Valuation of the electronics manufacturing industry

Weekly Corporate Growth Report, Oct 6, 2003 by Dolbeck, Andrew

The electrical equipment manufacturing industry, covered by SIC Group 36, covers all companies engaged in manufacturing equipment, machinery, and supplies for generating, storing, transmitting, and utilizing electrical energy, with the exception of computer equipment. The industry includes power distribution equipment, communications equipment, semiconductors, radio and television receivers, lighting and wiring, electronic components, industrial electronics, and household appliances.

The Industry Today

Electronics Manufacturing Services (EMS) companies provide advanced electronics manufacturing and related services to Original Equipment Manufacturers (OEMs) on a contract basis. In the past, OEMs performed all aspects of product manufacturing, including design, assembly, testing, and fulfillment. Over the last ten years, OEMs have reduced their costs by outsourcing functions to EMS companies, creating more demand for specialized electronic components.

The demand for electronics components greatly increased in the 1990s. This was partly driven by the growth of the Internet, which brought about a bigger demand for communications and bandwidth. Another factor contributing to the growth of the industry was the increase in the electronics content of most consumer appliances.

But the high demand didn't last. The economic downturn reduced the sales of expensive electronic items. Many of the industries that rely on electrical components and equipment to make their products saw their own markets dwindle, decreasing their demand for parts and equipment. The computing and telecommunications markets in particular have shrunk, causing electronics firms to turn to the automotive and industrial markets, which were overlooked in the past because of the strong demand from the computing and telecom sectors.

Pricing in the Industry

Pricing for electromechanical switches and relays is currently very competitive. While this is good for the OEMs that purchase these devices, it makes it harder for suppliers to achieve profits while competing for a shrinking number of orders. Prices for switches and relays have dropped between five and ten percent over the past year. Price erosion has begun to slow for relays, but switches are still expected to decline about five percent this year. Even if demand improves, prices are so low that revenues will at best be flat, according to analyst John Gordon of Venture Development Corp.

Not only is the demand for electromechanical parts weak, but competition from foreign suppliers has increased. Asian suppliers, particularly from China, are entering the US market and undercutting the local prices.

Electronics companies, struggling to cope with reduced business and low selling prices, have adopted a number of different strategies, such as moving manufacturing offshore and focusing on niche markets with fewer competitors. Another tactic is developing products for higher-performance applications where meeting technical requirements is considered more important than maintaining a low price. Electronic component suppliers are also working to provide services such as logistics, inventory management, and reduced lead times in order to distinguish themselves during the soft market.

Hope for Recovery

The electronics industry is moving away from the downturn and may see a rebound in 2004. Although prices for electronic components remain low, there are signs of recovery for the electronics industry. Supply chain inventories are lower and unit shipments of semiconductors, passives, and connectors are. rising.

A joint study by Pembroke Consulting, Economy.com, and the National Association of Wholesaler Distributors predicts a rise in the global market for semiconductors. The strongest growth is anticipated in the Americas and the Asia-Pacific region. The Semiconductor Industry Association predicts ten percent growth for 2003 - below average but an improvement over the two percent seen last year. According to market research group Gartner, demand for chips is increasing, with the chip industry expected to grow 11 percent this year to $173 billion.

Not all analysts are optimistic, however. For a true recovery to occur, the increasing demand must prove to be consistent. Increases in unit shipments may just be seasonal demand as OEMs build products in advance of the holiday season.

Going to China

North American electronics operations are losing jobs to China. Ron Bishop, president of Bishop & Associates, expects that 40 percent of all manufacturing and engineering jobs in the con- nector industry will eventually migrate to Asia. The only region growing in the electronic industry, according to Bishop, is Southeast Asia - China, Hong Kong, and Singapore. Half the world's commercial electronics manufacturing is expected to move to China in the next four years, according to an EBN arti- cle.

Moving materials in and out of China can be difficult, however. The United States requires export control licenses for a greater number of technologies exported to China than to most other destinations, according to James Reed, an attorney specializing in international trade and export controls at law firm Cromwell & Moring.