Cover Story
Motorola Plans $30 Billion+ In Outsourcing To Flextronics
Also Lucent Update: 2 Plants Off List
Market Makers
Supply Chain
Second Group Forms Internet Exchange
E-Business Issues Surface at Nepcon
EMS Spotlight
News
Poll Finds More Outsourcing in 90% of Cases
Solectron Making Deals in Australia and Brazil
Canada's EMG To Buy CM Near Toronto
Flextronics International and Motorola have formed a strategic alliance that will allow Motorola's Communications Enterprise (CE) to outsource in a big way to Flextronics. This outsourcing is estimated at more than $30 billion over a five-year period. In the fifth year, the estimated value of services is expected to exceed $10 billion. The alliance dwarfs previous outsourcing agreements, even Solectron's $10-billion contract with Nortel (see April, lead article).
Not only is the deal big, it marks a sea change in the progression of outsourcing, More and more large OEMs have gone beyond outsourcing single products or even product lines. These companies are outsourcing in a single pass across entire business segments. Outsourcing has evolved from tactical to strategic to enterprise-based. It is enterprise-level outsourc-ing that is driving up the size of EMS contracts. This trend results in plant divestitures, but not always. Indeed, Motorola's CE is not divesting any facilities as a result of this alliance.
Under the terms of the alliance, Motorola's CE is consolidating some of its current outsourcing and plans to award the business to Flextronics provided that certain competitive conditions are met. Flextronics will need to win each piece of business. At present, Motorola's CE uses about 25 CMs. This alliance could be bad news for some companies in the EMS supply base for Motorola's CE. A company spokesperson was unable to predict how many CMs will be used in the future, but did say Motorola expects to continue using other CMs.
Flextronics will perform PCBA and box build for CE products including cell phones, two-way pagers, wireless infrastructure equipment and set-top boxes. The provider currently manufactures all of these for Motorola except the pagers. Flextronics will also furnish Motorola's CE with plastics, bare boards, backplanes, enclosures and engineering services.
Motorola's CE will remain a full-line manufacturer and plans to continue to add internal capacity to support future growth. In fact, Motorola's CE is not moving any work out of its facilities as a result of this alliance. The CE business operates more than 60 manufacturing facilities around the world. The alliance is expected to affect about 15% of CE's total manufacturing over the five-year period.
Production will take place throughout the world including North and Latin America, Western and Eastern Europe and Asia. Volumes will kick in during Q1 and Q2 2001.
This deal, says Motorola's CE, will streamline its supply chain. Informa-tion flow will be centralized across multiple product lines. Motorola's CE order entry and logistical requirements will be tied to Flextronics' activities to provide a seamless interface between Motorola customers and Flextronics.
As part of this deal, Motorola will purchase an equity instrument at a discount for an initial payment of $100 million. According to analyst reports, this instrument will be convertible into 11 million shares of Flextronics stock at the discount if Motorola meets its targets. This incentive program also determines when Motorola can convert the shares. Interestingly, it is not the first time Motorola has done something like this. When Saturn Electronics & Engineering became a preferred EMS provider to Motorola's Integrated Electronics System Sector, Saturn gave Motorola a warrant to buy stock in Saturn under an equity incentive program (April issue).
Two plants have come off the list of Lucent plants that were possible candidates for divestiture (May, p. 7-8). Lucent will retain its mammoth Merrimack Valley facility in North Andover, MA, as its manufacturing center of excellence and global systems integration center for optical networking products. Also staying with Lucent is the nonunion Mount Olive, NJ facility, which will serve as the wireless integration center.
Besides North Andover, two other systems integration centers were designated for North America this month. They will be located in Columbus, OH, and Oklahoma City, OK. According to Lucent spokes-person Mary Ward, Lucent will set up both contract manufacturing facilities and system integration centers in the two cities. As a result, work being done at the Columbus and Oklahoma plants will stay in those cities. She says Lucent is looking at the best way to accomplish that goal. One possibility is to have a contract manufacturer take over the existing plant and locate the system integration center on a new site in the area.
As of last month, up to 11 U.S. sites were divestiture candidates. Now there are nine locations on that list. In addition to Columbus and Oklahoma City, the others are Charlotte, NC; Little Rock, AR; Merriam, KS; Omaha, NE; Phoenix, AZ; Shreveport, LA; and Westminster, CO.
Opinions may vary as to what puts a provider in the EMS top tier. But few would argue about Jabil Circuit's place in that select group. The provider was ranked number five in the 1999 MMI Top 50. Still, Jabil does not always march to the same drum that other large providers listen to. Jabil relies on a business model that sets it apart from the rest of the top tier, yet has made Jabil successful.
Indeed, the company describes itself not as a single entity, but as a confederation of independent business units formed around each of its larger customer relationships. Jabil considers each business unit as an independent company with its own P & L and its own supervision headed by a business unit manager or business unit director.
To find out more about this business unit model as well as other aspects of Jabil and its view on various industry issues, MMI recently interviewed Tim Main, Jabil's presi-dent. Formerly senior VP of business development, Main was promoted to president in early 1999. Here are the results of that interview.
MMI: Please explain how the model benefits Jabil's operations and finan-cial performance.
Tim Main: The model has very strong benefits, we think, for opera-tions and financial performance in the context of getting focus on individual customer requirements and their needs for specific technologies. One account may be a high-mix, low-volume communications type customer. Another maybe a more commodity-product type customer with high volume, low mix. These business units are specifically scaled from a resource and technology standpoint to that individual customer or product profile requirements. And that in and of itself, we think, lends both to strong operational performance and enhanced financial performance. A good planning customer does not pay for the resources or the disruptions to production that a bad planning customer might exhibit. A PC customer doesn't pay for the higher levels of infrastructure needed for an engineering-intensive, development-intensive communications account. So these are ways for us to separate the costs and insulate one business unit from another from an operational and financial standpoint.
MMI: No model is perfect. What are the trade-offs in adopting Jabil's model? Is customer concentration one of them?
Tim Main: I think in the evolution of Jabil, customer concentration was a big issue. And our model was kind of a limiting factor on whom we could do business with.
But over the last four or five years, the overall OEM industry has decided that they want to go down an outsouring path....Today they're turning over the keys to global manufacturing to us and expecting us to take it from cradle to grave. That has played into the design of our company. Jabil has really designed itself from day one to be the perfect virtual manufacturing model partner. So we've seen the market open up to us. And we've been more successful with a broader range of customers than we were historically. Today, we have 30 to 35 material accounts. We have more than that in terms of straight customer count, but 30 to 35 customers that contribute materially to our revenue. And our customer concentration levels in terms of top five and top ten are not unlike those in the rest of the industry. So I don't think customer concentration is an issue.
We have somewhat of a reputation that we'll only do big deals, that if you're a smaller account, you can't do business with us. I think we've specifically addressed that with our Massachusetts and California operations. Those operations are specifically chartered to develop relationships with emerging technology companies - accounts like Sycamore Networks and others that may or may not be work-cell or business-unit size. This gives us an opportunity to do business with them on a nondedicated-resource basis and incubate those relationships to the point where they fit a business unit model, maybe are rolled out globally, and use more services. So I think we've added some capabilities that open up our model to more companies, and that is healthy for us.
MMI: How does Jabil differentiate itself from the competition?
Tim Main: In terms of the top tier, we're all saying the same things. We're all saying that the virtual manufacturing model is very important. It's emerging as the core mission of the top tier to provide a very rich, comprehensive stream of services everywhere from design through order fulfillment and repair of the product after it ships to the field. How do we differentiate ourselves within that context? Our goal is to differentiate ourselves through execution and performance. We just flat out want to do that job better than anyone else in the business.
We've been in design a long time...for about 15 years. We have hundreds of engineers specifically devoted to the design mission. We think we execute well on a global manufacturing model, particularly enabled through the business unit model. We're doing a lot of order fulfillment. We acquired a repair company last year. So our goal is to continue to build the business very rapidly through growth, but to execute that model and link those services in a more cohesive way than the competi-tion does. Our thought process is: In the end the customers will recognize that. And the business will migrate to those who execute the best. At its heart, this is still a manufacturing business.
MMI: Is Jabil interested in participating in large OEM acquisitions such as that announced by Lucent? Does this model prevent Jabil from pursuing certain acquisi-tions?
Tim Main: Are we interested in acquisitions of OEM capacity? Yes, we are. We accomplished the HP acquisition a couple of years ago. We've looked at a number of deals since then. For a variety of reasons - either we lost or the customer changed their mind or one of our competitors made a preemptive bid - we haven't made any additional acquisitions since.
We look at the OEM divestiture process as fundamentally organic outsourcing with the added aspect of buying capacity along with the relationship. What's happened unfortunately is that there seems to be an insatiable appetite to put up top-line growth. We think that has been destructive to the fundamental goal of the divestiture relationship. The goal is to convert the OEM capacity to the EMS sector and end up the day after the acquisition with a fully outsourced, organically driven outsourcing model. Many of these acquisitions have ended up turning into overly financially engineered acquisitions that don't tie in well to the organization and have been done to drive top-line growth and for some other reasons. We think that people need to refocus their efforts to fundamentally choose the right supplier, get the products outsourced and then take the benefits of that process in the form of very competitive product cost as opposed to big dollars up front.
MMI: Are you referring to some of the premiums that have been paid for some of these large divestitures recently?
Tim Main: Yes, the very, very large up-front premiums. My comment is: You can make the argument that our competition are very intelligent business people, and they are. They made the acquisitions for good economic reasons. That is one side. The other side is that financially driven people are dominating that process. And when they communicate to the board of directors or to the senior management of the OEM, they need to show them "look at the money we got for our manufacturing." They're not responsible for what happens two to three years after that process is complete. If it's disruptive to the supply, disruptive to the people that were acquired, if it makes it more difficult for the EMS provider to reduce product costs long term, then the real goal of the divestiture was not accomplished. The real goal of the divestiture process is to put the OEM on a more competitive footing and get them more competitive product cost long term and more flexibility in their manufacturing location choices. To the extent that the financially driven people in the process disrupt that goal, then it hasn't been accomplished.
I think Jabil will participate in this process in the near term as well as long term. We think it's healthy. And to the extent that the OEM is somebody we want to do business with, we want to buy their factories. Will our model prevent us from making these acquisitions? No, it won't, although our appetite will be tempered by our ability to continue to execute to a very, very high level. We are a company that is willing to forego top-line growth if we think it will disrupt our execution and level of performance to all the existing customers and existing business. So we don't want to overindulge and pay the price of overindulgence.
MMI: How is the Global Services business doing [see July 1999 issue]? What are Jabil's plans for expanding this business?
Tim Main:. The Global Services business is going fine. We think it's an important service offering. We bought the company to improve our service portfolio. Jabil Global Services has a unique hub-based model that we think is very important. And we think that hub-based model can be expanded on a global basis. So I think you'll see us show up in Europe as well as Asia in the next year or two.
That business is fairly unique in that it operates as a completely stand-alone company inside of Jabil with its own president, Allen Braswell. Allen certainly has aggressive growth plans for that business, but we have not positioned our financial analysts, our shareholders or anybody else to expect runaway growth in that area. We want it to be tied to customer benefit and certainly profitable growth.
The acquisition has been a good one for us. They're hitting their numbers, their operating plan. The next step for that service group is to expand globally, and they're in the process of doing that now.
MMI: With the acquisition in Brazil and the new plant going up in Hungary, has Jabil completed its global expansion?
Tim Main: I wish I could say at any point in time something was complete. As soon as you get what looked yesterday like a complete global footprint, new areas open up. I think Brazil and Hungary put us on an equal footing with everyone else in the business, but expansion isn't com-plete. I don't think it ever will be, at least not in my tenure as president of the company. We have interest in Brazil. We certainly have an interest in expanding in some of the geogra-phies that we're already in. I think Central Europe will see additional growth, possibly into other countries in Central and Eastern Europe. I'm not so sure about Latin America. Certainly in Asia, there's room for expansion into Japan and potentially other Southeast Asian countries.
Within our operations group, we have a dedicated team that is continually going out and scouring what is the next step in our global expansion. I'm very confident within the next 12 to 18 months we'll have additional sites announced.
MMI: What about further expansion in the U.S.? Does Jabil have any plans to set up new product introduction [only] centers?
Tim Main: We've been expanding in the U.S. just as fast as we can. We put up Massachusetts last year. That plant is ramping rapidly. It's about 217,000 ft2 and has a very aggressive ramp plan. We're considering whether we should expand that plant currently. We added California last year. We just leased a new building in California so that is under significant expansion. We just opened the new 175,000-ft2 plant in Boise, Idaho. We relocated the HP operations, which were positioned in about 110,000 ft2 on the HP campus, into the new facility. So there's room for expansion there. [See also News.] We just leased in the last month another building in Florida, about 165,000 ft2.
MMI: What is that building to be used for?
Tim Main: That is to be used for PCB assembly, full system assembly and some order fulfillment - so straight core business expansion. And the Michigan expansion has hit the press. [See April, issue]
Other sites in the U.S. are definitely possible. I'd say probable. But do we have a plan to put in product-introduction-only centers? We run new product introduction in every single facility that we manufacture product in, particularly in the United States. Virtually every product we manufacture has gone through an NPI process within Jabil. It's up to the individual business unit to decide whether or not they would like to use dedicated, flexible NPI manufacturing assets, which we have in Massachu-setts, California and Michigan. Or do they want to do all the new product introduction, prototyping, preproduction, test development - all that kind of thing - within the assets and resources of their business unit? In most cases, the business units will opt to control that within the resources that they have, operating as a complete extension of the customer's engineering group.
So I don't think you'll see us set up dedicated NPI-only centers through which all customer NPI product will run. But we do already have dedicated NPI groups within three different facilities today. We sell NPI in a different way.
MMI: I've seen that Jabil has a new 40,000-ft2 facility in Chihuahua City, Mexico, to serve the automotive industry. How does this facility play into Jabil's strategy for its Mexican locations? Does Chihuahua (or Tijuana, for that matter) give Jabil an alternative to Guadalajara, which is reported as a tight labor market?
Tim Main: We have very aggressive plans for the Chihuahua activity, and it will service our automotive accounts. I think our first customer in Chihuahua will be an automotive account. We will also build commercial products there. So we'll run both computing and communications products as well as automotive products there. It does give us an alternative to Guadalajara, although part of the Chihuahua decision had to do with logistics to the border in a location that still has very competitive costs and high levels of labor availability. So we think that will be a competitive site. It will be ideal for larger, bulky products that need to be shipped into the United States. But it will also be an alterna-tive to Guadalajara and, we think, kind of a rich market in terms of DL [direct labor] and IL [indirect labor] availability. We're going to keep Tijuana open for the time being. That will give us three strong locations in Mexico, all of which are in stages of growth.
MMI: Are component shortages the number-one challenge that Jabil faces today? How are the shortages affect-ing Jabil?
Tim Main: The number-one challenge facing us today is just to grow at the rate we're growing without falling down too much and scraping our knees and elbows. The component market has made that more difficult, certainly, and is a challenge. But we've done a pretty decent job of being able to maneuver through that through the support of our strategic suppliers, better planning and a lot of tactical reactionary buying in some cases just to keep ourselves supplied with material. So our lines aren't going down. Some of it has required spot buys, but I don't think that is the biggest challenge we face today. The biggest challenge is really continuing to grow the company at this rate and supporting the customer base with world-class execution.
The component shortages are not impacting us materially from a financial standpoint. It is something we have a huge amount of focus on in our supply chain management group. We will continue to focus on it. At multiple times in a day, we have people in contact with our key strategic suppliers in a global plan to support commodities like capacitors. So it's taken a lot of management attention. But we've been able to maneuver through it. We think we'll be able to get through this market in pretty decent shape.
MMI: According to one analyst, Jabil expects to triple its PC business in FY 2000 to 20 percent of revenue and increase its set-top business to about nine percent of sales from zero in FY 1999.
Tim Main: Yeah, it's close. I'm not sure about the set-top business being nine percent of sales. In any case, those sectors are showing some pretty decent growth. Where's that coming from? It's really just coming from having some pretty fast ponies in those sectors. Jabil's number-one basis of growth is organic growth with the existing customer base. So that has been really good for us.
MMI: How will Jabil accomplish these increases?
Tim Main: We're going to accomplish it based on having the assets. We're building factories as fast as we can. We're ramping to capacity. It's just pedaling the bike hard.
MMI: This one unnamed PC account keeps cropping up in various reports. Has Jabil ever named that account officially?
Tim Main: We haven't named it officially because the customer doesn't want us to.
Some people have said it's Dell. Our two biggest customers in that sector are Dell and Gateway. I don't think I'd argue much with that. I've seen that show up in a lot of analyst reports.
MMI: So you wouldn't argue with Dell?
Tim Main: No.
MMI: What can Jabil say about its communications, peripherals and automotive businesses going forward?
Tim Main: The communications business is very strong. That is maintaining like a 40 to 50 percent share of our total business. I think it's forecasted to be about 45% this year. So that is showing outstanding growth given that we're growing revenue 55 percent. Peripherals are primarily our LaserJet printer business, and that is not showing really strong growth. It's growing, but certainly not as fast as communications and PC products are. So peripherals will probably shrink a little bit in terms of percentage of our total business.
The automotive business has been shrinking as a part of our total business, although in absolute dollars it's continued to grow. We actually have pretty high aspirations for the automotive sector. It's a very, very difficult business to operate in. The benefit that we have is that we've been in the automotive business for over 20 years. We understand it. We have the resources and know-how to go after that market. And we think they're going to do a lot more outsourcing.
MMI: When you say it's a very, very difficult business, are you talking about margins? What's the hard part of that business?
Tim Main: No, I'm not really talking about margins. It's extremely difficult from a product qualification, product reliability and product quality requirement standpoint. So just as an example, an acceptable end product dpm [defects per million] for some-body in the computing business is about 2000 dpm. In the automotive business, we're required to have dpm in single digits. And getting a product to market takes three years of intensive component-level qualification, reliability testing, multiple levels of preproduction builds, product quality control plans and so on. By the time that product goes to market in that three-year time, people can lose inter-est....So it's tough to stay focused on.
But we like it. We think it's a good business. And the benefit is that the product lives are pretty long.
MMI: What is Jabil's view of vertical integration of materials such as PCBs, plastics or enclosures?
Tim Main: We think it's important for the EMS sector to have fundamen-tally strong command of the entire supply chain. That is, command of the supply chain, not complete ownership of it. I don't think it's credible to say that you can be world class in every single aspect of manufacturing different types of products in different businesses. Can you operate effectively as a conglomerate of these different supply pieces? I don't know. We'll have to see. The OEMs tried that out and ended up deciding to get out of it. I'm not sure it's appropriate for us to go back into it.
However, there are areas where there may not be an adequate supply base. Or that supply base may not be adequately deployed in a region. In other words, as we press into the Chinas, Hungarys, Mexicos, Indias and so on, is there an adequate supply base there? If not, then there may be a good argument that you should own some of those resources. Or you should have strategic relationships such that your suppliers will agree to locate there to support your business.
So we're not saying never, but we don't think it's credible to say that you can be world class in PCB fab, metal bending, plastics, printed circuit board assembly, system integration and everything else. You need to be able to focus your management attention and know-how in the most critical areas and then to the greatest extent possible use the existing supply base and the people who are willing to invest in their businesses.
MMI: Does Jabil have a goal for revenue level or industry ranking?
Tim Main: We have not expressed a goal for revenue. We have some benchmarks that we think we'll meet internally. We've purposefully not sent those out to the street simply because we don't want to paint ourselves into a box. Financially, our goals are to grow operating income at 30 to 35 percent a year on a long-term basis. We've exceeded that over the last few years. I think we'll probably continue to exceed that for the foreseeable future. But that's our financial goal. We think that is good for shareholders.
From a customer standpoint, our goal is to continuously improve our execution and continuously improve our cost profile and so forth. Revenue does not tie in any appreciable way, we think, to shareholder value or customer satisfaction. So that is not something we have articulated as a goal. We do think it's important for us to stay in the top tier. And we think we have sufficient scale, and based on our growth we'll stay there for a long time.
MMI: How does Jabil define the top tier?
Tim Main: First of all, you must have global manufacturing infrastruc-ture. You must have a global IT infrastructure. You must be able to manage effectively global manufac-turing of products, transitions from one region to another. You must have sufficient scale to be cost competitive for your customers. You must have a very broad, comprehensive set of services...everything from design through depot service. If you have all of those things, then you probably ought to be considered a top-tier player. The ultimate judge of whether you have sufficient scale is the customer - certainly not EMS providers themselves. Right now we think we have sufficient scale to satisfy our customer base. So we feel pretty comfortable with that.
We're certainly not going to sit around and have revenue flatten out even though we're making good growth in operating income. We're going to continue to grow this company aggressively.
MMI: What is Jabil's take on EMS industry consolidation and what the industry will eventually look like?
Tim Main: There are two reasons to do deals like this. Hopefully, you get a yes to both. In some cases, you may not though. You might do it because it's financially a positive. So it's good for the shareholders. And you might do it because it's good for the customers. You've added some know-how or capability that you wanted to have.
I think in some of the industry consolidation plays that you may see...some deals may get done because they can be. The top tier has a multiple of 40, and the second tier has a multiple of 25, 26. Therefore you can pay a fairly substantial premium for a tier-two guy's stock and have that work out financially. We're not going to play that game just because integrating any acquisition sucks management bandwidth like crazy. We want to focus the management bandwidth on customer satisfaction and core organic growth.
We'll probably do deals if that makes sense to the customer base. But we won't do it strictly because it can be done and is financially good from an engineering standpoint.
MMI: Nobody has a clear picture, but do you have any strong feelings about what the industry will look like in, say, three to five years?
Tim Main: In the end, the industry will probably look like every other industry that you learn about when you go to MBA school. Eventually, three or four players will dominate the industry. There will probably always be a place for a small high-service, mom-and-pop kind of provider down the street. But the industry will end up being dominated by a handful of huge providers that have enormous economies.
You can look at industry after industry and the natural evolutionary forces that form them, and when the growth flattens out, they all kind of coalesce around one competitive thesis. The question is how far away is our industry from that. There is such enormous growth potential for the next decade that I don't see that happening for five years.
It's a 700-billion dollar market that grows at 70, 80, 90 billion dollars a year just on straight secular growth. And we still have a fairly low pene-tration rate.
MMI: What is your take on the penetration rate? I've seen everything from 9 to 20 percent or more.
Tim Main: I think we're in the high teens, moving into the high 20s in the next three, four years. And I think in the end you'll see about 70 to 75 percent of the total electronic cost of goods sold outsourced. So we will be going bonkers for the next three to five years.
MMI: How long does it take to get to that end point?
Tim Main: I think that takes a decade. But what that says about these companies today - Jabil Circuit at three and a half to five billion dollars and Flextronics at nine billion dollars - in five years it's absolutely within the realm of rational thought that these are going to be 40, 50, 60, 70 billion-dollar companies. The challenge will be what type of execution company are you at that size. How effectively will you manage that growth over the next five, six years?
EMS providers now have a second consortium-backed marketplace to ponder for supply-chain transactions over the Internet (see May, p. 1). IBM and seven other founding partners including Solectron along with technology and financial partners have signed up to open a new e-marketplace called e2open.com. Operations are expected to start by mid-July, with more functions to be rolled out within 12 months.
While the first coalition exchange was formed around three computer OEMs led by Compaq and HP, founders of this second marketplace represent a broader industry cross section including telecom, computers and consumer electronics. Besides IBM and Solectron, the other founders are Hitachi, LG Electronics, Matsushita Electric (Panasonic), Nortel, Seagate and Toshiba. Both Hitachi and Solectron are backing both exchanges.
Why is Solectron sponsoring both marketplaces? The company says it is interested in joining these exchanges as a vehicle to implement standards, such as the RosettaNet standards, for commerce within the electronics industry. At this point, there is no single right answer, and each of the two exchange proposals has its own strengths, according to Phil Fok, Solectron director of corporate operations. Solectron has chosen to participate in both, and possibly more, says Fok, to move the standards effort forward quickly. He describes the potential benefits to be gained from true collaborative planning as tremendous for all participants based on improvements to business processes.
Unlike the Compaq-HP exchange, technology has been chosen for this new marketplace. It will run on technology provided by Ariba, IBM and i2, serving as technology partners. The marketplace will be hosted and built by IBM Global Services. For the e-commerce platform, Ariba expects to provide capabilities such as auctions, reverse auctions, and bid-ask exchanges. Companies may also use Ariba's solution for indirect procurement (MRO). TradeMatrix technology from i2 will foster collaboration, for example, by allowing companies to communicate changes in production schedules to suppliers within the marketplace. Aspect Development, which intends to merge with i2, will provide a search engine and component data as well software for updating product information.
Founders are expected to contribute up to $125 million in capital, while the two financial partners, Crosspoint Venture Partners and Morgan Stanley Dean Witter, plan to chip in $80 million. Initially, founders will have equal shares in half the exchange's equity.
Doing business over the Internet holds great promise, but questions remain to be answered. That was the gist of some remarks made during a senior executive forum held Feb. 28 at Nepcon West 2000 (Anaheim, CA). Hosted by consulting firm Technology Forecasters (Alameda, CA), the forum brought together leaders from some of top OEMs and CMs. The overall theme was "The Future Factory: EMS in the 21st Century."
The attraction of supply-chain e-business comes through clearly in comments made by a Lucent Technologies executive. "What the Internet provides to us it the ability to get and engage with a lot of players very, very quickly because we can do it with little investment in time...," remarked Jose Mejia, senior VP and chief technology officer for Lucent. "What I think the Internet provides us is the ability to really get it going fast, get going with quick plug-and-play kind of modules, and do it with anybody, regardless of what darn ERP system they may use. So you don't have to get into the holy war discussion of ERPs. The implications are just phenomenal from my standpoint."
For SCI Systems, Internet B-to-B is not an option. "To not enter that arena and not take advantage of that capability will place a company at a very distinct disadvantage, and you won't get to play in the game. SCI is one of the larger companies in the industry, but if we don't embrace the Internet, we'll be one of the smaller companies in the industry. It's just that simple," said Dave Jenkins, senior VP at SCI.
But one of the issues with Internet communication is the need to standardize. "Excess inventory on the net, bidding associated with PCBs, tracking serial numbers through the process, interactive and proactive ordering systems - there are a lot of pieces, a lot of initiatives," said Mike McNamara, president of the Americas for Flextronics International. "The difficulty is to sort out which is going to be the survivor. Which is going to act in an area of standardization across the protocols and communications? The successful ones have all had very open systems and have essentially been created to be standards in the industry. There will be a lot of failed initiatives and investments that may not come to fruition. More important is to have the standardization than the individual applications."
Then there is the potential for garbage in, garbage out, if communications are allowed to run amuck. "How do you communicate demand and collaboratively do planning and forecasting? There's a lot of human intervention that goes into the process to rationalize the information...," commented Bryan Stolle, chairman and CEO of Agile Software (San Jose, CA).
He pointed out that companies can use the web to transmit their demand up and down the supply chain. But Stolle asked, "Who is looking at that, rationalizing that, putting objectivity to that demand? I refer to the diamond curve in supply, when you get one more unit of demand than you have of supply. Then demand spikes. Why? Because everyone starts going everywhere to try to find that extra unit. So it creates a much larger appearance of demand than truly exists. As soon as that one unit is fulfilled, the demand just drops off a cliff. So when you have those kinds of problems going, and you start trying to communicate that information on the web, it takes garbage in, garbage out to a whole new level."
Note: quotations were provided by Technology Forecasters.
Despite the loss of a major customer, MCMS (Nampa, ID) has its sights set on going public.
The company's plans for going public hinge on making sequential improvements in quarterly results. "What we expect is our third and fourth fiscal quarters will show improvement, still not to the level we'd really like," says Rick Rowe, CEO of MCMS. "But they will show improvement quarter over quarter, the fourth being better than the third, the third being better than the second. By the end of August, we'll launch into our next fiscal year, and then that's when a lot of the growth really starts to hit."
Fore Systems, historically MCMS' second largest customer, is disengaging from MCMS, which resulted in a $20.9-million revenue shortfall in MCMS' fiscal Q2 ended Mar. 2, compared with a year earlier. This shortfall was the primary reason that sales declined from $116.3 million in Q2 fiscal 1999 to $99.1 million in Q2 fiscal 2000. But MCMS expects to more than make up for the loss of the Fore business, worth about $80 million a year, with sales from new customers alone.
MCMS wants to establish a pattern of quarter-over-quarter earnings improvement. "I think the financial markets will say that if we do that for the next three or four quarters with the customer set we have, with the worldwide footprint, and with the support of our equity partners, I think people believe that it would probably be an appropriate time to think about going to the public market," says Rowe.
Recently, however, Moody's Investors Service did not have good news for MCMS. In March, Moody's lowered ratings on MCMS debt. The service estimated that MCMS' available cash at that time "would not be sufficient to sustain a level of operations commensurate with the company's highly leveraged capitalization."
Later in March, MCMS announced that it had earlier received an $8.7-million loan from its shareholder group, led by Cornerstone Equity Investors IV. According to MCMS, the loan enhances liquidity and supports the growth from existing customers and two new ones, Atmosphere Networks and Digital Lightwave (Mar., p. 11).
MCMS believes it is good shape as far as having enough capital going forward to finance growth. Rowe says the company is "working several things." He adds, "We feel also that as this business now starts to grow, it will start introducing the cash flow needed to essentially pay for itself." That will occur primarily in the second half of the calendar year, explains Rowe, because most of the new wins and programs start to kick in during the second half.
Unlike a typical CM, MCMS is highly leveraged as a result of being recapitalized as an independent company in 1998. At that time, Micron Electronics sold 90% of its contract manufacturing operation in a deal with Cornerstone. As of Mar. 2, MCMS listed long-term debt of $206.2 million, aside from the above shareholder loan. This debt exceeded total assets of $158.4 million. Interest expense for Q2 fiscal 2000 came to $5.3 million.
But when MCMS goes public, the company plans on investors using an EBITDA valuation, which, of course, ignores interest. Proceeds from an IPO could then be used to pay down some of MCMS' debt. "If you look at the multiples of the EBITDA in the industry, we think that we would be able to raise enough money in a public offering that we could get ourselves in a much better balance-sheet position and then continue to grow," says Rowe.
MCMS expects new customers will serve as a major source of growth. The company has provided analysts with guidance that business from new customers in a first full-year run rate would be 2 1/2 times the Fore loss. That does not count growth from existing customers.
Besides Atmosphere and Digital Lightwave, another new customer is Tachion Networks, which has developed a broadband switch for the convergence of voice and data. What's more, MCMS just disclosed two additional customers - Alidian Networks, which is involved in optical work, and Avail Networks, a supplier of broadband multiservice access products. For Avail, MCMS will act as sole source for a new line of products that enable broadband delivery of integrated data, voice and video over unified access networks.
This wave of new customers can be traced, at least in part, to management changes made toward the end of last year. Rick Rowe, a Honeywell veteran with a strong operations background, was brought in as CEO. Rob Subia, the former CEO, then became president and chief sales and marketing officer. This move allowed Subia to focus full-time on revitalizing the company's sales effort. "We had been in a real sales slump...for about a year," notes Rowe.
According to MCMS, new optical customers such as Atmosphere, Digital Lightwave and Alidian reflect one of its strengths - technology. MCMS believes customer care is another competitive advantage. And the company plans to make materials management its third differentiator. In that area, says Rowe, "I don't feel we're where we should be today, but [we] will be."
MCMS expects to grow at least as fast as the datacom and telecom market, which makes up about 85% of its sales. According to Rowe, that market is growing at about 30 to 35% a year. Note that Cisco Systems represented 43.5% of sales in fiscal 1999.
To ensure viability in a thin-margin business, MCMS has made some painful decisions. The loss of the Fore business forced MCMS to downsize its Durham, NC, operation, which relied heavily on that business. About 150 jobs were cut. The company has also taken a hard look at its SGA infrastructure. As a result, MCMS eliminated about 50 positions in Nampa. On the other hand, the company is hiring 10 to 15 engineers.
But there's more to financial performance than cutting costs. MCMS wants its work force to buy into improving performance. So the company has created an incentive program covering all employees. This incentive system is based 60% on EBITDA and 40% on control of working capital.
In the 3rd Annual Global Outsourcing Poll conducted by Bear, Stearns & Co. (New York, NY), 90% of OEM respondents said they expect to increase their use of an EMS provider over the next 12 months. That result is up from 84% in 1999 and 74% in 1998. Bear Stearns surveyed 200 OEMs and received 101 responses from companies representing $369 billion in cost of goods sold.
The firm also asked OEMs to give their long-term outsourcing goal as a percentage of total manufactured product. The average response was 72%, almost five times higher than the current estimate of 15% penetration cited by Bear Stearns. Given the results of the poll and the implied industry growth rates, Bear Stearns expects to see a $50-billion CM within five years.
Despite the attention given to OEM divestitures lately, 85% of respondents would prefer to transfer production to a CM's plant rather than outsource by divesting a facility to a CM.
Based on COGS-weighted responses, Bear Stearns found the outsourced portion of manufactured product from telecom participants came to 25%, the lowest figure for all segments studied. Repeating a forecast from last year's poll, Bear Stearns believes the largest growth opportunity for EMS providers over the next 12 months lies in telecom hardware. For OEMs in computers, storage and peripherals, 37% of manufactured product is outsourced, according to COGS-weighted results from the poll. Consumer and related OEMs indicated 30%, while data networking OEMs showed by far the highest portion outsourced at 89%. Bear Stearns believes this number largely reflects emerging growth companies.
Cost reduction ranked as the primary reason for outsourcing among 49% of respondents, the largest group. Last year, cost reduction also received the most votes (June 1999 issue).
Solectron (Milpitas, CA) has signed definitive agreements to acquire Bluegum Group, reportedly the largest CM in Australia, and IBM's manufacturing operations in Hortolandia, Brazil.
When the Blugegum deal closes, Solectron will be the first global EMS company with a major presence in Australia. Solectron will gain Bluegum manufacturing facilities in Liverpool and Wangaretta, Australia, plus a refurbishment activity in Melbourne and program offices in Sydney, North Melbourne and Singapore. Bluegum employs about 700 people, offers 317,000 ft2 of manufacturing capacity and is currently operating at a $200-million annual run rate. Bluegum customers include Alcatel, HP and IBM. The deal is due to close next month.
Solectron says major customers are asking for a presence in Australia prior to committing to a global solution. In a recent conference call, senior VP and CFO Susan Wang told analysts that the deal will allow Solectron to serve that market locally, in particular with repair and refurbishment services and system assembly.
Bluegum was founded in 1997 through the acquisition of IBM's Wangaretta facility.
In Brazil, Solectron will take over systems configuration and assembly for IBM's Personal Systems Group, Retail Systems Solutions Group, and Enterprise Systems Group. Solectron will supply PCs, servers, storage systems and point-of-sale systems to the Brazilian, Mercusol and Andean markets.
Through an asset purchase, Solectron will acquire 140,000 ft2 of additional manufacturing capacity in Brazil and will offer jobs to about 220 IBM employees there. At present, the operation's annual run rate is estimated at between $120 and $130 million. The deal is expected to close by the end of this month.
Solectron already supplies IBM with PCB assemblies from Solectron's Brazilian operation in Sao Jose dos Campos. The provider says the system assembly capabilities of the new site will complement the PCB assembly focus of the existing operation.
Meanwhile, Solectron has completed its acquisition of four Nortel facilities. They are located in Calgary, Canada; Research Triangle Park, NC; Monterrey, Mexico; and Cwmcarn, Wales (April issue).
In a stock-for-stock deal, Sanmina (San Jose, CA) has acquired Essex AB (Sundsvall, Sweden), a CM with two facilities each in Sweden and Finland.
Employing about 1100 people, privately held Essex brought in sales of more than $170 million last year. Customers include Nokia, Ericsson and Siemens Elema. Communications represents 67% of sales, while industrial and medical electronics account for the rest. Essex is projecting a 33% sales increase this year.
Sanmina says the deal expands its European footprint and complements its operations in Ireland. The company also believes Essex is well positioned to further expand within its key markets, especially global wireless. The two companies target the same key markets.
Rune Glavare, founder and CEO of Essex, will continue to run the company and report to Mike Landy, president of Sanmina Europe.
Nordic Capital, a private equity firm, and the 6th AP-fund, manager of Swedish pension funds, together owned 56.9% of Essex shares.
Last month, SMTC Corp. (Toronto, Canada), an EMS provider that has filed to go public, entered into an agreement to acquire Pensar (Appleton, WI), an EMS company specializing in design engineering services. With 600 people, Pensar operates a 75,000-ft2 design and manufacturing facility in Appleton and a Design Center in Minneapolis, MN.
Last year, Pensar generated revenue of $53.0 million, and EBITDA amounted to $5.4 million after adjusting for one-time charges. The purchase price is expected to be about $31.9 million. SMTC will pay a combination of stock and cash and will assume $4.4 million in Pensar debt. To fund the cash portion of the acquisition, SMTC intends to use some of the proceeds from its stock offerings in the U.S. and Canada (April issue). Net proceeds are now estimated at about $111.8 million.
Pensar's design and engineering services include turnkey product development, ASIC/FPGA design, firmware development, mechanical design, DFM/DFT, product verification and EMC testing. The company has design expertise in areas such as DSP, embedded networking, communications and power electronics. SMTC plans to expand its overall design capability by using the Pensar model as a benchmark.
The acquisition also gives SMTC a presence in the Midwestern U.S.
Pensar's largest customer is Power Conversion Products. In 1999, the next four largest customers were Best Power Technologies, Computer Network Technology, Hunt Technologies and IMI Cornelius.
Publicly held Electronics Manufacturing Group (EMG), a CM in Calgary, Alberta, Canada, has signed an offer to acquire another Canadian CM - JFB Technologies of Markham, Ontario, near Toronto.
EMG will pay a price of Cdn$10 million through a combination of Cdn$6 million in cash and 800,000 shares of EMG. The deal is expected to close by the end of the month. JFB is reportedly profitable with annual sales of about Cdn$10 million, all of it from consignment work. The Ontario-based CM operates in a 40,000-ft2 building with 200 employees. Automated PCBA capacity consists of five SMT lines, of which three are high-speed Universal Instruments' lines, and four through-hole lines.
"A number of potential EMG customers have expressed a desire to work with EMG, but a preference to manufacture in the Ontario region. JFB gives EMG a national presence and the ability to serve these customers in Central and Eastern Canada," states David King, EMG's president. Also, JFB's through-hole capacity will allow EMG to quickly add through-hole demand, for which EMG does not have the capacity in Calgary.
"We position ourselves to be a full-service turnkey manufacturer, but for the mid tier of the market," says David Snell, EMG's CEO and vice chairman.
EMG intends to convert JFB's consignment customers to turnkey as much as possible.
For the quarter ended Mar. 31, EMG earned net profit of Cdn$67,611 on revenue of Cdn$6.1 million.
ACT Manufacturing (Hudson, MA) is holding discussions with the French company Bull, S.A. to acquire Bull's EMS operation located in Angers, France.
Following French law, Bull is in the process of consulting its work's council regarding this potential transaction. ACT says it is hopeful that a definitive agreement can be reached promptly after consultation.
"If this acquisition is consummated, it would expand and strengthen our position in Europe, as well as expand our customer base and manufacturing capacity," states John Pino, president and CEO of ACT.
The French operation has been the major revenue producer within Bull Electronics, Bull's EMS business unit. Bull Electronics also includes a U.S. facility for contract manufacturing in Lowell, MA. At press time, no information had been released regarding the Lowell facility.
In a reverse merger, CTI Technology, a company with minimal operations but approved for OTC trading, has acquired CAI Acquisition Co., a privately held EMS company based in Springfield, MA. This move gives the EMS company access to public sources of capital.
What's more, CAI made two EMS acquisitions of its own in the last two months. The company acquired Contract Technologies, now CTI Electronics, in Pompano Beach, FL, and a CM located near Raleigh, NC, and formerly owned by a Scottish company, Clairement Electronics. That operation is now called CTI Technologies.
"We are going to continue to grow the company via acquisitions," says Vic Servello, COO of CTI Technology. "We don't intend to be a huge player like Solectron or ACT Manufacturing. We hope to get to 100 or 200 million [dollars] in the next few years."
He estimates that CTI as currently constituted will probably have a run rate of about $15 million a year. Among the three EMS operations, CTI has about 55,000 ft2.
George Davies, CTI's chairman, CEO and majority shareholder, had been principal owner of CAI.
In connection with the reverse merger, the two companies completed a $500,000 private sale of common stock and a $1-million sale of convertible preferred stock.
More deals done...Celestica (Toronto, Canada) has completed its acquisition of IBM's PCBA and system assembly operations in Vimercate and Santa Palomba, Italy (Jan. issue)....Plexus (Neenah, WI) has closed on its purchase of Elamex's turnkey EMS operations in Mexico (April issue). Subject to certain adjustments, the price of $53.7 million was paid in cash. Plexus gains a 210,000-ft2 manufacturing facility and a service center at 40,000 ft2, not 30,000 ft2 as previously listed....Salient Cybertech (Sarasota, FL), a new name to the EMS industry, has bought Futronix, a CM in Homosassa, FL. Occupying a 55,000-ft2 facility, Futronix is expected to bring in sales of $12 to $15 million for fiscal 2000. Salient, which is traded on the OTC BB, also owns Gemini Learning Systems, which develops adaptive learning technology for distance education and computer-based training....Flextronics Semiconductor, a Flextronics International group, purchased the silicon library and IP business unit of Aspec Technology, now known as Ingenuus.
Some new programs...S3, Inc. has selected Manufacturers' Services Ltd. (Concord, MA) to provide global manufacturing services for S3's Rio digital audio players....Jabil Circuit (St. Petersburg, FL) will manufacture an Optical Service Switch for Tenor Networks (Acton, MA) in Jabil's Billerica, MA facility.
Some new facilities...Jabil will add 98,000 ft2 to its 170,000-ft2 facility in Meridian, ID....Sanmina has started phase-one construction of a 275,000-ft2 enclosure facility in Toronto, Canada.
People on the move...Olin King, founder and chairman of SCI Systems (Huntsville, AL), intends to retire this month after 38 years with the company. Under King's leadership, SCI pioneered such industry practices as build-to-order production; OEM plant acquisitions; low-cost manufacturing in Guadalajara, Mexico; and global manufacturing coverage. Although King will relinquish the chairman's role, he will keep his seat on the board. Gene Sapp, SCI's president and CEO, is expected to be named chairman. In addition, SCI has hired Bhawnesh Mathur as senior VP of supply chain management. He joins the company after 21 years at IBM, where he held senior management positions in supply chain management, procurement and manufacturing....At Solectron, Walt Wilson, senior VP of business integration and information technology, has taken on additional duties as interim president of Solectron Americas. He has assumed these duties from Fred Forsyth, who is pursuing opportunities outside of the EMS industry....Manufacturers' Services Ltd. has named Bert Notini, formerly a Wang Global executive, as general counsel and executive VP of business development. His responsibilities will include leading MSL's acquisition initiatives. Also, MSL has promoted Lisa Ryan to VP of information technology....Gregg Thomas has become VP Americas at Universal Scientific Industrial (Nan-Tou, Taiwan), which is part of the ASE Group. Now based in Santa Clara, CA, Thomas formerly served as VP of sales for the West Coast operation of Century Electronics Manufacturing (Marlborough, MA)....Robert Legendre has joined Pemstar (Rochester, MN) as VP of worldwide materials. He formerly held the same position at Western Digital. ...Electronics Manufacturing Group (Calgary, Canada) has promoted David King to president....Mike Gibbons has been promoted to president of K*TEC Electronics (Sugar Land, TX)....Rick Ackel, formerly with Arthur Ander-sen, has joined Sanmina as executive VP of finance and CFO.
Correction: Last month on p. 7, the wrong location was given for PartnerTech's headquarters. PartnerTech is based in Åtvidaberg, Sweden.