Brocade Communications Systems Inc. is a big believer in sticking to what it does best. So it's no surprise that the San Jose, Calif.-based maker of data-storage equipment chose to outsource logistics in support of its global customer base. What's different is the type of vendor Brocade selected for the job.
Instead of turning to a traditional third-party logistics provider, Brocade went with Solectron Corp., one of the world's largest electronics manufacturing services (EMS) providers. EMS companies got their start making parts and finished goods for name manufacturers like Cisco, Dell, Nokia and Hewlett-Packard. In a remarkably short time, they snapped up business from companies that preferred to limit their role to product design, marketing and sales. Others could shoulder the burden of running factories and turning out physical product.
Recently, however, the EMS success story has begun to sour - at least in the way the industry was originally defined. Profit margins in manufacturing high-tech goods are perilously thin. And, with the collapse of the dotcom and high-tech sectors, EMS providers find themselves stuck with large amounts of underutilized plant space and unwanted inventory.
Stock valuations have fallen accordingly. According to J. Stuart Francis, managing director and head of global technology investment banking with Lehman Brothers, the combined market capitalization of publicly traded EMS companies has plunged from nearly $70bn in 2000, to around $12bn today. Revenues, meanwhile, have stayed essentially flat.
The solution for most major EMS players has been to broaden their service menus, drastically altering their very identities. Glenn Ritter, Solectron's global logistics program manager for the Brocade account, argues that the old term "contract manufacturer" no longer applies. "They have been expanding into design, sourcing, distribution, [customer] service and recycling," he says.
Original equipment manufacturers (OEMs) have responded favorably - sometimes at the expense of 3PLs. They're drawn to the notion of a single entity that can manage product lifecycles from the shipment of raw materials to final delivery. They also like the leverage that a big EMS company can deliver, in negotiating with underlying logistics providers.
Balance of Power
Brocade, for example, is hardly a minor player in its field. The maker of storage area network (SAN) equipment has revenues of around $562m, with an annual logistics spend of just under $5m. But that pales beside Solectron's $12.3bn in revenues, a position that gives it considerable clout in dealing with carriers. So Brocade is content to let Solectron handle its entire logistics function, including tracking and tracing, claims management, late-shipment expediting, freight payment and auditing, international trade expertise, even strategic supply-chain design and modeling. Brocade's own logistics department, says Ritter, consists of "two guys in shipping - Chris and Jesse downstairs."
Solectron was already manufacturing a good portion of Brocade's products. So the addition of logistics, says Ritter, was a natural progression. And so far, Brocade has had little reason to regret the move. It has realized a 30-percent savings on logistics, thanks to the increased use of ground instead of air, a shift to deferred delivery from overnight where applicable, the implementation of freight audits, and a greater reliance on consolidation, boosting the average weight per shipment.
Brocade was also attracted by the opportunity to deal with fewer vendors. "With Solectron, we could talk to one person with a view of the whole thing," says Nigel Johnson, vice president of supply-chain solutions.
Solectron makes no bones about its newfound logistics expertise. "We certainly believe that customer fulfillment capabilities are an absolute core competency of the company," says Jim Molzon, vice president of integrated supply chain and logistics at the Milpitas, Calif. headquarters. That service becomes even more important, he says, as customers shift manufacturing offshore to lower-cost locations. They must be able to deliver across borders and long distances without delays.
Solectron first ventured into the outbound logistics arena about two years ago, driven by the needs of a major customer. Since that time, it has built up a team of in-house logistics experts, in addition to relying on some traditional 3PLs, freight forwarders, carriers and warehouse providers. Molzon says the company is aiming to become a lead logistics provider (LLP) for select manufacturers. "We are managing a multitude of different solutions providers," he says.
San Jose, Calif.-based Flextronics, Solectron's biggest rival, has forged a similar path as a logistics provider. Much of its expertise in that area came from the acquisition in 2000 of Irish Express Cargo (IEC), a private company headquartered in Dublin. IEC had developed a full range of logistics services, including air and ocean freight, customs brokerage, vendor-managed inventory hubs, merge-in-transit, and reverse logistics.
"We do not see ourselves as a 3PL," says Tom Wright, president of logistics for Flextronics. "We do see ourselves as a manager of services." He views a tight relationship between product sourcing, transportation costs, delivery requirements and customization.
Logistics is a critical element in postponement, the practice whereby basic products are configured at the last possible moment for sale in targeted markets. Hewlett-Packard, for example, adds the appropriate power supplies, manuals and other features to its printers just prior to shipment. To make it work, the manufacturer must have access to reliable logistics, both for inbound components and outbound finished goods.
Flextronics can turn around an order for configured product within two to three days, Wright says. Its logistics-oriented services also include planning and forecasting, inventory management and carrier compliance. Flextronics even offers global supply-chain modeling, through its acquisition of the software tool known as SimFlex.
While the company maintains a limited number of "strategic relationships" with 3PLs, for the most part it deals directly with underlying carriers and other asset-based logistics providers. Wright questions whether there's room for another intermediary in the mix. "There's not a lot of margin in this business," he says. "When you make your decision to insource [logistics], you ask, can you really partner with a 3PL and still split margins?"
Even some of the more specialized EMS providers are jumping into logistics. Aftermarket Technology Corp. (ATC) of Westmont, Ill. is a major remanufacturer of automobile engines and transmissions. It's the product of a joint venture between G.E. Capital and Aurora Partners, a Los Angeles-based venture capital firm. In addition to manufacturing services, the partners grouped all of the company's logistics activities under a separate business unit, ATC Logistics & Electronics, with headquarters in Fort Worth, Tex.
According to president Bill Conley, the logistics arm provides a "soup-to-nuts" service which includes fulfillment, kitting, packaging, reverse logistics, warranty repair and asset recovery for scrapped or reclaimed parts. But the business isn't limited to the automotive sector. ATC Logistics has long acted as the fulfillment arm of AT&T Wireless, a position that was kept under wraps until recently, when the customer allowed the vendor to go public. Other ATC accounts include General Motors, for whom it performs all repairs of the automaker's OnStar vehicle locator technology; Hewlett-Packard; Motorola and Ford Motor Co.
Conley prefers to remain flexible on the question of dealing with 3PLs. ATC Logistics is a direct provider of most services to its customer base, especially for high-value, fast-moving goods. But it also partners with independent 3PLs, as in the case of aftermarket transmissions for AAMCO, a relatively new account.
The relationship between contract manufacturers and logistics providers can get complicated. Conley says ATC has even raised the possibility of handling some logistics for Solectron, a competitor. He had originally approached the EMS giant for help with electronics manufacturing and repair. He ended up arguing that ATC could perform some kitting, packaging and physical inventory management on Solectron's behalf. As of early spring, the discussions were still ongoing.
The Response from 3PLs
The third-party logistics community has responded to the EMS challenge in a variety of ways. Some argue that companies with their roots in manufacturing lack the expertise to handle the logistics end of the supply chain. Others are eager to partner with EMS providers, perhaps looking to retain some role in the process as OEMs shrink the number of vendors to whom they outsource key business processes.
Exel, whose logistics operation is based in Hayward, Calif., works with EMS providers on a global basis, says Steve Toney, vice president of global supply-chain solutions. (A major 3PL, Exel's own roots are in warehousing.) Toney acknowledges that control of logistics on behalf of OEMs is migrating from 3PLs to the EMS sector. But he insists that a logistics specialist like Exel still has a vital role to play.
EMS companies already control inbound logistics, by virtue of their performing manufacturing duties. But Toney says Exel can offer specialized services such as vendor-managed inventory, whereby manufacturers don't take possession of parts until they're needed on the production line. Exel's VMI customers hail from both the OEM and EMS sectors; they include Dell Computer, Motorola and Apple Computer in the first category, and Celestica and Jabil Circuit in the second. For EMS providers, a VMI program can help relieve the fixed-asset burden shouldered by them on behalf of OEMs.
Toney is aware of the double-edged nature of EMS companies that claim logistics prowess. "As control [of logistics] falls to the EMS sector, there is the threat of a shift in the business," he says, "but it's more of an opportunity."
Menlo Logistics, headquartered in Redwood Shores, Calif., was among the first non-asset-based entities to score a success with large manufacturers and retailers. Now, president and chief executive officer Bob Bianco sees a blurring of the lines between EMS and 3PL providers. "It's being driven by the customer's need for a turnkey transactional solution," he says.
Menlo isn't answering the EMS challenge by taking on classic contract manufacturing duties. But it has moved into light assembly, packaging and other value-added services that support postponement. It performs postponement duties for Hewlett- Packard's line of inkjet and laserjet printers in North America. It also assembles golf clubs for Nike.
Bianco has yet to go up against an EMS provider in a bidding situation. Nor has he lost any business to that type of entity, among Menlo's existing customer base. Still, he acknowledges the potential threat. "We view all competition as serious," he says.
Over the long term, Bianco expects EMS companies to align themselves with existing 3PLs to offer a "seamless solution" to customers. Otherwise, he believes, contract manufacturers would lag in acquiring the necessary expertise. Of course, that hasn't stopped big players like Solectron and Flextronics from going the other way.
Menlo has approached a few EMS providers about partnering on selected projects, Bianco says, "but nothing has come to fruition yet."
When it comes to heading off EMS competition, Caterpillar Logistics Services Inc. (CLS), another leading 3PL, has the advantage of having sprung from manufacturing. Based in Morton, Ill., the stand-alone unit of the well-known maker of construction and farm equipment has since carved out a position in five distinct markets: high-tech, industrial, automotive, consumer durables and aerospace and defense. The kitting and subassembly services of CLS span at least four of those areas, says director of marketing Mike Schmidt.
CLS considers subassembly and light manufacturing to be among its core competencies. That has helped the company to expand its business, when customers start looking for additional services. A similar response from contract manufacturers is "something we've kind of expected all along," says Schmidt.
CLS, too, has given thought to cooperating with EMS providers under a cohesive service package, although it has yet to make any such deals. For now, says Schmidt, the market seems too fragmented to support a single provider offering both contract manufacturing and logistics. Often the customers themselves are unable to seek a corporate-wide solution because of internal disunities.
The more common model, Schmidt says, is for a customer to outsource various logistics functions on a gradual basis, with the vendor picking up additional pieces of the business as it identifies new opportunities.
The success of contract manufacturers continues to provide a lucrative source of new business for 3PLs, says Chuck Lounsbury, senior vice president of U.S. supply-chain solutions with Ryder System Inc. He says EMS providers have been driven to offer additional services as a means of offsetting excess manufacturing capacity. Plant utilization in that sector has fallen by 75 percent in 2000 to just 44 percent today. Yet Ryder continues to derive a significant amount of its logistics outsourcing business from the EMS sector.
"We say we are the absolute experts in managing inbound and outbound supply-chain flows," Lounsbury says. "We're glad to partner with contract manufacturers with our world-class logistics support."
EMS providers have been generally open to Ryder's proposal for cooperation, he says. As of April, Ryder was about to embark on its first such relationship, although Lounsbury declined to name the partner.
He can't help feeling the pressure from EMS providers that are determined to expand their offerings. But those attempting to handle logistics on their own, he says, lack the necessary global network of suppliers. In the end, Lounsbury expects 3PLs to adopt both a competitive and cooperative stance with the EMS sector - a relationship he describes as "coopetition."
The Critical Cases
EMS vendors could have a tougher time expanding into the highly specialized world of expedited and critical-parts logistics. That's the territory of New York City-based Choice Logistics. The company supports OEMs and related service providers, offering parts storage and just-in-time delivery to service engineers.
Although its focus is on the aftermarket, Choice doesn't handle parts repair. "So far, we have stuck totally to our knitting," says Rob Kass, president and chief operating officer. For that, it relies on value-added contract manufacturers, among others. The repair vendors are located outside of Choice's distribution facilities.
Contract manufacturers have entered the aftermarket through repair services, Kass says. From there, it's conceivable that they could encroach on Choice's turf by offering to handle parts replenishment. But they only stand to succeed in overnight or deferred delivery, not the demanding world of one- to two-hour response times for critical parts. In any case, he says, "we haven't seen it happening yet."
Choice, meanwhile, is looking to expand its own offering, possibly to include more traditional 3PL services at larger distribution centers, or to replenish retail outlets such as pharmacies within narrow delivery windows.
3PLs hail from multiple origins. NFI Industries, based in Vineland, N.J., started out as a trucking company. Today it performs a broad array of services, including transportation, warehousing, real-estate development - and contract manufacturing.
That last service is the latest to be added to the NFI family of companies, having been initiated just under two years ago. Services include everything from receipt of raw materials to production, distribution and quality control.
NFI isn't directly challenging the big EMS providers, says chief executive officer Sidney R.
Brown. Its manufacturing expertise lies in consumer products, specifically cosmetics and perfumes. The company has pushed its newfound capability in tandem with other units, particularly logistics and inventory management.
Contract manufacturing involves long sales cycles, so NFI is only just finalizing some major contracts, Brown says. Customers will be making commitments of up to 10 years, with a single contract generating between $25m and $100m in revenue to NFI. And while profit margins are tight, "we feel we will get a reasonable return on invested capital, cement relations with our customers and become further ingrained in their back-end supply chains," says Brown. "Really, we become a pure extension of their business."
That, of course, is the same rationale that has drawn EMS providers into the logistics arena. Whether they can succeed there is another story. But one thing seems certain: there will still be room for partnerships between experts in their respective fields. "There can be a win-win in both situations," says ATC's Conley. "You just have to be careful who you partner with."
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