Examples of Successful Third-Party Suppliers

The assembly of consumer electronics is an activity that was largely performed in-house until the 1990s. Today, however, assembly is mostly outsourced by original equipment manufacturers (OEMs) such as Apple. In the 1990s, Macintosh computers were assembled at an Apple factory. Today, Apple tablets and smartphones are all assembled by electronics manufacturing service (EMS) providers such as Foxconn. A study of the evolution of the EMS industry points to why outsourcing of assembly has increased in the electronics industry and the capabilities that third party EMS providers have developed to further increase the value they provide.

EMS providers grew in the 1980s out of small job shops used by OEMs like IBM to supple­ment their own printed circuit board production capacity or to offload production of items such as cables that were not viewed as offering any strategic advantage. In the 1990s, most OEMs, such as IBM, Motorola, and Lucent, sold their production capacity and increasingly outsourced a large fraction of their manufacturing to the EMS providers. The initial manufacturing services offered by EMS providers included board assembly, final assembly, and testing. The outsourcing of board assembly to EMS providers made sense, given the expensive pick-and-place machines required by the surface mount technology. Although these machines were expensive, they were also flexible enough that they could be reprogrammed to handle a variety of products. EMS providers could thus obtain better utilization of these machines by offering this service to competing OEMs. Even though each OEM was uncertain about the success of its own product, the industry as a whole had stable sales. The ability of the EMS providers to aggregate uncertainty has become more impor­tant as the life cycle of electronics products has continued to shrink.

Over time, EMS providers such as Flextronics and Celestica took the lead in adding design services to increase their perceived value to customers. They expanded from offering printed circuit board design and design-for-test to offering expertise in designing mobile phones, print­ers, networking, and consumer products. Flextronics claimed that one of the great benefits of having design teams under the same roof as manufacturing was that “engineers can design prod­ucts that fit into our manufacturing flow and with our supply chain.”^[1] EMS providers could also leverage their experience in designing a product for one customer across others in the same industry. For example, Celestica designed a generic “black box” for IBM automotive applica­tions very quickly because it had done similar work for UK firms. This allowed IBM to reduce time to market to well below what it could have done on its own.^[2]

EMS providers handle most of the component procurement for their customers. More than 95 percent of the procurement is turnkey, meaning that the EMS provider sends out the purchase order for parts.^[3] Given the commonality of parts in the electronics industry, EMS providers could get lower prices for customers (especially compared with smaller OEMs) because of their large spending on parts. Flextronics, for example, was spending well over $10 billion a year on parts, allowing it to get good deals from suppliers.

Over time, EMS providers have started to include warehousing and shipping in the menu of services they provide. Flextronics, for example, offers the customers the ability to “design, assemble, and distribute” their products. Given the commonality of parts and supply sources in the electronics industry, EMS providers are able to gain economies in inbound freight that are not available to a single OEM. On the outbound side, most electronics products move from the assembly plant to common ports in Europe and North America. This allows the EMS provider to add value by aggregating outbound shipping to a greater extent than any OEM.

The commonality of parts and the short life cycles with unpredictable winners for each new generation of products have allowed EMS providers to add significant value in the electron­ics industry. The rapid change and uncertainty of demand allows EMS providers to add value through aggregation in design, procurement, transportation, and manufacturing. An interesting question is whether the development of all these capabilities in a third party has lowered barriers to entry sufficiently in this industry to allow new entrants to compete effectively against estab­lished players. In any case, the development of EMS providers has resulted in a constant drop in prices in this industry—a big benefit to the consumer.

Whereas EMS providers have added logistics services, UPS is an example of a logistics provider that has added basic manufacturing services to further add value to its customers. In a 2010 press release, UPS discussed the establishment of an “in-house laptop repair facility for a well known computer manufacturer” near its global air hub in Louisville. In less than 24 hours, the UPS facility could “repair refurbish and return laptops to their owners.” By setting up a repair facility at its hub, not only had UPS reduced transportation relative to the manufacturer doing the repairs, but it also established the ability to aggregate such services across competitors. In another example, UPS took over the kit, pack, and ship operations for a major telecom company. As a result, 16 order processing and distribution facilities for the customer were centralized by UPS in one of its locations. This resulted in quicker processing, lower costs, and improved customer experience. Another excellent example of a firm that grows the supply chain surplus by effec­tively aggregating demand across customers and capacity across suppliers is Li & Fung, which has built a multibillion-dollar business helping global companies such as Reebok manage sourc­ing and production across many locations in the developing world. The company has been an intermediary between suppliers in the developing world and global buyers since it was founded in 1906. Li & Fung originally exported jade, porcelain, and silk from China to the United States. In the 1970s, the firm expanded its network of suppliers and is now able to get around regional trade umbrellas such as the European Union and NAFTA by sourcing appropriately. Li & Fung is an information hub that is able to link thousands of factories in 32 countries to almost a thou­sand customers in an optimal manner. Li & Fung reserves 30 to 70 percent of a supplier’s capac­ity. These factories are accustomed to reliable repeat business from Li & Fung and are thus willing to commit this capacity. Li & Fung maintains detailed capability information for each factory that is used to match it to appropriate customer orders as they arrive. For its customers, Li & Fung facilitates short-lead-time production. This allows customers to observe sales trends before committing to an order. When an order arrives, Li & Fung procures yarn from one sup­plier, gets on the production schedule of a weaving mill, and finally farms out production of the garment to ensure that the delivery schedule is met. All this is done to minimize production cost while meeting delivery schedules. Clearly, Li & Fung is an integrator that adds to the supply chain surplus in ways that no individual customer or supplier could. The firm aggregates demand across hundreds of customers and capacity across thousands of suppliers and uses detailed infor­mation on both to match supply and demand in the most cost-effective manner.

Compared with the electronics industry, contract manufacturing for final assembly is much less prevalent in the automotive sector. Most auto companies set up their own assembly plants because product life cycles are longer, demand more stable, and it is difficult to design assembly plants that can produce a Toyota as well as a Ford. One successful contract manufacturer in the automotive industry is Magna Steyr, which is part of MAGNA International. The company’s main assembly facility is in Graz, Austria. Its key success factor is the flexibility to “build up to five different vehicle types/derivatives on a single assembly line.” This capability allows the company to produce low volume models for OEMs more effectively than they can on their own. In 2013, Magna Steyr assembled the Mercedes-Benz G-Class, the Peugeot RCZ, the MINI Countryman, and the MINI Paceman, each of which has has relatively low sales volume, in its Graz plant.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.