Circuits Assembly Online Magazine - When ‘Scaling Up’ Leads to ‘Belly Up’

Growth at all costs usually costs too much.

Psst! Hey you! Yeah, you over there … EMS guy. Don’t turn around and ignore me just because I’m a shadow of what I used to be…. I wanna help.

Maybe it’s because I’m getting older, or maybe because we North American fabricators are truly just a shadow of what we were a few years ago, but whatever the reason maybe we can help you EMS guys avoid the mistake we fabricators made. Or said differently, maybe you EMS guys can learn a couple of things by paying attention to what happened to PCB fabrication back in the late ’90s.

For the past few months, and especially at a recent industry gathering, the air has been abuzz with rumors, headlines, announcements and pundits pointing out lower tier EMS companies either in merger talks or trying to position themselves to be acquired in order to gain critical mass and scale to the coveted Tier I world. With the talk has come plenty of dreaming and scheming by smaller EMS companies, as they go through the awkward mating game in search of the perfect (or at least lucrative) corporate match. As a fabricator it all seems too much like “déjà vu all over again.”

The extended supply chain of our industry has been through this mating dance many times in the past and it never has resulted in the promised nirvana. Over the years, equipment suppliers have gone through merger mania, as have raw material suppliers and, of course, fabricators. I have seen this “topline trajectory” play as both victim and participant, and there are plenty of parallels.

Much like today’s EMS community, fabricators in the West, and particularly in North America, were a confident group in the late ’90s. Growth, while choppy at times, was generally strong. Profitability was reasonable, and the emerging industries that fueled the demand for boards were growing thanks to the power of large, world-class companies. Those were heady times and the leaders of those companies were tasting the Kool-Aid and loving it.

Ominously, the industry had gained the attention of investors who knew little about technology, cyclical businesses and build-to-print service. They did preach, however, economies-of-scale. Simply by merging similar companies, the thinking went, sales would increase and greater efficiency would lead to higher profitability.

Growing via merger, it was believed, would enable greater capacity to supply large, global OEM drivers far cheaper and faster than organic growth ever could. And as the Kool-Aid cups were passed, companies large and small were actively seeking any available match to engage with in merger mania.

Some bankers made good money. Some companies were purchased for sums far in excess of their true value. But some strange phenomena began to emerge. Pricing began to erode – and fast. The big guys really embraced the sport of growing the topline. For many, especially investors new to the industry, the mantra became “fill the plant at all costs.” And that they did. Then companies that typically spent their hard-earned cash on equipment and technology found their balance sheets leveraged to a point where what few renegade dollars were available got snapped up to pay debt. What they failed to appreciate is that the one-two punch of decreasing margins with excessive debt is not a good combination, especially in a capital-intense, technology-driven industry.

No one was paying much attention to this at the time, of course. After all, they were living large in the midst of all the mania.

What came next should be no surprise.

Elsewhere in the world were people watching with fascination the party in full swing in North America and Europe. These people had been trying for years to get into the industry. And amid the greed, they saw opportunity. If the overleveraged guys in North America could not afford investing in bleeding- and cutting-edge technologies, they would – and in doing so complete an end-run around some of the industry’s most highly respected companies. And they studied the hodgepodge of companies paired like a jumble of unrelated jigsaw puzzles, with their ill-fitting (and mediocre) facilities and high logistics costs, and decided to invest in new, state-of-the-art facilities – low-cost and high-technology facilities. Of course no one was paying attention to what was happening elsewhere in the world because everyone knew that the established companies in mature markets, like America, were the industry leaders managed by financially savvy executives. Or at least that’s what everyone at those companies thought.

You know how this story ends. The Western fabricators overpaid for ill-fitting competitors to “scale up,” trashed their balance sheets and margins, and could not reinvest in the equipment and technology necessary to remain competitive.

Even more regrettable was how easily we fabricators gave up industry leadership, if not the entire industry, to Asia, and particularly China. What took 50 years to build took only half a decade to undo.

So, EMS guys, there is a lesson here. If you are going to leverage your balance sheet, make sure you also add technology and capability – not just debt – to your “value proposition.”

Grow your sales, but do so only if you also grow profits. We fabricators learned this lesson the hard way not so many years back. Not trying to rain on your parade, but please, learn from our mistakes!