eastern Europe with EMS in mind, believes that global providers will eventually want a number of Central/Eastern European plants. Referring to the 22 countries in the old Eastern Europe, he foresees that an EMS company would want a plant in the north, middle/center and southeast of that region as well as a site in Russia. For more information about MHM's report, East European EMS Manufacturing Facility Partner and Greenfield Site Opportunities, call 44-1292-263625 or fax 44-1292-265081.
Not every product is suited for a site in an emerging market. But for customers that need both regional manufacturing and low labor rates, the definition of global takes on a new meaning. And the providers that want to compete for that business must position themselves accordingly.

Solectron Opens Office in Israel

The definition of global provider will expand yet again if the Middle East is added. And Solectron is the first major EMS player to take a step in that direction. The EMS provider has opened a program office in Tel Aviv, Israel.

"Solectron sees Israel as an emerging market with untapped potential for EMS services," states Dr. Ko Nishimura, Solectron's chairman, president and CEO. "By placing a program office in the center of one of the world's most technically advanced markets, we will be well-positioned to attract high-caliber associates and capture additional market share." The office will also be used to seek out local suppliers and support multinational customers in Israel.

Reportedly, Israel accounts for more than 15% of networking industry sales worldwide with companies such as RadVision, VocalTec, LanOptics and CheckPoint Software.

News

Celestica To Share in Building PCs for HP

Reports Two More Acquisitions

Hewlett-Packard has awarded a share of its commercial PC final assembly business for North America to Celestica (Toronto, Canada). This new program is intended to complement HP's relationship with its existing provider, SCI Systems (Huntsville, AL). Celestica expects to begin shipments late this year.

As a result of landing this HP business, Celestica will establish a new high-volume operation in the U.S. for build-to-order manufacturing and distribution of PCs. Meanwhile, SCI is constructing three dedicated plants -- including, say analysts, a large plant in the Netherlands -- to support planned growth from HP.

In other news...Last month, Celestica announced that it closed one acquisition and signed a letter of intent for another. The EMS provider purchased Analytic Design, a design and new product introduction center with 95 employees in Santa Clara, CA. Also, Celestica intends to enter into a strategic alliance with Silicon Graphics, which will sell its board assembly facility in Chippewa Falls, WI, to Celestica. Under Celestica, this facility will continue PCB assembly for various products under the CRAY brand. Silicon Graphics described this alliance as "a first point of execution" of its manufacturing strategy. The agreement between the two companies is expected to close by the end of this month.

Flextronics To Make HP Inkjet Printers

Hewlett-Packard has selected Flextronics International (San Jose, CA) as a primary manufacturer in Europe for HP's inkjet printers, beginning with the HP DeskJet 720C. Flextronics will perform both board and complete box assembly at its campus in Sarvar, Hungary. The first printers are due to ship in September for distribution by HP.

"We have a very experienced management team in Hungary. Our big selling point is we are the experts at manufacturing in Eastern Europe. That is what really sold HP on coming with us," reports Robert Dykes, Flextronics' CFO.

"Plus we can do the plastics work in the campus. We're also doing the stampings and circuit boards as well," he adds. It is expected that EcoPlast, Flextronics' injection molding subsidiary, will supply printer plastics on campus, while an unnamed European company, also on campus, will do metal fabrication.

"This is the first large commercial activity that validates our worldwide campus strategy," states Michael Marks, chairman and CEO of Flextronics.

Dykes puts the value of this program at "somewhere in the $100-million range." He says, "We are the only vendor that has this business."

HP is also outsourcing a larger amount of business associated with its inkjet printer site in Vancouver, WA (March, p. 5). Dykes says HP is "evaluating a whole bunch of contract manufacturers," including Flextronics, for this North American business.

HP Called Largest Outsourcer

A Wall St. analyst says Hewlett-Packard is the world's largest user of EMS and estimates that at the current run rate HP outsources a total of about $5.2 billion a year to seven top-10 EMS providers. Furthermore, the analyst, Alexander Blanton of Ingalls & Snyder (New York, NY), has shown how it is possible that HP alone could increase the annual sales of these seven EMS companies by 23% in HP's fiscal 1999.

In a recent report, Blanton estimates that HP outsources a total of about $6.5 billion a year, of which 80%, he figures, goes to SCI, Solectron, Celestica, Flextronics, Jabil Circuit, NatSteel Electronics and The DII Group. Based on contacts with various business heads at HP plus recent announcements, Blanton projects that HP may outsource as much as $12 billion in fiscal 1999, an increase of 85% from this year.

Blanton says HP chairman, president and CEO Lewis Platt told him that eventually "the bulk" of HP's manufacturing would be outsourced. According to Blanton, HP is outsourcing an estimated 23% of its annual production, as measured by the pro-jected cost of goods for fiscal 1998.

More new programs...CMC Industries (Santa Clara, CA) has won a turnkey contract from Next Level Communications to manufacture NLC's N3 Residential Gateway set-top devices. This program is expected to generate revenue of about $100 million for CMC. Meanwhile, CMC's 55,000-ft2 facility in Hermosillo, Mexico, has started production....Hitachi Computer Products (America) will begin manufacturing storage subsystems in Norman, OK, for Zitel Corp. (Fremont, CA). The Hitachi operation says it "is aggressively expanding its contract manufacturing business."...EFTC (Denver, CO) has landed a large repair and warranty contract for Compaq notebook products and has named Fujitsu as EFTC's first customer for build-to-order services (May, p. 5)....LG Technologies Group (Montreal, Canada) has announced its largest ever contract, a five-year agreement with Northern Telecom for production of electronic components for telecom equipment. The contract is valued at an estimated $29 million Canadian for the first year....Rockwell Collins has awarded Group Technologies (Tampa, FL) a $3-million contract to build complex card assemblies for avionics and aircraft communications. GroupTech is now a wholly owned subsidiary of Sypris Solutions....Michael Carr Enterprises, a CM in Salem, OR, has signed a multimillion-dollar production agreement with a Northwest maker of fax modems.

Ingram Micro and Solectron To Team Up

Ingram Micro (Santa Ana, CA), a distributor and channel assembler, and Solectron (Milpitas, CA) have signed a letter of intent to form a strategic alliance for providing build-to-order (BTO) and configure-to-order assembly of PCs, servers and related products worldwide. The companies plan to begin shipments to customers before the end of this year.

Up until now, channel assemblers such as Ingram have been viewed as either potential competitors or customers of the EMS industry (Oct.'97, p. 1). This is the first time that an EMS provider has joined forces with a channel assembler to supply BTO services.

The two firms plan to leverage their combined resources, including facilities, systems and personnel, under a joint management matrix. This alliance will allow Ingram to extend its channel assembly and configuration initiative to 11 locations worldwide, instead of the five it originally planned. Ingram currently operates integration centers in Memphis, TN, and the Netherlands. To those, Solectron will add sites in California, Ireland, Brazil, China, Mexico, Malaysia and Georgia. Also, two new centers will be located in Japan and Canada, but it is to be decided which company will manufacture there.

Ingram will send orders electronically from resellers to one of the alliance's facilities.

EMS acquisitions...The MATCO Electronics Group (Vestal, NY) is acquiring KBS, Inc. (Deerfield Beach, FL) and plans to merge KBS' contract manufacturing operations with MATCO's Florida-based company, U.S. Assemblies in Florida, formerly U.S. Assemblies Coral Springs. The merged operations will do business as U.S. Assemblies in Florida and will eventually be located at the KBS facility, which will be expanded....Solectron has completed its acquisition of IBM's Electronic Card Assembly and Test operations in Charlotte, NC (May, p. 2)....Distributor Reptron Electronics (Tampa, FL) has purchased CM Hibbing Electronics (Hibbing, MN) for $29.7 million in cash and the assumption of about $11 million in debt (March, p. 6)....Unique Mobility (Golden, CO), an R&D firm going into mass production of motor systems, has acquired Franklin Manufacturing (St. Charles, MO), a private CM that will provide Unique with capacity. The purchase is valued at $9.3 million, including the assumption of $3 million in liabilities and debt. Franklin was profitable on revenues of about $10 million for its fiscal 1997 ended Sept. 30.

MMI May 1998

MMI July 1998

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