How Big is Too Big?

05 August 2007

Susan Mucha

Susan Mucha argues that while Tier one EMS providers will continue to dominate, they will not take over.

When I saw Tim Fryer’s June 5th editorial on Tier One consolidation predictions, I immediately requested the opportunity to respond in my next column. Tim is correct in pointing out that consolidation predictions have been around for nearly a decade. However, most consolidation theorists forget two things. First, classic industry consolidation models assume the top one or two market share holders control all aspects of their markets. Second, there are a finite number of truly Tier One accounts.

In visiting the first assumption, consider two classic market share dominated industries: automotive and appliance. In both industries, the largest market share holders control access to raw material and key elements of the supply base, consumer choice in available models and ultimately the price at which the largest volume of products are sold. As long as they have that level of control, they also hold the power to limit competition. In those industries, global competition had an impact because there was a regional dominance factor that disappeared as global competitors used their regional leverage and cost structure advantages to enter higher cost markets. In the EMS industry, Tier One companies can control the supply base to some extent, but they don’t control the customer base. Study the history of any Tier One and you’ll find that one or two dominant customers started the momentum that migrated them from Tier Two to Tier One. Large OEMs don’t like the idea of a handful of Tier Ones and tend to help grow a new crop in that segment whenever the existing market starts to consolidate beyond their comfort zone.

The second issue is also significant. As companies grow their revenues into the tens of billions, investors don’t stop expecting double digit growth. Yet the number of mega-sized OEM accounts is finite and large-scale acquisitions such as that of Solectron by Flextronics are risky because there are a lot of facility redundancies which must be addressed rapidly. For that reason, I predict smaller contractors will continue to grow. There are simply more accounts out there that are a better fit for smaller players and often smaller, more focused businesses offer these accounts cost structures and flexibility that Tier Ones can no longer match.

So do Tier Ones get bigger and bigger? There is no question that size does matter. In the Tier One realm, being number one or two in market share is far better than being number five. However, it is likely that continuously successful growth will be driven not by pure EMS, but by a diversified approach closer to the Foxconn/Hon Hai model. In that approach, EMS is one segment of a very synergistic portfolio of products and services. That type of growth through synergistic diversification opens the door to a greater realm of growth opportunities, offers more stability to customers closely aligned with the business model and potentially can more attractive to “growth seeking” investors.

In the meantime, smaller EMS players should look to clearly define their brands. If Tier One consolidation continues at this pace, it is likely that many OEMs may be rethinking their outsourcing strategies if they feel their current suppliers are more focused on growth than service.


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