Dissecting the EMS Business Model

I find the EMS industry interesting; it is not so much about what they do, but their business model. While their function is interesting it pales in comparison to their low profit margin business model. They do so much for so little. Why is this?

I have many of the largest (as well as small and mid-sized) EMS companies as customers.  I have visited their factories in North America, Europe and Asia and have been impressed with their pursuit of manufacturing excellence. Sure, I have seen some bad ones, but most pursue manufacturing excellence and customer satisfaction.

The scope of what they do is impressive.  Along with their core investment in electronics manufacturing technology, many offer full configuration and product assembly services, design and test engineering, logistics and reverse logistics as well as fabrication and manufacturing with capability in areas like metalwork, paint and plastics. Some even move up the food chain with component manufacturing capability. It is a smorgasbord to delight any knowledgeable OEM.

In my last blog I pointed out that most EMS companies do not have sufficiently differentiated technology and that there are many of them; maybe too many. Both are significant aspects of their margin problem. Another is that EMS companies can be modelled as a bank and a source of labor; their capital is used to finance inventory yet they do not achieve the profit levels of banks. They take on the risk of resource capacity management yet temporary employee placement agencies outperform them financially.

In other ways they are like a grocery store, a high transaction turns business, and their profit levels are similar. Distribution, another high transaction business in electronics, can also be modelled as a bank and a source of labor and distribution operates with low profit margin. Grocery stores and distributors offer less in transformational value creation than EMS so one would think that they should make less, but they don’t. Some distributors make more through reducing their role as a bank by limiting on shelf inventory which may not have helped anyone in the long term.

So I am back to the question of why can’t this valuable industry segment extract more worth from the supply chain? One reason is that their pricing is constrained by the customer’s expectation of what it should cost to manufacture and deliver a product. EMS don’t have the luxury of introducing a new feature that can be priced at a premium because every new thing that EMS companies do is essentially replacing an OEM function. To make money they must do it more cost effectively than the OEM at a price which is less than what the OEM is currently spending.

When Lytica works with EMS companies, our focus is on reducing their materials cost and the overhead associated with processing quotations for customer bids. Our services are appreciated as we add significant dollars to their profit line, but we are unable to fundamentally change their reality by catapulting them into a new margin range. This is also true of other productivity initiatives.

Perhaps my premise is wrong and EMS companies are being paid appropriately for their contribution to the supply chain. In order to move into a higher margin range maybe they need to do something fundamentally distinctive. Sounds like I am circling back to where I finished off in my last blog – technology differentiation.

By Ken Bradley – Lytica Inc. Founder/Chairman/CTO

 

 

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