China Electronics Manufacturing: Growth or Decline?

by Pamela J. Gordon, TFI Founder and President, and Matt Chanoff, TFI Chief Economist

Anyone visiting Shanghai in the past 10 years can easily be convinced that China’s superpower ranking is rising to the top. Today half the world’s contract electronics manufacturing is in China, and Foxconn (with most of its employees in China) is now the world’s tenth-largest employer. Yet last month’s at IPC’s APEX Conference, attendees were flush with stories about electronics manufacturing projects leaving China and returning to North America, Europe, or other geographies. In this post, TFI Chief Economist Matt Chanoff and I point to three factors that threaten China’s position as the world’s electronics producer, and three factors that strengthen it, and then provide our take on it.

First, these are the three biggest threats to wholesale, unabated growth of the electronics contract manufacturing industry in China:

Return to regional manufacturing strategies. For reasons of greater control, IP protection, reduced risk, lower total cost of ownership, social and environmental concerns, and shorter cycle times, some products previously manufactured by contract manufacturing (CMs) in China are now moving out to customer regions. Customers outsourcing not only manufacturing but also design to Chinese Original Design Manufacturers will have a greater barrier to leaving China; the CM model has a lower threshold for change.
Competition from the ODM model. Our recent research supports our long-held forecast that more name-brand companies of differing sizes and product varieties prefer to outsource design as well as manufacturing—favoring the ODM model. At the same time, however, some China manufacturers in search for more profitable business models have shed ODM business lines, or―like Pegatron―are shifting from ODM to EMS-type models (more on this in an upcoming post). Those name-brand companies that DO maintain control of design are more susceptible to the regionalization strategy described above.
Increased costs. This refers both to the substantial increase in salaries for contract manufacturing workers as well as the “soft costs” of inadequate (1) labor law enforcements, (2) intellectual property protection, and (3) environmental scrutiny (e.g., widely publicized incidence of lead in children’s toys and toxic toothpaste). Also consider that as oil prices rise product-shipment and customer air-travel costs rise. All of this affects the total cost of China manufacturing.

However, these three threats are balanced by several factors that continue to drive the Chinese EMS market:

Supply chain supremacy. Despite rising direct labor costs, several factors have enabled China to maintain a leading role in electronics manufacturing. Coastal China has developed the world’s leading supply chain and transportation infrastructure for high-volume electronics. In the process, Chinese businesses have created a near monopoly on the supply chain; many products necessitate sourcing components in China regardless of where manufacturing takes place.
Engineering prowess. More engineers are graduating from Chinese universities than from universities in any other country. From TFI’s years of experience in training Chinese engineers we know that the engineers are hungry for challenging product-design positions.
Market of the future. China is becoming a substantial electronics market in its own right. China consumers are increasingly able to purchase home and personal electronics. At the same time, several B2B industries are growing strong in China, such as aerospace, thus narrowing the distance and culture gap between CMs and their corporate customers. So for consumer and B2B markets in China, manufacturing in China IS a regional strategy.

Underlying these specific opportunities and challenges for the CM model in China is the overall slowdown in the growth of electronics outsourcing in general. Manufacturing of networking, consumer, and other electronics are already highly outsourced, meaning that CM growth now mirrors growth in product demand, and no longer gets a lift from new adoption of outsourcing strategies. Meanwhile, segments like military and industrial electronics retain significant resistance to adopting outsourcing. Many Chinese OEMs, such as Huawei, are growing rapidly, but they already benefit from a low-cost Chinese manufacturing base, and gain less advantage by switching to outsource providers.

In the balance, TFI forecasts that the China CM industry will continue growing through 2016, then experience moderately diminished growth owing to the factors above.

What do you think about the China CM market outlook? Are you making different plans at your company?


Comments

China Electronics Manufacturing: Growth or Decline? — 4 Comments

  1. An interesting question will be how contract manufacturing itself becomes commoditized, and then, the reverse process, how it becomes differentiated again. Think about steel production – “commodity steel” left the US. Then “custom steel” re-emerged. Looking at all the ways CM has evolved – CM, OEM, ODM, EMS – we might examine how these models “settle” into commodities. China’s core strength was low cost (with high externalization into their own local “commons”). Labor prices will rise. Externalization will be more visible and less tolerated.

    What strengths will remain? Logistics, perhaps, is the primary one . In the same way that FedEx’s core competency is logistics, not “overnight delivery”, China’s will be logistics, not “manufacturing”.

    Is logistics a substantial competitive barrier to entry?

  2. I agree with your thesis that there are many forces in dynamic tension. I believe an additional negative hindering electronics manufacturing’s return to North America is loss of manufacturing and test engineering competence as older workers, who learned their trade at OEMs and Tier One CMs, retire and few new engineers enter this field because of a dearth of opportunity.

    There’s no question that China will remain the premiere producer of high volume, short product life consumer and office electronics (PCs, tablets, smartphones, etc.) where, as John points out, logistics is king. After all, they somehow have to get those new iPads and iPhones to every Apple store in the world on the same day in vast quantities.

    But as China costs increase, some competitive advantage will gradually return to “boutique” manufacturers closer to the end user where supply chain logistics is not a primary driver. On the other hand, for the reasons noted above, I doubt we will ever see a return to manufacturing by OEMs themselves. Those glory years have long passed.

  3. Logistics is indeed a substantial competitive barrier to entry; but markets shift, capabilities change, and costs vary. Advantage isn’t permanent, and China cannot dominate forever.

    The right approach to choosing manufacturing locations must consider replenishment leadtimes, new product introduction cycle time, logistics costs, and service implications.

    Understanding the balance of these forces today, and where trends are heading for the future, is key to making the right decisions. Whatever the outcome, you can be sure that the answer will change over time.

  4. I have a slightly different take. On the logistics side for final product shipment, I don’t believe the contract manufacturers have a core competency. There are plenty of global 3PL players that are entrenched and have good businesses.

    China’s biggest asset is as described above-the whole eco system of parts for low-mid end electronics: cut glass, cables, connectors, Toroids, plastic parts including fans etc. It used to be that way in Japan in the 80s.

    Challenges for China are a) Currency value (huge) and b) regulatory environment. For example, if the US law changes to say that all Electronics hardware purchased by the Federal government has to have > 50 % local content (NAFTA zone), NOT including s/w, there will be a major resurgence in NA manufacturing.

    I personally like the model where the OEM partners with global CMs, who in turn move product manufacturing to the best location based on volume and maturity of the product. They do an internal transfer of the BOM and the material planning. NPI should be close to design, except for true consumer products.

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