An Alternative Approach to Vertical Integration in Manufacturing
The past 50 years have seen the emergence of the EMS industry as OEMs outsourced increasingly more of their product to various global contract manufacturers. Originally concentrated in the United States, the industry has blossomed into nearly $600 billion in sales and their growth shows no indication of slowing in the near future.
The EMS industry was fed by acquisitions of manufacturing concerns from OEMs in the 1990s, followed by mergers of many EMS players in the 2000s. The worldwide manufacturing landscape has changed forever. The days of OEMs owning large vertically integrated manufacturing assets are gone and will probably never return. Oddly, the large vertically integrated manufacturing capability of the OEMs started to be dismantled by the emergence of the EMS companies. Now, some of these same EMS companies are adopting the same, vertically integrated solutions themselves.
Changes in EMS—ODM & Vertical Integration
Even within the EMS world, the past 10 years have witnessed two significant changes. First, there was the emergence of the original design manufacturer (ODM) as third parties participated more in the design and engineering of product on behalf of the OEMs, and then the merger of the ODM capability into the EMS players either through acquisitions or in-house development of the capability. Second, there was the broadening of manufacturing capability within EMS through vertical integration. Again, the vertical integration originated from the EMS’ acquisition of existing technology manufacturers (such as metal fabrication and plastic injection molding) or the in-house development of the capability.
The ODM factor immediately draws in the unwanted complication of intellectual property (IP) rights and protection of them. The fear of losing IP to competitors through undisciplined or unscrupulous ODMs is sufficient to justify customers’ staying clear of EMS partners who rely heavily on this capability for revenue. The larger Tier 1 EMS players are heavily invested in customers with consumer products where small design developments can be a differentiation, but the life cycle of their product is so short, the need to maintain intellectual property security is less critical. However, these same Tier-1 players have some customers who are not part of the consumer market yet the financial support of the ODM infrastructure within the Tier 1’s corporate structure is still burdened over the broader base of their corporate costs. MC Assembly prefers to invest in engineering resources dedicated specifically to processes like design for manufacturability (DFM) and design for excellence (DFX) where the output is not directly sold to its customer, but rather their customer benefits from the associated cost reductions gained from the improved efficiencies in the manufacturing processes.
Vertical Integration in EMS
The vertical integration factor is a little less straightforward. Initially, the movement towards vertical integration of manufacturing capability was limited to the exceptionally large EMS companies and, at first, was usually the result of them acquiring an auxiliary manufacturing capability as part of the acquisition of circuit board assembly and surface mount technology (SMT) from an OEM.
Figure 1: MC Assembly process lines demonstrating high-complexity mechatronics assemblies. Note the metal fabrication and cables that are fed from MC integrated partners.
The added capability did improve the marketing concept of “womb-to-tomb” manufacturing but also burdened the EMS company with large capital machinery assets that could not be easily relocated and manufacturing technology that was foreign to EMS companies. Over time, many of the larger EMS companies were better able to harness the technology and by investing even further into the different technologies associated with manufacturing, they could offer their customer base the concept of a “one-stop shop” for the supply chain needed to build their customer’s product.
Figure 2: High complexity wire harnesses from MC integrated partners being staged for next step assembly.
The expansive EMS corporate campuses we see in China today are the hyper-outgrowth of this vertical integration. In cities such as Shenzhen, vast industrial areas, walled-off and secured from the public eye dominate the landscape. Supporting employee populations larger than most cities in the United States, these manufacturing entities are the apex of vertical integration in the EMS world.
Figure 3: Fan assembly being integrated in enclosure from MC integrated partner.
Despite the bad press received over the poor working conditions of these mega-factories, the manufacturing model seems to be working particularly for high-volume consumer products where the repetitive manufacturing nature of the product and the ability to dedicate capital machinery to single product minimizes set up costs long term. Plus, the ability to stack margins on the multiple layers of the product bill-of-materials (BOM) enhances the overall profitability of the company and is less transparent to the end customer.
Figure 4: Enclosures and harnesses in queue at MC waiting final integration.
Vertical Integration in Low-Volume EMS
When you apply the same model to lower-volume manufacturing, directionally the results become much more problematic. The profitability equation for any capital-intensive manufacturing machinery is utilization and set-up minimization.
Figure 5: Supermarket at MC with enclosures waiting for pull by final assembly.
As EMS companies brought in vertical integration, the need to optimize the utilization of their newly gained machinery often outweighed the needs to support the required service level of the customer. Obviously, the practice of meeting customer’s needs unprofitably is a solution that is doomed for long- term failure for a business. Adding to this is the often-heard statement within these vertically integrated EMS companies: "My internal manufacturing teams that feed me components are my worst suppliers. You would think I have greater leverage since we wear the same badge but in reality, they are more driven by their own P&L and since I am a captive customer, they know I cannot fire them."
Vertical Integration in HMLV
When you now apply the same model to the high-mix/low-volume (HMLV) manufacturing environment, directionally, the results become dismal. This is the environment that MC Assembly matriculates as does most EMS mid-tier companies. Strict dedication of capital-intensive manufacturing machinery is impossible.
Figure 6: A worker can be seen inspecting the final boards for quality.
Our customer base values flexibility and responsiveness. They look for EMS partners instead of EMS suppliers and seek supply chain solutions that integrates their consumption with the EMS partner’s production.
Vertical Integration in Mid-tiered EMS
Curiously, vertical integration has seeped further and further into the EMS world, even to some mid-tiered EMS companies. Not understanding their business plans, it is difficult to judge this move as right or wrong.
Instead of trying to be the best in every manufacturing technology, it’s preferable to develop suppliers who are best-in-class for their respective technology. Even within specific technology groupings, differentiations such as press size, cosmetic capability, labor costs, and site locations are factors that differentiate one from another. Ultimately, this “virtual” integration may probably be a better solution for the mid-tier EMS companies versus a “vertical” integration solution.
This article was originally published in the July 2017 issue of SMT Magazine.