Still plenty of life in the ole gal

Should you be concerned about the pricing/profitability trends in the passives business?

In the world of electronic products it’s pretty easy to locate the fastest game in town. Just follow the invitations to the conferences and count the plenary sessions on a given theme. In components right now the action seems centered on concerns over disturbing pricing/profitability trends in the passives business. At Carts 2007 this writer participated in a workshop addressing the market for commodity passive electronic components with particular focus on the supply/demand requirements for the Asian market, particularly China. Also discussed were the size and growth rates for key products that require commodity components, the content requirements for products using commodity components and the outlook for distributors, EMS and ODM companies.

Let’s start with the good news: it was pointed out that the size of the market in volume of pieces for passive electronic components has increased eightfold in the past 10 years. Further, this trend is likely to continue because of some very strong drivers, particularly in consumer electronics.

No matter where you design it, buy it, or build it, the number of discrete components inside just keeps on increasing. For example, it is estimated that the number of multilayered ceramic chip capacitors (MLCCs) consumed over the next five years should continue to grow at a rate of between 10% and 15% per year as new demand is created from converged handsets, dual-core computers, and HDTV flat-panel TVs. iSuppli’s Eric Pratt presented lots of evidence on the need for passives in today’s hottest consumer products. One example is Sony’s Vaio Ultra Mobile PC. As the chart below shows, passives represent about two-thirds of the total number of parts.

Speaking on behalf of the Paris-based research and consulting firm Decision, Sebastien Rospide put the average growth of world passives consumption at 3.6% over the period 2006-2011. New semiconductor functions require more passives than they can integrate, he said. As an example, he noted that CRTs used between 300 and 500 passives while flat-panel TVs utilize 2,500 to 3,000 such parts.

Another key issue discussed is how much further can the downward pricing trend line go for passives? In the worst-case scenario, the supply base reaches a point where there can be no additional costs removed through productivity gains, technology improvements, manufacturing cost reductions, outsourcing, or material cost reductions. A limit is reached where the cost to produce the product is at or even below the price received for the products.

Fortunately, Decision’s Rospide said that his company’s research indicated that in the medium term the Average Sale Price (ASP) decrease of commodity products would be less intense than over the past years, and in fact a “single digit” number. He attributed this to the increased pace of innovations in passives, which will help to maintain margins, as well as external factors such as raw material prices and environmental regulations.

Considerable time was spent at the workshop evaluating the market in China. Amy Wang, VP, China Outlook Consultants, said if you include facilities of international component suppliers, China shipped $155 billion worth of component products last year. Divided by geographical location, most component makers are located mostly in East China (60%) and South China (20%), she said.

Sebastien Rospide pointed out that between 2000 and 2006 China doubled its share of world electronic production from 11% to 24%. From 2006 to 2011 Decision expects China to take a strong focus on mass-market products. China’s share of world production of TVs will slip slightly from 27% to 26%, Decision predicts, while set-top box production will jump from 38% to 47% and PC production will move from 38% to 44%.

China Outlook’s Wang placed near-term demand for cellular handsets at 130 million units (66 million handset users in 2006, and 70 million new users expected in 2007). In particular, in rural regions of the country handset sales chalked up a 48% growth last year, she noted. The average handset lifecycle in China is only 21 months, according to Wang, a fact that powers the new handset market.

Similarly remarkable growth can be seen in China’s automotive industry. China Outlook estimates the country produced 7.3 million cars in 2006 and year-on-year growth for 2007 is expected to be a gaudy 28%. Major automotive manufacturers in China include GMC (Shanghai), Volkswagan (Shanghai and Chaungchn), Cherry Automotive (Anhui), Toyota (Tianjin), Hyundai (Beijing), Nissan( Wuhan), and Chitron (Wuhan).

Bruce Rayner VP Consulting & Research, TFI thinks that very large percentages “probably the majority” of commodity items used in China today are sourced in China, adding “in the near-term (say the next 4-8 quarters) this trend is expected to continue.”

Energy-savings initiatives will power growth as will government initiatives to develop reural markets in telecom and TV networks. Another driver, Amy Wang said, is the upcoming 2008 Summer Olympic Games, to be held next year in Beijing. Demand associated with the games includes surveillance systems, digital TV (both broadcast equipment and consumer sales of HDTVs) and networking gear.

On the negative side of the ledger, Wng said, China faces difficulty in maintaining the necessary infrastructure and trained people needed to support technical innovation. There is also renewed awareness of patent/royalty issues and the fees and licenses associated with both, as well as the possibility of more quality-related lawsuits; any success of these cases could negatively impact growth, and possibly, component supply too.

TFI’s Rayner examined electronic manufacturing services (EMS) providers and original design manufacturers (ODMs). Some trends he noted:

• EMS/ODM share of total manufacturing is rising: 20% in 2005 going to 26% in 2010.• ODM’s are dominant in Asia (54% versus 46% in 2005) with ODMs share growing over time.• Profitability for EMSs and ODMs are under pressure (see chart below)• Both are looking to cut costs where they can.• Both are in the BOM aggregation business–making margin on volume procurement.

Other interesting observations presented by Rayner:

• EMS 5-Year CAGR is 12.1%• Driven by the Foxconn phenomenon (Editor’s note: Taiwan’s Hon Hai Precision Industry Company Ltd. is the anchor company of Foxconn Technology Group) maybe 8%–9% without.• Computing opportunities working in favor of ODMs• Communications opportunities in emerging markets, capex• ODM 5-Year CAGR is 13%.• Deceleration in growth: 15% in 2006 to 12% in 2010• Lower margins: Focus on own-brand business• Difficulty moving up the handset value chain• Limited market penetration (medical, mil/aero).

Thomas J. Dinges, Senior Analyst for JPMorganChase emphasized that distribution will continue to play a vital role in finding new customers, entering new markets and determining the next hot products. The shift in manufacturing from integrated OEM to outsourced model has added another layer in sales/fulfillment complexity, he said. But at the end of the day “customers will always want better, faster and cheaper products,” and as a result, “the R&D investment required to sustain competitive advantage is increasing.”

Dinges also confirmed anecdotal reports that distributor profits have improved (see chart below), although they are not at the peak levels of the mid-to late ‘90s.

Add it all up and the passives business has plenty to concentrate on and a little bit to worry about. But as optimists and some would say pragmatists remind us, the industry has been backed up against the wall before and it turned out OK. Can they do it again? What do you think?

http://www.eebeat.com/?p=633

Murray Slovick

Other great blog post at www.eebeat.com include: $100,000 design contest pushes EEs to help environment, http://www.eebeat.com/?p=598