When it comes to electronics manufacturing services (EMS), "there's a lot less 'e' than there used to be," according to Thomas J. Dinges, senior principal analyst, electronics and media, at IHS.
Dinges is referring to the diversification efforts of a wide swath of the traditional EMS industry. With hardware margins ever shrinking and electronics product cycles speeding up, many of the traditional EMS companies, particularly in North America, have switched gears and stepped back from that business. Hardware OEMs—EMS' traditional customers—have already outsourced all that they are likely to outsource, said Dinges. On top of that, most hardware OEMs' sales are stalling. "If you're in their food chain, every year you're just wondering how much more it's going to decline," he said.
So EMS companies are going elsewhere—to non-traditional markets—in search of growth. In particular, "they are looking for products that have better margins, different customers and longer product cycles," said Dinges.
Jabil Circuit Inc. provides a good illustration of the changes happening in EMS. Like others in the EMS industry, it is trying to diversify as fast as it can. And it has made progress. In 2007, 93 percent of Jabil's business was electronics, according to a company spokesperson. By 2013, that had shrunk to 65 percent.
The company has made key acquisitions in the materials, packaging, healthcare and service industries. And more may follow. Mark Mondello, newly appointed as CEO this year, said at the company's analyst day in October that acquisition would be a key part of Jabil's strategy going forward. Because of the incredible rate of change in technology and products, the company must spread its bets, he said. "It's becoming exponentially more difficult" to predict tomorrow's hit products, he added.
Jabil was already shifting its business before he rose to CEO, but Mondello is pushing the process more urgently. "He's really emphasizing moving outside the traditional EMS business," said Shawn Harrison, senior research analyst at Longbow Research. "That's his focus. He wants to diversify the manufacturing base and reduce the volatility in the business."
The best of both worlds
Indeed, reducing the wild swings in business and adding high-margin products is the goal, and Jabil is trying to do that by expanding into more predictable markets. At the same time, it still seems to want to be on the cutting edge of at least some emerging electronics categories.
Chief Operating Officer Bill Muir cited several "megatrends" in Jabil's strategic sights. One is healthcare, particularly disposable drug-delivery products like syringes and epinephrine pens. Jabil moved strongly in this direction this year with the acquisition of Nypro Inc., a Clinton, Mass.-based precision plastics manufacturer that earns more than half of its revenue from disposable, single-use medical products, according to Dinges. Healthcare disposables and consumables is a $65 billion market, according to Courtney Ryan, Nypro's CEO. A disposable syringe may not seem very sophisticated, but such products require high-quality, precision design and manufacturing and so typically have margins of 6 to 7 percent, much higher than the 2- to 4-percent margins in electronics, said Dinges. And they have long, stable lifespans. Jabil needn't worry that a new, redesigned epi pen will be out in six months. "Once you're in this supply chain, you have a good runway," Dinges noted. "You pretty much know how many syringes to make a year."
On the other hand, Jabil also has its eye on emerging consumer electronics markets, like the wearable computing market, even though it could be fickle and volatile. Nevertheless, "we think that's a megatrend that is poised for some very, very explosive growth," said Muir. Lots of hardware, software and startup companies are pouring capital into that market, he said. "And there's an interesting intersection between that marketplace and our healthcare business, where Jabil is positioned exceptionally well. It could be a significant growth driver for our company."
Meanwhile, Jabil still must deal with the fickle and volatile consumer electronics business it already has. In fact, its ties to a major consumer electronics customer—BlackBerry—have dampened Jabil's financial performance (see table). The failing smartphone vendor is Jabil's second-largest customer, comprising 12 percent of 2013 revenue. And Jabil has announced that it expects to lose all of that business.
That will be a significant earnings hit, according to Harrison. "That customer was north of $2 billion in revenues for Jabil's last fiscal year," he said, "and sometime in the next six months that goes to zero." Jabil had already announced a restructuring program of $188 million. With the loss of BlackBerry, the company is now forecasting additional restructuring charges of somewhere between $35 million and $85 million.
The BlackBerry debacle is a perfect example of why EMS companies must change strategies. "What's going on with BlackBerry is one of the challenges that EMS companies have faced," said Harrison. A large, well-known consumer electronics product goes gangbusters, then quickly loses favor, because "the next wave of product didn't work or consumer sentiment toward that product changed, and you are left with a significant hole," he explained.
Until Jabil can ramp up its new, more diverse businesses, it will remain vulnerable. Its other two largest customers are Apple, which was 19 percent of 2013 revenues, and Cisco, which had been 10 percent in 2012 but dropped below that level last year, according to Jabil's annual report.
Key acquisitions
Jabil started branching into materials in late 2006, when it acquired Taiwan Green Point Enterprises Co. Ltd., which makes plastic and metal parts for mobile phones. It now operates within Jabil's Diversified Manufacturing Services—one of the company's three business units and the one the company considers its growth engine (see sidebar)—and is a major supplier of cases for the Apple iPhone.
In 2011, Jabil expanded its aftermarket services business by acquiring Telmar Network Technology, which focuses on reverse logistics, repair, technical support and spare-parts management for network operators and OEMs. The deal broadened Jabil's capability to provide maintenance for everything from consumer electronics to set-top boxes to telecom infrastructure equipment.
Then came the Nypro purchase, which brings more than just healthcare products. It also makes packages for the type of consumer goods you're more likely to find in a grocery store than a Best Buy: food, beverages, household and personal care products. It's an entirely new area for Jabil, a $130-$140 billion market in custom-engineered rigid plastic packaging, Ryan told analysts. That means lots of new Fortune 500 customers, as well, such as Kraft and Coca-Cola.
Meanwhile, there's also future growth in the pharmaceuticals business. After all, once you're making the inhaler, it makes sense to go ahead and insert the asthma medication. The next step for Jabil is to actually insert the appropriate drugs into the devices before shipment, Alan Myers, Jabil's vice president of drug delivery and diagnostics, told analysts. This type of business cannot be categorized as EMS, he said. "It won't look like what you've seen to date in our industry."
And yet Jabil plans to stay in EMS, but to move up the food chain. For example, Jabil is going deeper into sophisticated systems design and manufacture of larger medical equipment. The company helped a customer redesign a hemodialysis machine. It was a comprehensive remake that included redesigning the electronics, mechanics and software. It took 10,000 engineering hours of work and reduced component cost and increased reliability. "If we were doing something like that five to seven years ago, our role would've been building two or three circuit boards into that machine," said Muir. "Our role today is a comprehensive redesign."
The big picture is for each of these segments to complement the other. The precision materials expertise of Nypro, combined with Jabil's electronics expertise, is a "skillset and infrastructure that is unmatched in the industry," said Muir, which could give the company a key competitive edge in the future. Meanwhile, the company hopes to balance the volatility of consumer electronics with the steady, predictable plastics and materials business. The company doesn't see much of a future in building only the electronics for mobile phones, for example. However, "when we have the ability to control the entire value chain, leveraging a great deal of our materials tech expertise and maybe some other parts of that value chain, that would be of interest," said Muir.
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