Original design manufacturers (ODMs) in China and Taiwan that have cut their teeth making notebook PCs are preparing to take bigger and tastier bites out of the electronics industry.Riding a wave of OEM outsourcing and eager to tap the potential of mainland China's 1.3 billion consumers, a growing number of ODMs are beginning to design and manufacture everything from cable modems and servers to PDAs, cellular phones, and other wireless communication devices.
"China's growing popularity as a manufacturing center is drawing business away from other countries in Asia," said Irwin Chen, vice president and general manager of BenQ Corp.'s wireless business unit.
The Taipei-based enterprise is one of several companies that stand to benefit from the growing popularity of the ODM model among OEMs craving low-cost manufacturing solutions in China. That's why BenQ and its rivals have turned the mainland into an unofficial battleground, taking on major EMS providers like Celestica, Flextronics, Sanmina-SCI, and Solectron.
ODMs already produce close to 60% of all notebooks made worldwide, and that will rise to 80% in 2004, according to Chris Whitmore, an analyst at Deutsche Bank Securities Inc., San Francisco. To date, ODMs such as BenQ, Compal, GVC, and Quanta have won accounts from the likes of Dell Computer, Ericsson, and NEC, sometimes at the expense of EMS providers. And the trend is expected to continue, according to analysts.
"Nokia is still in the process of evaluating potential ODM or EMS partners in Asia to produce low-end handsets," said David Toh, an analyst at Lehman Brothers Inc., Taiwan. "[The company] procures connectors from [Taiwan's] Hon Hai for its Beijing plant, but has yet to outsource its printed-circuit-board assembly production."
That could change. Taipei's Hon Hai Precision Industry Co., which has plants in Kunshan and Shenzhen, China, is already picking up extra handset business from Motorola Inc., according to a spokesman for the ODM's connector division, Foxconn Electronics Inc. Last year, Hon Hai's sales of roughly $6 billion included contributions from its cable assembly, backplane, PC enclosure, flexible-circuit, and PCB businesses, in addition to its manufacturing services mix.
However, some industry observers believe that ODMs, despite their reputation as rapid design and manufacturing artists, will have a huge hurdle to climb as they attempt to use their limited physical vantage point to mirror global EMS companies.
"Few ODMs have plants outside the Asia-Pacific region," said Reiko Tomasch, an analyst at Gartner Dataquest, San Jose. "To support a global market, ODMs need a global footprint. For example, ODMs can't send everything back to Asia for repair. They will need repair operations in regions like Europe."
The pressure to expand geographically is mounting, particularly as ODMs in Taiwan and China branch into new product areas. BenQ's Chen noted that many have established sales offices in other countries "to access and pay frequent visits to customers." BenQ, for instance, has offices in Australia, Europe, Japan, and Southeast Asia, which helped it boost revenue to $1.68 billion last year.
However, many industry observers insist that a sales presence alone is not enough to fill EMS providers' shoes.
"ODMs would only truly be a threat if they offered worldwide manufacturing and logistics services and offered the sort of integrated IT support that only the large EMS companies now have," said Jim Sacherman, chief marketing officer at EMS provider Flextronics International Ltd., Singapore. "Often customers tell us that they prefer to work with a company like Flextronics-whose core skill is manufacturing-and then use ODMs when they need a complete product."
ODMs are also saddled with a reputation as commodity specialists that, while able to churn out large volumes of specific products, lack innovation and the ability to serve multiple clients in varied markets.
"People want to know how much design [value] they can build into other products," Gartner's Tomasch said. "Can they build more-complex telecom products? They may have to start out slowly and build things on speculation [until they] gain technical expertise."
Cost models differ
Elite Electronics Group Inc., a division of Elite Industrial Holdings Ltd., has been selling its services to OEMs in the United States since 1978 from its Hong Kong headquarters, and has established plants there and on the mainland in Dongguan and Shenzhen. John Constantine, general manager for the Americas at Elite, said most ODMs are also aware that by attempting to take EMS providers head on they will incur heavy capital costs.
"If you're going to offer services to a number of countries, you have to duplicate the time and effort in coming up with different versions [of your business model]. Those versions have to pass regulatory agency requirements, and it's expensive to do that," Constantine said.
Indeed, the cost structures that drive ODMs and EMS companies stand in stark contrast. The EMS industry generated revenue of $95.3 billion in 2001, providing OEMs with product development, test and measurement, and manufacturing and aftersales support services. That figure could rise to $136.5 billion in 2006, according to IDC.
ODMs, meanwhile, made $15.7 billion last year from their design and manufacturing efforts, and will see revenue climb to $27.9 billion in 2006, the Framingham, Mass., research firm said.
Though operating with a smaller revenue base, ODMs' lower overhead has been kinder on their margins. Without absorbing the added cost structure of their EMS rivals, ODMs have historically garnered gross margins of 20% to 25%, compared with about 10% for the EMS sector, Tomasch said.
The gap is expected to narrow, however, as OEMs over time begin imposing the same tight pricing policies on their ODM partners as they do now with the EMS industry, according to observers.
Other fundamental differences exist between contractors and ODMs. Under a pure EMS model, for example, EMS providers build products exclusively for their OEM customers, which retain all rights to the intellectual property used in those products. ODMs, on the other hand, often own the IP they use to build their customers' goods, which allows them to sell their own branded items. This creates a potentially competitive scenario that most EMS companies have been careful to avoid.
Such distinctions may be blurring, however, as the OEMs pouring into Asia from Europe and the Americas seem to be less concerned with sparking rivalries than securing the lowest prices possible. Nowhere is this more true than in China, where hourly skilled manufacturing wages are in the range of 60 cents to $1, compared with $10 to $20 in more developed countries.
The wage disparity, combined with the cultural affinity and longstanding relationships that Chinese ODMs have with the domestic supplier base, is proving to be a sustainable, competitive benefit, according to some observers. Deutsche Bank's Whitmore also noted that, far from a shortcoming, the narrow product focus for which ODMs have long been noted has given them "a substantial time-to-market advantage over more diversified OEMs/EMS companies."
Still, ODMs are also intent on branching out. With $3.9 billion in revenue last year, Quanta Computer Corp. is Taiwan's largest notebook PC maker. The company is pushing hard into the wireless telecom and high-end computing markets at the same time that it begins shifting lower-margin notebook PC production to Shanghai.
"Quanta in the past was purely a notebook provider," said Tim Li, the company's chief financial officer, during a recent conference call with Lehman Brothers in New York. "Now we want to be a total solutions provider. We want to diversify our notebook business with handsets, servers, and wireless products."
Last year, Dell Computer Corp., Austin, Texas, sent most of its low-end notebook business to Quanta and Compal Electronics Inc., which was initially earmarked for Jabil Circuit Inc., a St. Petersburg, Fla., EMS company. Around the same time, Japanese computer maker NEC Corp. outsourced all of its motherboard work to Taiwanese companies.
More recently, Sony Ericsson Mobile Communications A.B., which uses Flextronics to manufacture its cell phones, expanded its wireless handset outsourcing roster to include Taiwanese ODM Arima Computer Corp. Meanwhile, L.M. Ericsson licensed its 2.5G handset technology to Taipei's GVC Corp. as part of a licensing agreement that will jump-start a push into the handset space.
And in August, Dell revealed plans to enter the white-box PC market, which industry observers believe will generate work destined for ODMs and resale channels in China and India.
"EMS players have performed poorly in the last two years due to the slowed economy worldwide, while we still grew," BenQ's Chen said. "Our handset shipments rose 50% in 2001 and will probably double this year. This year about 7% of handsets worldwide will be made by Taiwanese players, jumping from 3% in 2001. In the next five years the percentage is likely to reach 50% to 60%."
Some observers expect EMS companies to adopt the best aspects of the ODM model, especially as they optimize their Asian operations. Flextronics, for example, is China's largest contract manufacturer. Earlier this year it began making a generic cell phone that will be sold to OEMs eager to bring entry-level handsets to market. However, the company does not own the cell phone IP, holding fast to the belief that such a practice could jeopardize existing business.
Other companies are adopting the hybrid model as well. Elite straddles the line between EMS and ODM, making cordless and corded phones, CB radios, and typewriters on a contractual basis and selling a strictly limited line of industrial equipment like plastic injection-molding systems.
"[Branding] means you need an infrastructure that allows you to take returns, offer credit, and deal with warranties," Constantine said. "We found it was better for us to partner with customers and bring them products we design for them and bring them to market faster."
As long as the world is willing to go to Asia, the ODM model is expected by many to flourish provided it can maintain its low-cost model. But when it comes to service options, few see ODMs ousting the complex series of global relationships that the EMS industry's largest companies have laid in place without large and regular capital investments.
"ODMs are great for high-volume products like cell phones, radios, and TVs," said Mike Verstegen, president of Plexus Technology Services, a division of EMS provider Plexus Corp., Neenah, Wis. "As they move away from commoditized products their challenge will be cost. Will they be able to use the same designs on different product versions?"??
Additional reporting by Faith Hung