Smartphones' Rise Limits Growth Opportunities for Outsourced Manufacturers

April 5, 2013. Outsourced manufacturers that previously were making strong gains in the cellphone market now face a diminished growth outlook, as mobile communications brands increasingly opt to manufacture smartphones on their own, according to an IHS iSuppli Global OEM Manufacturing & Design Market Tracker Report from information and analytics provider IHS.

Cellphone original equipment manufacturers (OEM) that have their own manufacturing facilities—a group that includes Samsung Electronics, LG Electronics and Nokia—accounted for 73.4% of all cellphones manufactured in 2012. Meanwhile, the two major types of outsourced manufacturers—electronics manufacturing services (EMS) providers and original design manufacturers (ODMs)—accounted for the remaining 26.6% of production, as presented in the attached figure.

During the next few years, these percentages are likely to remain largely unchanged, with the outsourced manufacturers’ share of shipments rising only slightly more than one percentage point to 27.9%—an increase mainly driven by gains in non-smartphone market segments.

“Cellphone OEMs have been scaling back their use of outsourced manufacturers as they realign their product portfolios toward smartphones,” said Jeffrey Wu, senior analyst for outsourced manufacturing at IHS. “OEMs like Nokia, LG, Sony, and Motorola all have trimmed their use of outsourced manufacturers to ensure that internal facilities are being fully utilized and not being idled, and also to safeguard the quality of the smartphones being produced.”

Nokia and LG, both suffering in the smartphone segment, will experience little change in their overall outsourcing strategies, Wu noted. Motorola, on the other hand, with its divestiture of its manufacturing facilities in China and Brazil, will fully outsource its smartphone production in the future.

EMS beats ODM

Among the two groups of outsourced manufacturers vying for what handset-production business remains, EMS providers will have an edge over ODMs. The primary reason is that Apple, which is well-positioned in the growing smartphone segment, will continue to retain design in-house and engage either EMS providers or traditional ODMs on an EMS basis for production and assembly.

Even so, EMS providers will face their own challenges moving forward. In particular, the once-successful formula for handset production created in the mid-2000s by Foxconn International Holdings—the subsidiary created by Taiwanese manufacturer Foxconn to focus on mobile handset manufacturing—is no longer working. That model relied on three factors: the deployment of manufacturing in low-cost countries, a vertically integrated supply chain that allowed for production synergies, and reference design capabilities that bolstered EMS strength.

But because many handset brands that relied heavily on EMS missed the opportunity to develop smartphones early on, these handset OEMs have been caught up instead with restructuring efforts that include managerial changes, layoffs, and capacity reductions—leaving their EMS partners with little to do.

ODMs are also encountering the same difficulties. Taiwanese ODMs such as Compal Communications and Arima Communications have suffered reduced outsourcing opportunities as their primary OEM customers, including Motorola and Sony, went through rounds of restructuring and then cut down previously established outsourcing business to the ODMs.

Cultivating Growth

For growth to occur in the future, outsourced manufacturers should concentrate on core capabilities, IHS believes.

For EMS providers, this means going back to basics and focusing on servicing OEMs that retain proprietary product designs in-house but outsource the manufacturing of their products. Examples of such successful collaborations are Foxconn with Apple, Jabil with BlackBerry, and Flextronics with Motorola.

For ODMs, putting more resources toward developing entry-level and midrange smartphones could be a key factor, especially since smartphones will be driving growth in the mobile handset space overall.

This means ODMs should decouple from the entry-level and feature-phone production process for which they have been renowned in the past.

If entry-level smartphones become further commoditized in the future, however, EMS providers and ODMs may see an increasing number of programs outsourced by brand companies. Still, the same challenges posed by feature-phone production will inevitably resurface: those relating to low margin, intense competition, and little customer loyalty.