CSCMP's Supply Chain Quarterly
December 13, 2017
Supply Chain Executive Insight E-Newsletter
Each week the Supply Chain Executive Insight e-newsletter will include brief articles about developments that are often overlooked by other supply chain publications. We will present you with summaries of the latest research as well as new ideas on how to make your supply chain operations more effective. And we'll offer commentary that sheds light on what's happening in supply chains today.
Sign up now!

Most Read Articles

News from our sister publication
DC Velocity
Top-Performing Supply Chains

Top-performing supply chains: Contract manufacturing

Comment
Analysis suggests that the contract manufacturing model is failing to produce supply chain efficiencies and resiliency in the high-tech industry.

High-tech is a tough business to be in these days. Sitting three and four layers back in the supply chain, manufacturers serve demanding high-tech brand owners that exert severe cost pressure on them while also asking them to improve social responsibility and customer service. Contract manufacturers also struggle with demand variability, low margins, and ever-changing business conditions in a volatile world.

Back in the 1990s, however, the contract manufacturing industry was full of promise. Outsourcing the manufacturing/assembly of high-tech components allowed brand owners to improve time to market and reduce supply chain complexity. Supply chain leaders believed that the aggregation of assembly and the evolution of the contract manufacturing industry would drive efficiencies in the value chain.

Over the last two decades, outsourcing grew in popularity. However, while companies can outsource their supply chains, they cannot outsource the risk. Despite outsourcing, brand leaders must own and manage the ethical implications of their supply chain.

Today's business conditions are making it hard for contract manufacturers to improve their supply chains, as evidenced by the results of Supply Chain Insights' Supply Chains to Admire methodology. Key supply chain metrics show that the industry is stuck and is making very little progress. These difficulties pose a risk not only to the contract manufacturers themselves but also to the entire high-tech value chain.

Defining excellence

While they sound like simple concepts, supply chain excellence and improvement are not easy to define. To help supply chain leaders, like those in contract manufacturing, understand the necessary components involved in supply chain excellence, we created the Supply Chains to Admire methodology in 2014. (For more about the methodology, see the sidebar.) This analysis evaluates companies within an industry on both performance and improvement. In 2015, we found that no contract manufacturers qualified for the "Supply Chains to Admire" designation.

Figure 1: Analysis of Supply Chain Performance for the High-Tech Value Network

The financials of the high-tech brand owners in Figure 1 and the contract manufacturing results in Figure 2 show some troubling signs. (Figure 1 shows the averages for the period 2006-2014 as well as the percentage difference of 2006 compared to 2014.) In Figure 1, we see that margins for the high-tech industry are down by double digits, and that inventory turns have dropped for both consumer electronics and business-to-business (B2B) electronics. While outsourcing to contract manufacturers has improved the revenue per employee for the consumer electronics industry, it has negatively impacted contract manufacturers' balance sheets.

Indeed, when we compare the financials of the downstream partners in Figure 1 to the contract manufacturing results in Figure 2, we see a stark contrast. Growth and operating margins are in the double digits for consumer electronics, B2B electronics brand owners, and semiconductors. Contract manufacturers, however, operate in single-digit models on growth and operating margin. Additionally, inventory turns and ROIC for contract manufacturers are half of those of their downstream customers.

Each of the contract manufacturers has attempted to drive supply chain improvements—Celestica's massive investment in lean, Jabil's creation of a digital manufacturing facility using robotics, and Flextronics' massive operations to support Apple in China. But the business model remains a difficult one as contract manufacturers' customers continue to push cost and waste back down the value chain and onto them.

A better demand signal from their customers would help to offset the pressures on costs. But upstream demand signals are getting worse, not better, due to increasing item complexity and the slowness of the high-tech value chain to build demand networks to sense channel consumption.

A closer look at Figure 2 and Figure 3, which shows performance on inventory turns versus operating margin for two of the top contract manufacturers, indicates that among the contract manufacturing group, no company outperforms the others. We believe that it is time to rethink the contract manufacturing model for the high tech industry and the definition of processes to drive more effective flows between and amongst trading partners. Both figures demonstrate the business instability experienced during the recession of 2007-2009 and the industry's lack of resiliency through economic cycles.

Figure 2: Analysis of Supply Chain Improvement and Performance of Contract Manufacturers
Figure 3: Orbit Chart of Supply Chain Leaders in the Contract Manufacturing Market

Given this analysis, supply chain leaders in the high-tech industry must ask themselves several questions: Is the contract manufacturing model for the high-tech value network flawed? Is there a way to redefine the value chain to improve value? And, if this model is not redefined, does the instability of the contract manufacturing model pose a risk for the high-tech value network?

Supply chain excellence requires discipline and focus. It is about balance and resiliency. Gains happen in small increments over time. Progress happens over many years. In designing the value networks and mitigating risks, leaders need to take a long-term view. It is for this reason that we believe that the contract manufacturing model adds greater risk than value to the high-tech supply chain.

The supply chain is a complex system that needs to be managed through the use of a balanced scorecard. In our research, we find that success does not happen by focusing on a single project, a series of projects, or functional metrics. Instead, the leadership team must steer the helm to focus on year-over-year momentum while maintaining resiliency. For the high-tech supply chain dependent on contract manufacturing, this is a challenge that requires attention.

Lora Cecere is founder and chief executive officer of the research firm Supply Chain Insights.

Join the Discussion

After you comment, click Post. If you're not already logged in, you will be asked to log in or register.


Want more articles like this? Sign up for a free subscription to Supply Chain Executive Insight, a monthly e-newsletter that provides insights and commentary on supply chain trends and developments. Click here to subscribe.

We Want to Hear From You! We invite you to share your thoughts and opinions about this article by sending an e-mail to ?Subject=Letter to the Editor: Quarter : Top-performing supply chains: Contract manufacturing"> . We will publish selected readers' comments in future issues of CSCMP's Supply Chain Quarterly. Correspondence may be edited for clarity or for length.

Want more articles like this? Subscribe to CSCMP's Supply Chain Quarterly.