EMS cycles are like the California housing market. Here’s how to manage your risk.

Market consolidation and accountability cost are two dominant trends this year. Neither is new. They repeat in a four-to-seven-year cycle. The value in looking at these trends from a marketing perspective is they will influence OEM decision teams’ perceptions and focus. If your sales and marketing process addresses these concerns, you will appear stronger in the minds of these decision-makers. If your process fails to address the concerns, and your company appears to fit in a risk category, your competitive position may weaken.

Understanding Consolidation

Like the California housing market, the EMS industry goes through a consolidation frenzy every few years. And, like the housing market, by the time people are writing about the trend, valuations have peaked and are on the way down.

For more than a decade, some industry watchers have predicted the market would shrink to two or three major EMS providers, and once it did, those few companies would be able to dictate pricing. But most Tier One EMS providers owe their emergence from the middle tier to one or two key accounts that placed large quantities of business in a fairly short time. When Tier One begins to shrink, business usually shifts to add a few more to the club, because larger OEMs like the formula of a hungry pack of Tier Ones forced to compete on price.

Investors are a key driver of consolidation. In acquiring companies, the investor base is interested in seeing continued revenue growth. As bigger and better deals are done, the M&A pace picks up because investors who value growth want to see rapid acquisition of additional revenue. In companies with more conservative investors, decisions to sell may be made as either valuation trend upticks or concerns about the likely capital needed to continue to compete motivate investors to place the company on the block. Momentum eventually slows, as either poor acquisitions or integration drives lowered valuations, or as overall production demand slows and excess capacity becomes an issue. Companies downsize; the market improves, and the cycle renews.

OEMs have four potential fears about EMS consolidation: The first is that a key EMS supplier will be acquired by an EMS provider whose business model doesn’t value that type of project, and they will be forced to switch suppliers on short notice; the second is that a critical EMS supplier in acquisition mode may acquire badly or become so focused on acquisition integration that performance or financial stability is in jeopardy; the third is that change in ownership will drive significant performance issues and loss of technical expertise; the fourth is that change in ownership will place an unacceptable percentage of business in a single supplier or eliminate a competitive situation that has been driving favorable pricing.

In short, it takes time for projects to transition, and OEMs have valid concerns that M&A activity can negatively impact a carefully crafted sourcing strategy. The aforementioned “motivated investor” component of M&A often drives fears that an EMS provider may be on the block, even when not officially announced. The pitch being made to company owners right now by the investment banking community is, “If you don’t sell now, you may have to wait a few years before prices will be this good again.” OEMs understand this dynamic and quietly may be evaluating risk in their potential supply base. When a company is in acquisition mode, its focus on business model and success in integration will be evaluated.

Addressing Consolidation Fears

Very few company CEOs go on record as saying their company is not for sale at any price, because the reality is most companies will consider the right deal. However, if acquisition is unlikely, reinforcing the company’s commitment to its business model and market niche and outlining its financial stability can be good ideas. The best places to do this are in sales presentations and in new customer quoting packages. New investments in plant and equipment should also be highlighted. Public relations activities such as articles related to company processes are another way of underscoring robustness of business model. Having key-executive-to-key-executive presentations in the final phase of competition may also be a good idea.

If the company is in acquisition mode, discussing the core business strategy and integration successes can be very important. Sales presentations, quote packages and articles are relevant tools here. It is also important that Sales is aligned in what they are selling and that plant personnel with customer contact also present the same message. Customers will be looking for signs of disconnect in processes and personnel.

Executive presentations can be important in this situation as well; there may be a perception that only executives are truly attuned to the new business model. Not only is this valuable in the final phases of new account acquisition, it is also important with existing acquired accounts. These accounts selected a different supplier, and it is important to sell the specific benefits of the change in ownership. Fear of negative impact from business process change will be high. The longer it takes to provide reassurance, the more time OEMs have to start shopping for more predictable alternatives. Additionally, the actual benefits of change in ownership may influence acquired customers to add business previously not suitable for the prior EMS provider. Delays in selling new capabilities may result in business being placed elsewhere.

For companies not involved in acquisition, opportunities may exist to absorb business that is either a bad fit for an M&A intensive competitor or simply hasn’t gotten the reassurance needed to stay in place while change occurs. The market uncertainty that accompanies the peak of the EMS consolidation cycle inevitably opens the door to new business opportunities for companies that can both market and offer stability and high levels of service.

Understanding Accountability Cost

The most graphic example of cost of accountability is the recent pet food debacle. U.S. consumers now understand their cherished companions’ food is manufactured by a cluster of contract manufacturers, and that expensive food carries the same tainted ingredients found in the cheap stuff. And, now that the media has been sensitized to this issue, the public is learning that 60% of product recalled this year came from China. Questions about the safety of consumer products, the food supply, country of origin labeling and globalization are increasing in frequency.

Like consolidation, this trend isn’t new. Remember the SARS scare? The reality is that developing markets always have tradeoffs. While it can be validly argued that in the U.S. business is over-regulated and labor benefit costs such as health insurance have become unsustainable, it can also be validly argued that most low-cost countries under-regulate and may lack critical infrastructure for ensuring consistent product quality and enforcement of basic environmental and safety standards. The more popular the market becomes, the less attention is likely to be paid to this type of infrastructure. When an issue such as the pet food recall arises, however, consumers start to recognize the issues, and ultimately retailers and OEMs start to evaluate manufacturing choices. If concern translates to a drop in demand, the issues start to be addressed.

Addressing Cost of Accountability Fears

Engineers reading this will ask, What does food safety have to do with electronics products? The answer is twofold: First, consumers are now thinking about supply chains at a much more detailed level than done in the past. Every recall sensitizes them a little more to the cost of poor quality; manufacturers and retailers are aware of this.

Companies with the greatest interest in understanding systems integrity and quality controls are those manufacturing products with high potential liability risks, those in highly regulated markets, those with concerns about intellectual property protection, and those manufacturing products for markets with RoHS.

OEM audits look strongly at:

• Robustness of systems and processes related to regulatory compliance.
• Traceability systems.
• Quality control processes and metrics.
• Systems for ensuring material integrity.
• Systems for protecting IP.

Sales presentations, plant tours, Web sites, literature and quote packages should reinforce company capabilities in this area, particularly if Chinese facilities are involved. Case studies are a good way to illustrate how internal checks and balances support customer needs in these areas. Companies without Chinese facilities may choose to emphasize the benefits of the regions they’ve chosen.

In the EMS world, product integrity is more a factor of a company’s processes and controls than the particular country in which it has placed a factory. Companies that market their processes and controls well will see little change in market perception, regardless of factory location. There is actually one major benefit to today’s China-bashing environment. Companies with substandard systems, marketed or not, will see a drop in competitiveness. In the current phase of the market cycle, competition on price alone for products that require reasonable quality levels will be less common. The result of this part of the cycle is a weeding out of companies that use low pricing to mask lack of infrastructure. They’ll be back during the next boom cycle, but for the next year or so, quality and process robustness are valid selling points.

Most of this is common sense and some readers may ask why it is necessary to point out the obvious. The reality is that EMS providers tend to develop comfort zones. In most EMS companies, marketing material is updated every few years and then tends to stay the same until a change in personnel or change in brand drives a review. Developing the discipline of analyzing trends once a year and then doing a quick review of easily updatable materials helps drive competitive advantage.

More on this topic will be discussed in the tutorial Identifying EMS Market Trends: Learn to Predict the Future and Help Your Company Lead the Pack, scheduled for SMTA International on Oct. 8. For information, visit www.smta.org/smtai/.

Susan Mucha is president of Powell-Mucha Consulting Inc. (powell-muchaconsulting.com), a consulting firm focused on optimizing EMS account acquisition processes, and developer of the EMS Integrated Marketing™ and EMS Concentric Selling™ training programs; smucha@powell-muchaconsulting.com.

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