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.
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.
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.
Supply chain excellence is a story of patterns. Success happens when there is year-over-year improvement. Studying averages, therefore, does not tell a complete story.
To build the Supply Chain Index (a methodology to understand supply chain improvement) and the Supply Chains to Admire methodology (analysis of supply chain excellence considering both performance and improvement), Supply Chain Insights studied balance-sheet patterns for over 2,000 public companies and shared the results with more than 150 executive teams. The metrics selected are based on correlation to market capitalization: growth, inventory turns, operating margin, and return on invested capital (ROIC).
We believe supply chain excellence is based on the ability to improve across this entire portfolio of metrics. (For more details about the Supply Chain Index and its associated metrics, see "The Supply Chain Index: A new way to measure value" in the Q3/2014 issue of CSCMP's Supply Chain Quarterly.) Success requires balance and alignment.
As a part of this methodology, we analyze performance and improvement for three time periods: 2006-2014, 2009-2014, and 2011-2014. The choice of these time periods and the methodology are based on several principles.
1. Complete and accurate data. The analysis extends back to the first year where there is generally available public data for the industries studied. Prior to 2006, the data is too sparse to analyze.
2. Understanding post-recession trends. The period of 2007-2010 included a major economic downturn. We measure the entire period of 2006-2014, but our primary focus is on the post-recession performance of 2009-2014, which we believe is the time period that allows the most accurate comparisons. We also look at 2011-2014 to check for recent trends. However, the year-over-year analysis of the patterns within that period is limited due to the fact that it only covers three years. Supply chain excellence takes three to five years to see marked improvement compared to a peer group.
3. Analysis of a peer group. The data analysis is by industry sector based on North American Industry Classification System (NAICS) codes. We must have at least five companies in a peer group to make an assessment. While there have been many mergers and acquisitions, we want to derive as "clean" a peer group as possible, so we eliminate companies that have gone through major merger and acquisition activity during the period from our analysis.