Bold changes ahead: Electronics manufacturing rethinks the supply chain; the time is now to review your long-term strategies.

Since the advent of contract printed circuit board assembly almost three decades ago, the one certainty in outsourced electronics manufacturing has been uncertainty. Regional shifts, service offerings, and the ups and downs of the business all require quick reflexes. Companies thrive if they're able to embrace the uncertainty of constant change. If not, they struggle—or worse.

Based on findings from research studies and consulting engagements, Technology Forecasters Inc. (TFI) anticipates several trends over the next five years. The availability, price, and environmental impact of oil will play a larger role in business strategy. The record price of oil is forcing OEMs to rethink where they manufacture and the geography of their supply chain networks.

Farther out, TFI believes the carbon footprint of products will drive buying decisions for both business customers and consumers. A product will be judged not only on its cost, but on the cradle-to-grave emissions it produces. One important contributor is the typical 12,000-mile supply chain that many manufacturers rely on today, with manufacturing in China and the end market in North America and Europe.

In an industry where maximizing margins is everything, these will be difficult challenges, and only the savvy will survive.

The move away from one mythical low-cost center to regional manufacturing is a trend we already see, and is likely to accelerate for reasons already stated. In five years, TFI expects the global electronics manufacturing footprint to be more evenly balanced geographically than today. Regional manufacturing will replace “send everything to China” as the optimal sourcing strategy.

Although still important, low-cost labor is not driving sourcing decisions as strongly as it did five years ago. Decisions are more nuanced and OEMs are factoring in proximity to the end markets when choosing a manufacturing location. Astute OEMs pay closer attention to the true cost of ownership, which includes an array of factors other than materials, labor, and direct overhead; now it's border security issues, infrastructure, currency fluctuations, and labor force capabilities.

OEMs tend to acquire a more regional mind-set after having one, or all, of the following epiphanies:

1. China is losing its low-cost luster;
2. New lowest-cost regions don't have the capacity, infrastructure, or trained labor force to replace China; and
3. Once you analyze all the factors—including impact of oil and environmental issues, a supply chain that entwines the globe becomes less appealing.

Several factors are driving up true cost of ownership in China. Manufacturing demand outpaces supply, which means contractors can charge more and workers can command higher wages. Corporate costs due to regulations compliance and other expenses not directly related to cost of materials and labor are rising faster than elsewhere. Since TFI began tracking costs in China several years ago, these sunk costs have more than doubled. The conclusion: China's cost competitiveness may have peaked.

OEM executives who thought Vietnam, India, or western China were the next lowest-cost locations experienced rude awakenings when they scrutinized those options. These locales don't have the capacity or infrastructure to replace industrial eastern China as the low-cost Nirvana. We hear stories—perhaps exaggerated, but not much—like this: “We went to Vietnam expecting to look at 12 factories in three days, and we couldn't find 12 factories.” And we've encountered some OEM executives who return from India appalled that it remains so underdeveloped.

Low-cost labor is not driving sourcing decisions as strongly as it did five years ago. Decisions are more nuanced as OEMs factor in proximity to the end markets when choosing a manufacturing location.

One intangible to consider is a regional strategy that enhances the ability to address the growing demand for better and quicker customer service and fulfillment. Regardless of whether OEMs keep these services in-house or outsource them, a regional strategy can boost customer service.

TFI fully expects that over the next five years, sourcing decisions will increasingly involve more thorough analysis of total landed costs, and will require a keener understanding of where to source within a region. Electronic manufacturing services (EMS) providers can bind themselves to their OEM partners by doing the homework necessary to help customers with the rigorous analysis to make these difficult decisions.

Top-tier EMS providers have the global footprint to benefit from the regional approach. Small EMS companies can stop sweating about the pressure to move operations halfway around the world as the industry's obsession with China wanes. Mid-tier EMS companies may find themselves too small to win big OEM work that requires a regional strategy, and too big to compete in smaller niches. Thus the EMS industry is expected to continue to consolidate. Much of this consolidation may come from mid-tier companies joining forces or getting acquired by top-tier players.

At some point, regional sourcing will converge with growing concern over carbon intensity from transportation, plant operation, and product materials. As a result of the EU directive spelling out restrictions on the use of hazardous substances—i.e., RoHS—the electronics industry is forced to confront some fundamental issues. Five years from now, TFI expects at least some OEMs to have learned how to be environmentally sustainable, and reap higher margins as a result.

The electronic manufacturing services (EMS) industry likely will continue to consolidate. Much of this activity will involve mid-tier companies joining forces or getting acquired by top-tier players.

The smartest OEMs will find ways to define “green” as both eco-friendly and profitable, improving margins with environmentally sustainable products and services. A few companies already report financial savings from environmentally sensitive changes in materials used in casings, packaging, and shipping; and by using components from renewable sources.

Within five years we expect to see environmental sustainability produce new revenue models. For example, at least one OEM is likely to experiment with consumer product leasing. Imagine a cell phone or laptop designed to be expanded through replaceable modules and software upgrades with each new generation of technology, without having to replace the entire box or recycle all the innards. Such a model could dramatically reduce electronic waste, and give the OEM a guaranteed “annuity” of five or 10 years.

Doing the bare minimum to meet the EU RoHS directive and similar regulations is like starting elementary school, and that's where most OEMs and EMS providers are today. Five years from now, leading OEMs, assisted by their partners, will be graduate students, their rivals struggling to catch up. Enormous opportunities exist for EMS companies and original design manufacturers (ODM) to develop expertise in design, materials, and recycling to support these efforts.

Against the broad trends of regionalization and environmental sensitivity, TFI finds some large OEMs are reexamining everything in their sourcing models, rethinking which aspects to outsource and which to keep in-house—or in some cases, bring back in-house.

For the past several years, the OEM mantra seems to have been, “No one ever got fired for outsourcing.” In their zeal to offload anything and everything to outsourcing partners, some OEMs ended up with no strategy at all, but an unwieldy, piecemeal approach they now find unmanageable—and they've lost control of their supply chains.

We have not encountered an OEM that wants to completely reverse its outsourcing strategy, but some are seriously considering course corrections that would reverse at least some aspects of supply chain strategy. More critically than before, they're asking themselves where outsourcing is appropriate; where is it not; which competencies are truly core to business goals; and, if we do not have these competencies, how do we acquire and develop them internally instead of giving them—and any margin they add—to someone else.

The OEMs doing this soul searching realize that too often they put the cart before the horse: If they weren't good at something, they outsourced it, rather than asking if the competency was something they should be good at, and, if so, how to acquire the skills and do so cost-effectively. Some acknowledge that the motivation for many earlier outsourcing decisions was to unburden themselves of material and parts inventories.

Some of the more creative OEMs are beginning to develop sourcing formulas or models that force them to rethink what is core to their business—and how all the moving parts along the supply chain fit together—to find more top-to-bottom strategies for sourcing. TFI anticipates this rethinking will continue, and in five years, many OEMs will have retrenched somewhat on the outsourcing model to a more balanced approach of in-house and outsourced capabilities.

The next five years in electronics manufacturing will be filled with the kinds of changes and uncertainty we've outlined here. History may not repeat itself, but it certainly rhymes. Looking ahead, what will rhyme with the past is the certainty of uncertainty. The OEMs, ODMs, and EMS providers that stay constantly in sync will be the most likely to succeed.