Contract manufacturers face stagnant growth in mobile handsets due to rise of smart phones

EL SEGUNDO, USA: The impact of the recession combined with rising sales of smart phones will deal a setback to contract manufacturers in the global cell phone market, limiting the companies to less than a 30 percent share of the wireless handset market during the next four years, new IHS iSuppli research indicates.

Contract manufacturers—a group encompassing firms engaged in electronics manufacturing services (EMS), as well as original design manufacturing (ODM)—accounted for 25.2 percent of global unit shipments of cell phones in 2009, down from 27 percent in 2008, as presented in the attached figure. The impact of such a reduction will be long-lasting, with the percentage of cell phones shipped by contract manufacturers reaching just 28 percent by 2014, up less than three percentage points from 2009.

Such minimal growth represents a stumbling block for contract manufacturers, which had been enjoying a steadily expanding presence in handset manufacturing as their share of unit shipments exceeded 31 percent in 2005.

“Consumer demand for cell phones shrank during 2009 in light of the worst recession in decades,” said Jeffrey Wu, senior analyst for EMS and ODM at IHS. “As a result, some cell phone original equipment manufacturers (OEM) sought to reduce costs, pulling back outsourced production to in-house manufacturing facilities in order to optimize utilization of internal capacities.”

Among the companies that followed such a strategy were No. 1 cell phone OEM Nokia Corp. and No. 2 OEM Samsung Electronics Co. Ltd.

Meanwhile, OEMs making greater use of contract manufacturers, such as Motorola Inc. and Sony Ericsson, adjusted their product portfolios to reduce reliance on lower-cost, lower-margin phones, the majority of which then were outsourced to the contract manufacturers.

In either case, contract manufacturers suffered from reduced shipments and idle capacity, prompting IHS to maintain a conservative outlook on the growth of wireless handset outsourcing, Wu added.

Reduced role for outsourcing
By the time the economy started to show signs of recovery in 2010, the wireless handset market had evolved, with smart phones becoming the main focus of the business. Factors that contributed to the success of contract manufacturers in the mid-2000s, including the design and building of highly commoditized phones at competitive costs, were no longer considered viable competencies in the changed market.

Many OEMs today still want to retain a measure of in-house design and manufacturing control over their smart phones. Not only do they wish to maintain better control of quality and supply chain activities, only a few contract manufacturers actually are well positioned to accommodate the shift toward smart phones. For its part, the only contract manufacturer that could competently design and build smart phones—the ODM HTC—has decided to focus exclusively on its own brand.

A few good contract manufacturers
Proprietary smart phone OEMs such as Apple Inc. and Research in Motion (RIM) currently use contract manufacturers exclusively on an EMS basis. Both RIM and Apple saw increased shipments and expanded market share in 2010, benefiting their contract manufacturers.

But, while EMS providers with exposure to the two OEMs enjoyed significant growth in both revenue and profitability during the last two years, there is no guarantee that EMS providers will continue to reap such benefits in the future. On Apple’s part, it is unlikely that the design giant will engage new contract manufacturers with which it has not worked before in products like the iPhone.

Meanwhile, growth prospects for RIM’s BlackBerry are clouded with uncertainty, with success hinging on how it competes against the increasingly popular iPhone and Android smart phones. Should RIM’s shipments begin to stagnate or decline, EMS providers such as Flextronics will be adversely affected.

As for other contract manufacturers, such as FIH, Compal Communications and Arima Communications, unless they can further develop their smart phone capabilities to provide a one-shop solution to OEMs—especially those based on the open Android platform—it will be difficult for these entities to counter the stagnation of shipments and the erosion of margins.

Source: IHS iSuppli, USA.