As handset makers continue to stretch their resources in the three digital technologies and future 3G technologies, they are finding an increasing need to outsource a portion of the business.
L.M. Ericsson, struggling for profitability in its handset business, has turned to outsourcing lower-end handsets, a path it hopes will lead to better quarters.
“We haven’t focused as heavily on the low-end market in the past,” said Bo Albertson, marketing director with Ericsson’s mobile communications division in Stockholm. “This is one of the reasons we’ve had difficulties in the last two to three quarters.
Components shortages and a widespread shift to entry-level phones impacted Ericsson’s second-quarter earnings, and analysts are predicting another dismal third quarter for the world’s third-largest handset maker.
Albertson said at this point, 60 percent of global sales are entry-level products.
“We are finding in order to be able to put a focus on our R&D resources toward the next generation and new technology, we need to focus on that,” said Albertson. “We’re always pressed to cut down production costs and to be more efficient.”
Ericsson has made two moves in this direction in the last few weeks. It established an organization in Malaysia for managing its efforts in the entry-level segment and signed an agreement with Arima, a Taiwanese partner that will handle development and manufacturing of low-end phones for Ericsson. Ericsson’s agreement with Arima should also ease the components shortages Ericsson is facing since Arima can tap into other sources. More outsourcing announcements will follow, said Albertson.
Siemens AG earlier this year signed an outsource agreement with Flextronics International Ltd., calling for Flextronics to manufacture about 33 million phones for Siemens by the end of 2003. Siemens said this outsourcing strategy will support its goal to become one of the top three mobile handset makers in the world. Vendors like Nokia Corp. and Motorola Inc. have teamed with partners globally to enter new markets. Both companies have OEM agreements with Korean vendors.
“It’s a growing trend,” said David Kerr, director of wireless programs with Strategy Analytics. “We’ll shortly arrive at the point where one-third of entry-level products, which represent 65 percent of total volume, will be outsourced. … For Ericsson, this will be critical as they are looking at a single-point margin on handsets and even Motorola is struggling to achieve a 10-point margin on their handsets.”
“Without a doubt, this is just the first drop in the bucket,” said Bryan Prohm, senior analyst with Gartner Group’s Dataquest. “Historically, price has been the key dynamic that consumer purchase decisions are based on. As mobile migrates to greater sales on the consumer side, what has become even more of an acute concern is how do you stay on the price curve as the greater percent of sales are on the low end?”
Outsourcing allows vendors to react quickly to market conditions and get products out the door at greater speeds while at the same time decreasing the amount of capital manufacturers spend on production because they don’t have the factory overhead. Audiovox Communications Corp., which years ago embarked on an outsourcing strategy, today is poised to lead in U.S. CDMA handset market share by the end of the year, according to Dataquest.
“Strategically, they look like visionaries,” said Prohm. “The bottom line is, they will be much more profitable than others in the business.”
One of the keys to Audiovox’s success is the company’s ability to sell volumes of differentiated phones to carriers, said Philip Christopher, CEO and president of Audiovox. The company outsources phones in all three digital technologies from a number of companies, including Japanese vendors Toshiba Corp., Hyundai Electronics and Sanyo. This allows Audiovox to sell custom handsets rather than pushing the same form factor across all three digital technologies.
“Verizon wants to advertise a phone exclusive to them. All the national carriers want this,” said Christopher. “In the old days of one technology, analog, you could bring millions of phones in and sell to everyone. It was easier to run a factory. … In order to be a true supplier to carriers and a true partner, you must have the ability to develop products that carriers need,” said Christopher.
Audiovox demonstrated this concept with the CDM-9000, a tri-mode CDMA phone Verizon Wireless is exclusively selling. Verizon has committed to buying a minimum of 1 million of those phones. Few other vendors are offering tri-mode CDMA handsets today.
Maintaining product quality is more difficult when vendors outsource because they don’t have control over the production process, say analysts.
“That’s the greatest concern,” said Prohm. “How do you keep your guard up in order to maintain quality control while driving down prices on the handset?”
Christopher said Audiovox has developed strong engineering expertise to control product quality and work with all of its OEMs. It provides a turnkey operation to carriers and makes sure it uses manufacturers that meet quality standards that both Audiovox and carriers set.
“We make carriers part of the engineering process,” said Christopher. “They are there with us every step of the way. This way, we develop exactly the product carriers want and in the quality and specifications they want.”
