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EMS Providers and OEMs in China
December 31, 1969 |Estimated reading time: 6 minutes
Both OEMs and contract manufacturers (CMs) now feel that not having manufacturing operations in China means missing an opportunity. More than one-fifth of electronics manufacturing in 2001 took place through contracts and is likely to grow.
By Bhargava Attada
The Chinese domestic market for consumer electronics has grown to more than one-fourth of the total market. Toward the end of 2001, distributors found it more lucrative to serve the domestic market with respect to volume and profit margins than global electronics manufacturing services (EMS) providers. They felt the new market would outweigh the influx of EMS providers. This was until the domestic market grew larger and most of the global players were relying on distributors and manufacturers' representatives for access into new markets. Now almost all have a manufacturing location in at least one Chinese province (Figure 1). Currently, the electronics manufacturing and components markets rely heavily on exports as the prime impetus for growth, though there is significant in-house demand.
EMS vs. ODMs
Original design manufacturers (ODM) have begun replicating the EMS providers. The ODM business model focuses on design capability and assembly service. Competition grew as ODMs started providing other services originally offered by EMS providers, sometimes transgressing into their core functional areas. Nevertheless, ODMs lack global presence and therefore cannot match EMS providers with manufacturing locations outside Asia. They cannot offer OEMs the logistics, repair, post-sale support and other value-added services due to lack of a global footprint. This is a major deterrent for ODMs to enter the global market. Additionally, ODMs offer manufacturing and design services for a particular product category, but lack versatility. ODMs are suitable for large-scale OEMs, who churn out the same product in large quantities. But EMS providers can cater to numerous product categories, offering manufacturing solutions as a package. It is easier for the EMS provider to replicate the functions of the ODM because of their huge financial base and scale of operations.
Vertically integrated EMS providers have begun offering semiconductor packaging and testing services, challenging semiconductor assembly and test service (SATS) providers. As OEMs are more inclined toward manufacturing solutions and streamlining the supply chain, EMS providers are benefited by their scale and scope of operations.
Many perceive China to be faced with strong competition from Taiwan, but China caters to diverse applications, while Taiwan serves more specialized ones. Chinese engineers also work for half of Taiwanese salaries.
Figure 1. The landscape of China.
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EMS Market Challenges
- OEMs have demanded efficiency of the EMS provider in product lifecycle information management (PLIM) to strengthen their supply chain. This process is critical during the product introduction and end-of-life stages. Worst hit are Tier Two EMS providers. Strengthening this process requires major investment because Tier Two EMS providers must start the process from scratch.
- OEMs feel that margins improve with the consolidation and integration of the supply chain and reduction in the number of supply chain partners. This again will hit the Tier Two EMS providers, especially the smaller domestic players in China. This trend has been observed more prominently as a cost-cutting measure post-recession.
- ODMs have been showing slightly greater compounded annual growth rates (CAGR). This is because OEMs are looking at turnkey solutions from introduction to the end-of-life stage including design, assembly, manufacturing and other services. Therefore, ODMs are more profitable because of their design capabilities along with other services, blurring demarcation between EMS and OEM.
- Some OEMs and EMS providers remain hesitant to shift manufacturing to China because of a perceived high learning curve, which offsets cost benefits.
Market Trends and Forecasts
- China is expected to double its revenue from electronics manufacturing in the next three years, one-third of which is expected to be from EMS providers, and ODMs combined with the EMS industry are likely to double their current size by 2006.
- The largest market for EMS in China remains consumer electronics and wireless communication, followed by industrial electronics and automotive.
- With the likelihood of strong world economic recovery in mid-2004, military spending is forecasted to increase, bolstering growth.
- Surging demand in optoelectronics will provide new market opportunity for EMS providers in China.
- Falling prices and eroding margins mean that EMS providers in China are making money on design platforms, grabbing share from ODMs.
- EMS providers are tapping unconventional markets such as medical electronics, defense, automotive electronics and other electronics applications. This is because telecommunications is flooded with innovation, development and frequently changing technology, requiring changes in manufacturing and assembly processes, especially in the Asian markets.
- Post-recession, most EMS providers started scrutinizing their client base critically to avoid loss-making contracts, especially in China.
- OEMs are looking to cut their supply chain partners and seeking out solution vendors, meaning more consolidation is likely in the industry, eliminating niche and small EMS providers and giving way to generalists.
Imports and Tariffs
Capital equipment imported into China is duty-free. Most global manufacturers in China still import certain components and parts from various foreign countries, attracting significant import duties, though these recently have been relaxed. Nevertheless, manufacturers suffer from discriminatory taxes like Value Added Tax (VAT) on semiconductors and surface mount devices. There is a 17 percent VAT on foreign electronics components, while domestic goods can claim a rebate up to 10 percent. The majority of imports for raw material fall into electronics manufacturing equipment, accounting for 35 percent of total imports in 2002, and semiconductors and SMT components, which account for 7 percent.
- Serious quality issues recently were reported when assemblies from China had to be shipped to the United States for rework and repair. Such incidents have generated a feeling that China is suited for consumer electronics, where lifespan is low, but risky when reliability is the prerequisite.
- Intellectual property protection laws in China are not sound. Designs and R&D are the major part of ODM earnings.
- Tariff and import duties on electronics components in China are unpredictable, fostering an unfriendly environment for import of surface mount components and devices.
- China derives 60 percent of its GDP from exports. A few countries now are tightening their anti-dumping duties against Chinese goods.
- Transportation facilities and telecom infrastructure in China are not very advanced, negatively impacting logistics requirements. This is especially true for global EMS players, who depend significantly on just-in-time (JIT) delivery and logistic services.
- Cultural and political differences between China and the West can be potential barriers to managing the Chinese workforce.
Manufacturing Equipment Impact
Recent EMS market consolidation has been eliminating small niche players, meaning top- and mid-tier EMS providers are emerging more financially and technically sound. Coupled with a tariff-free import market for capital goods into China, this may drive future demand for high to mid-range SMT manufacturing equipment.
For the past six months, price pressures from OEMs have been mounting, which negatively impacts manufacturers' willingness to purchase capital equipment. Therefore, easy financing options such as leasing, as well as the used equipment market, should gain momentum. Depreciation laws in China allow manufacturers to write off their equipment in two years. Total yearly spending of all EMS providers, OEMs and ODMs on electronics components and equipment is expected to reach US $100 billion as the economy is expected to recover in 2004.
Conclusion
The global CM majors who moved in from the West must understand that the business and regulatory environment in China is vastly different, and supply chain practices from the West do not work well there. To work around taxes, companies ship products to third-party destinations, sometimes causing supply chain inefficiencies. Coupled with weak transport and infrastructure and widespread corruption, this weakens logistics in China. Additionally, the Chinese market is not suited for all applications or players. New entrants need to be patient and change-compliant to understand, adapt to and succeed in China.
For more information, contact Julia Paulson, Frost & Sullivan, (210) 247-3870; E-mail: jpaulson@frost.com.