Inside the No. 1 Tech Outsourcer


Like a lot of technology companies, contract manufacturer Flextronics International barreled into 2001 confident that it could maintain its phenomenal growth. And considering the carnage visited on America's technology sector, Flextronics (FLEX), Singapore-domiciled but with its main operations in Silicon Valley, so far has fared surprisingly well. Especially when you consider that some of its biggest customers are Cisco (CSCO), Hewlett-Packard (HWP), Lucent (LU), Ericsson (ERICY), and Motorola (MOT). Even though profits dropped by 19%, to $249 million, in the first nine months of its fiscal year, its revenues rose by about 11%, to $9.8 billion. Flextronics has surged past traditional industry leader Solectron, whose sales plunged in 2001.

And if you look at quarterly numbers, a curious fact emerges: Flextronics is now about the same size as many of the electronics behemoths whose brand names go on the products it makes. Flextronics' revenues for the quarter ended Dec. 31 were higher than those of Sun Microsystems. It's about even with Nortel and Lucent -- and not that far off of mighty Cisco.

Of course, this is a bit of an optical illusion. As Flextronics CEO Michael E. Marks is quick to point out, these data reflect the severity of last year's contraction for big electronics companies, and roles likely will reverse again when the recovery is in full swing. But it is indicative of the greater role that contract manufacturers are playing in the U.S. economy.

How has Flextronics managed to do relatively well while its biggest customers have been crashing? For one, it has been able to win enough big new contracts to compensate for the lost business from old customers. In 2001, it began manufacturing all of Microsoft's Xbox game consoles. It has taken over all of Ericsson's cell-phone manufacturing, and it snared new deals to produce office equipment for Xerox and take over HP's Singapore printer plant.

During a recent visit to New York for the World Economic Forum, Marks sat down with BusinessWeek's Pete Engardio to give his view on what it's like to operate in such tumultuous times, and what he thinks is ahead. Here are edited excerpts of their conversation:

Q: A year ago, you were confident that Flextronics would easily grow by 25% to 30% in 2001. What kind of shape are you in?

A: Profits certainly are down from what they should be. But relative to our competition and our customers, we're at the top of the world. When you're growing at 60% a year, it's a wacky environment. But now, we're taking out a lot of functions and really working on making our business run more efficiently and effectively. This will create some stability. We can pay less attention to making acquisitions and moving around.

The interesting thing, though, is Wall Street's reaction to what we're doing. I told them we're building more on fundamental profitability, not as much on revenue growth. I tell them we're no longer focused on being the biggest. The issue now is: Let's be really, really good.

But this message has not been well received by some investors. I think people hear me say that there will be no revenue growth. This appears to be a function of age: Some of the older investors think this is great, but younger guys, who only invest in revenue-growth stories, don't like it. Revenue growth is so easy to measure.

When you're in the middle of it day to day, this is really no fun. But when you sit back, you realize that we're not going to go away if we miss our numbers or lose a contract. So I view this is a healthy cleansing. A lot of other companies are going bankrupt.

Q: Hard questions are being asked of every 1990s high-flyer about their accounting these days. What's that like for you?

A: Suddenly, you're being looked at with a different magnifying glass, and it's a little scary. The fact is, the world is loaded with conflicts of interest. Does this mean you can't ask your accountant how to account for a transaction? The core thing is that you pay them to audit your books. That's a conflict right there.

Q: As you look back on the boom and bust, what do the 1990s look like?

A: There was so much easy money that everyone was getting funded. It was obvious when it was happening. Companies could raise $50 million, get a few customers, raise billions, and then become flaming hunks. You would go to one company and find all of their executives were from other companies. You would say: 'These aren't real businesses.'"

A lot of startups would have been better off staying inside bigger companies and creating their innovations there. Now, you're back to company valuations of $5 million. You build that company over five years. And it's a good company.

Q: It has been almost a full year now since many electronics makers started saying there was a lack of "visibility" regarding demand. Any visibility yet?

A: Not much. In normal times, you have inventories of a few days. Now, it's three weeks. That's as much visibility as you get. When you talk to companies about their expectations, they're all saying things will get better. But they've been saying that for a while.

This Christmas, there was more down time than I can ever remember. Nobody checked e-mail or voice mail. They just shut down. Everybody was pretty cocooned.

Q: Why is recovery taking so long?

A: For one thing, you continue to have capacity being shut down. The whole circuit-board business is in complete disarray. And companies like Global Crossing (GBLXQ) and Kmart (KM-T) [are declaring bankruptcy]. That's the normal business process. You can't have a recovery until you have a shakeout. Enron (ENRNQ) is helping this process. The companies at the bottom can't get capital, so they're going out of business.

Q: Every good shakeout seems to cause companies to devise new business models. Will the electronics industry look different when it recovers from this downturn?

A: It definitely won't be as easy for new players to jump in. Look at venture capital. The amount of money has shrunk dreadfully. In telecom equipment, some companies probably need to go out. But some of these companies are national treasures -- Alcatel, Siemens, Ericsson. Their governments won't allow them to go out. But companies like Lucent have nobody to protect them.

On the other hand, it may not be bad that these companies have hugely shrunk their base. Lucent could go down to $4.5 billion in sales -- but it could make money.

These big companies are just taking a lot of stuff out now. We aren't going back to the old days. The old days didn't really exist. A lot of their stuff is in warehouses, and their capacity is unused underground. A lot of these companies are very weak. They've had their first losses ever.

Q: How are the dynamics of the electronics industry changing?

A: The thing that's changing in technology is that a lot of products are becoming commodities really fast. A lot of products that used to be complex and hard to design just aren't today -- routers, handheld computers, notebook computers. One of our board members is the chairman of Circuit City. He said it used to take 10 years for the price of a product to drop from $1,000 to $100. Now, that takes 18 months.

If you were a manufacturer and sold a $1,000 cell phone, this contributed $400 to your operating earnings. You built big buildings, manufacturing plants, lots of design operations. At $100, you get $10 to $15. This brings change to the retail industry as well. Big retailers were training people to sell $1,000 items. But with $100 items, you just stack them up.

Q: What will be the impact on electronic-manufacturing services?

A: For one, it's bringing huge consolidation. A year or so ago, there were about 20 companies that mattered in our business. Now there are 10. And this will continue to shrink. But there also are some new players. There's a big contract manufacturer in China that's now meaningful in our space.

Also, the things that companies are expecting of us are changing dramatically. They really want you to help them run their businesses now. A lot of companies have taken manufacturing operations out of their business. Now, they're handing over procurement and supply-chain management. These are high-cost operations if companies do it themselves because they need large staffs running around checking out suppliers. Customers also want us to do design and logistics. And they want us to be good and strong financially.

Q: Cisco, Hewlett-Packard, and other companies that have aggressively outsourced manufacturing have been hit hard this past year. Does this call into question whether this is healthy for a company in the long run?

A: I think that outsourcing has made these companies better, not worse. Look at HP. Its printer business is 100% outsourced, and HP is killing everybody. But its servers and storage products [which HP largely still makes in-house] are in bad shape. One HP executive said recently that had they kept all of their manufacturing in-house during this period, they would have had to lay off another 15,000 people.

Outsourcing isn't the reason companies are having problems. Everybody is doing badly. Most of these companies are doing badly because they overestimated the market. We took over all of Ericsson's cell-phone manufacturing, and we'll manage it a lot more successfully. Will it sell more cell phones? We don't know. That depends on how good its cell phones are.

If outsourcing doesn't exist, Microsoft would never have done the Xbox. That's the good part of this model. You can have faster innovation. Companies can come out from left field.

Q: Why do you believe there's still a lot of new business to be won?

A: A lot of industries have just embraced outsourcing. In 1996, when we did our first deal with Ericsson, the whole telecom industry was still manufacturing in-house. Now, you have the Japanese companies, a giant sector that's opening up. That's another giant business. Globalization is really hurting the Japanese, but they're still building television sets in Tokyo. Japan is a sad place. People know how much trouble they are in, but they don't know what to do about it. I think they will move faster to outsource, rather than slower.

Q: If there's less venture capital available for new startups in electronics hardware, won't this hurt the pace of innovation?

A: There absolutely will be no end to innovation. There are things that are getting funded. There are guys who want to leave the industry, but they can't leave when things are so terrible. But there are younger guys who are staying, and they say they're having fun. So you will see a wholesale change. This is all like a forest fire. When you go to Yellowstone after a big fire, you see devastation everywhere. But go back two years later, and you see green shoots.

Q: What do you now expect for 2002?

A: The rest of the year won't be great. Revenues will be up, profits will improve some. But coming into this year, I thought that hitting $16 billion in revenue would be a slam dunk. This year, maybe we will have $15 billion. Maybe $17 billion. Maybe $13 billion. But we'll be making money at it. Then, one of these days, business will turn about again -- and it will be great.


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