By Matt Wickenheiser
The downturn of 2001 may not have been all bad news, after all, every cloud has a silver lining. One thing the somewhat slower business conditions did allow was a chance for OEMs to take a strategic look at their relationships with suppliers.
The result may well be acceleration toward outsourcing to component and subsystem suppliers.
According to several analysts and executives interviewed by WaferNews, it’s a move that will continue to grow that middle ground of components and subsystem suppliers, including a variety of companies such as CoorsTek Inc., MKS Instruments, Asyst Technologies, SEZ, Entegris, Metron Technology, Advanced Energy, BOC Edwards, Carl Zeiss, and Cymer Inc.
“I think if you look at the OEMs and the announcements they’ve made, you can glean that momentum from them. Lam has announced a major effort, the ion implanters have talked a lot about outsourcing, Applied’s talked a lot about it,” remarked John Coors, CEO of CoorsTek. “We’re not driving the trend, the trend is driven by the OEMs.”
In the late 1980s and through the 1990s, pressures on the OEMs became increasingly great as chipmakers asked them to take on more tasks, explained Lehman Brothers Analyst Ed White. In response, they’ve moved some of the engineering and production they used to do down the value chain, to the components and subsystems companies.
“In the past, the equipment companies would have to basically put all of their subsystems and modules together themselves. They would have to engineer all the stuff, power supplies, gas panels, whatever it might be,” explained White. “The inefficiency that comes with that is that, number one, they didn’t always know what the best subsystems were to use. Secondly, they couldn’t keep up with the technology. They didn’t have the time to be vertically integrated.”
Outsourcing allows OEMs to focus on their core competencies, and also affords them flexibility, lower cost of goods, lower overhead, and quicker time to market, as they push inventories onto their suppliers, noted Morgan Stanley Dean Witter Analyst Steven Pelayo. There’s a value shift underway, as the trend intensifies with the amount of the bill of materials being outsourced growing, Pelayo believes.
The main name in OEM outsourcing has been Novellus, according to Pelayo.
“Novellus has been one to manage the volatile cycles better than everyone else, and it used a more intense outsourcing strategy,” Pelayo pointed out.
Novellus outsources about 60% of its components, said Pelayo. The company’s strategy has been to take advantage of scale to get better pricings in times of low capacity, and the firm’s increased negotiating power protects it on the downside, he noted.
Industry leader Applied is moving to the model, with about 15% outsourced at 200mm, said Pelayo, and about 30% at today’s mix, with goals for 60% at 300mm. Applied declined to be interviewed for this article, but Pelayo told WaferNews that the company has reduced its supplier base from 1,300 down to 500 through outsourcing.
White noted similar stats lending to the benefits of outsourcing:
*One OEM has reduced the number of part numbers on a critical process tool from 6,000 to 140 over three years;
*A metrology toolmaker has increased the outsourced portion of its bill of materials from 30 to 60% over the past few years, while reducing the number of suppliers by 70%;
*Lehman Brothers estimates the components and subsystems markets at nearly $3.9 billion in 2001, a cyclically depressed year.
“A company should expect at least a 10% reduction in cost of goods sold,” remarked Pamela Gordon, president of Technology Forecasters, commenting on the benefits of outsourcing production. She noted the contract manufacturers run on tighter margins, generally pay their people less, and have larger buying power and materials management systems to reduce materials costs.
The market obviously exists for the company that wants to take advantage of the business model shift. In the last year, the number of OEMs doing business with CoorsTek has grown from nine to 28; the number of programs jumped from 49 to 61 in one quarter, Coors said.
Indeed, Pelayo noted that he’s found recently that OEMs are aggressively ramping their supply chains.
“We expect we would grow at a rate faster than our customers during the next downturn,” noted Coors. “We think it’s a large market. The opportunity is as large as the cost of goods of our customers – that’s really our total market.”
Commented White, “This is a good place to be. Instead of competing against the major companies, you’re their partners. From an investment standpoint, do I want to buy the guy competing against Applied Materials, or do I buy those selling into Applied?”
Several executives gathered recently at SEMInvest in NYC noted a few surprises they’ve encountered as outsourcing has become more common.
As negotiations with OEMs continued over time, the tool companies sometimes change their views of what were core competencies, remarked MKS’ VP of Corporate Marketing Paul Blackborow, and instead outsource certain systems, regarding them as no longer “near and dear.” Jim Wright, president of Entegris’ microelectronics division, noted that with the transition to 300mm, many OEMs are outsourcing R&D, as well. He’s also been surprised at the amount of information customers have been willing to share, including inventory management, logistics, and forecasts.
Wherever there are benefits, there are bound to be pitfalls. Some exist for both OEMs and suppliers in this model.
For the OEMs, there’s the danger of getting caught short on supply, if the relationships with suppliers aren’t managed well. There’s also the risk inherent of working with a “middle man,” said White – you pay a higher price. OEMs may need to ask if they can get the component or device cheaper if they build it themselves.
“I think what happens in the end is many of these equipment companies realize they don’t have an alternative,” suggested White.
On the side of the suppliers, said White, companies need to know where the inventory they are producing is going.
“Semiconductor equipment companies will build up an inventory – if you don’t know where that inventory is, and where it’s going, you can get caught,” warned White. “You’re shipping at a pretty good clip, everything’s great, all of a sudden, it’s not.”
Additionally, said White, most companies in subsystems don’t ever end up with a very big backlog. Anytime a company doesn’t have a backlog, the predictability of business isn’t that good, White said, and that’s a consideration as well.
Pelayo said the biggest pitfall he could see for suppliers would be pricing pressures.
“If you get married to the biggest player, you certainly don’t want to lose that account,” he noted.
There’s always the question of increased volatility – the so-called “tail end of the whip” theory, in which suppliers feel even more pain from cycles than the rest of the industry.
In a business even more volatile than semiconductor equipment, contract manufacturers suffered even more in the downturn, remarked Gordon, of Technology Forecasters.
“EMS companies who serve this space have seen orders go down to 10% of normal,” she noted.
But execs in the sector downplayed the concern, saying they were no more exposed to volatility than their customers.
“The tail end of the whip is oversold,” MKS’ Blackborow stated flatly.
To mitigate the volatility, MKS practices lean manufacturing; has diversified into FPDs, optical switches, and the bio-med field; targets areas with intrinsic growth such as 300mm, tool control systems, and power management systems.
Asyst CEO Mihir Parikh noted that 2 to 3% of capex would be spent on automation at 200mm, and that was forecast to increase to 5 to 6% at 300mm. While clearly the sector will experience volatility, Parikh said, “If you can grow through value, then you dampen volatility.”
Coors noted that CoorsTek has dealt with volatility in part by diversification, with business “in every industry, and we compete globally,” including oil and gas, medical devices, telecommunications, automotives, and computer peripherals – besides semiconductors.
“It certainly is a volatile industry. I don’t have any dream we’re going to make this smooth sailing,” said Coors. “I also don’t think we’re going to be any more volatile than our customers. I think the OEMs’ equipment is either shipping or not. We’re either making it or we’re not. We’re going to be as volatile as our customers – and that’s pretty volatile.”