Industrial Management: Contract Manufacturing
You Order It, They'll Make It
Electronics manufacturers like Celestica are booming
As he struggled to coordinate half a dozen suppliers scattered across the U.S., Eric Turnquist was living out of a suitcase more than he liked. So Turnquist, a supply-chain manager at Visual Networks Inc., began to look for a partner to take over manufacturing, provide design and engineering support, and even after-sales services. A tall order perhaps, but Turnquist feels his company, which makes network monitoring systems, has found all that and more in Celestica Inc. of Toronto, Ontario. Celestica has become a leading player in the exploding field of contract manufacturing, in which brand-name companies hire others to design, make, and sometimes even service their products.
Not long ago, some contract manufacturers did little more than plain-vanilla assembly. But now, in addition to manufacturing, these electronics-manufacturing services (EMS) companies can provide design, distribution, even customer services. "There's seemingly no end to the degree to which name-brand electronics manufacturers want to outsource to reduce costs," notes Pamela Gordon, president of Technology Forecasters Inc., an industry consultancy.
The range of service is certainly welcome. Ceaseless demand for new products--made faster and better--has forced the likes of IBM and Nortel Networks, Inc. to outsource even more. The contract manufacturing companies "have invested in the manufacturing technology, so a company that's developing a product doesn't have to worry about figuring out how to make it," says analyst Meg Keough of Robertson Stephens Inc. What's more, the contract manufacturers' clients don't have to worry about running factories below capacity or failing to meet demand--and they benefit from leading-edge manufacturing technologies while reducing costs.
Offloading all or part of manufacturing has freed the brand-name equipment makers to focus on research and development, marketing, and sales--and has led to huge growth among the contract manufacturers. Gordon says the industry is growing at upwards of 25% a year. But among top-tier players, revenue is growing by an average of more than 40%. Technology Forecasters reckons that the market for electronics manufacturing services totaled $75 billion in 1999.
Behind this growth is a growing rush out of manufacturing by top-tier electronics brands. Currently, for example, companies are outsourcing the equivalent of just 10% to 15% of the total cost of all electronics goods sold. Looking ahead, Gordon predicts that in the next few years that figure could rise to 50%. Other forecasters go as high as 75%. "That's pretty significant when you consider that total electronic-equipment revenue is about $1 trillion," Gordon observes.EXPANDABLE. Amid this Internet-speed growth, Celestica has emerged as the third largest player, with revenues of $5.3 billion in 1999. Last year, it grew faster than both Solectron Corp. and SCI Systems Inc., its two leading competitors. Given such sustained, 40%-plus annual growth rates, Celestica believes its goal of $10 billion in revenues may be in reach by 2001, with the $20 billion mark following just a few years later.
One reason is that Celestica has staked a position as the industry leader at the upper end of the EMS market. "Celestica fits as a provider to higher-end markets such as servers, network equipment, and telecommunications equipment," says Jerry Labowitz, an electronics industry analyst at Merrill Lynch. For example, the company has become Sun Microsystems' biggest provider and the second-largest source for Hewlett-Packard and Cisco Systems.
Celestica has also built a substantial war chest for further acquisitions and investment. Eugene Polistuk, Celestica's president and CEO, notes the company could stand to strengthen its presence overseas, where the outsourcing model is less prevalent. Over the past three years, Celestica has acquired factories in Europe, Asia, and Latin America spun off by Hewlett-Packard, Lucent Technologies, and IBM, plus a number of smaller contract manufacturers. The acquisitions gave the company global reach, along with lower-cost labor.
Analysts say Celestica may also be a player in the scramble for the contracts and plants that will come out of a recent announcement by Lucent. The company will be divesting itself of up to 12 U.S. plants and tripling its outsourcing.
As fast as Celestica has been acquiring capacity and broadening its service base, its market capitalization has grown faster still: by more than 650%, to $8.5 billion, since its initial public offering in mid-1998. The $750 million that Celestica raised in a stock issue in March, as well as a $500 million line of credit syndicated by the Bank of Nova Scotia, give it the heft to continue its aggressive growth.CRITICAL MASS. Size matters in executing big acquisitions and deals. Celestica was able to close a $1.5 billion annual supply contract with IBM and acquire its facilities this year, in part because it had grown enough to handle the business, Polistuk says. "The biggest players do the best because when companies outsource a billion dollars to you, if you're only a billion dollars in size, they'll think twice," Polistuk says.
There are a few constraints to growth. Execution is not the least of them. Sustaining such high-altitude growth rates is famously difficult. Gordon notes that in the race to become the biggest, most global, most diverse electronics-manufacturing provider, Celestica could spread itself too thin and fail to provide enough customer attention and responsiveness. If that happens, clients will jump to smaller companies.
Another problem is the nature of the Celestica-client relationship. Not every original equipment maker has wholeheartedly embraced the outsourcing model. Gordon notes that some companies--such as Germany's Siemens and ADC Telecommunications Inc. in the U.S.--worry about becoming overly reliant on outsiders. Confidentiality is a problem, too.
And even for those who do take the plunge, choosing a contract manufacturer can be a perilous decision. Polistuk observes that contract manufacturers can't always meet the demands of their clients: "Every time they pick a provider, they bet their business--because if they pick the wrong provider and they can't get their product to market at the right quality, at the right time, they don't have a business."
Risks aside, the movement toward outsourcing is gathering strength. "The next five years or so should be extraordinarily bright for companies like Celestica that have the worldwide presence to support the original equipment manufacturers," says Merrill Lynch's Labowitz.
And if, as analysts expect, at least half of the $1 trillion plus market for electronics production shifts to the contract manufacturers, their clients may one day wake up to find that the servants have become richer than their masters.By Hugh Filman in TorontoReturn to top