Contract Manufacturing - Panel Discussion

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As more and more multinational companies are considering outsourcing their requirements to contract manufacturing firms in India, there is an opportunity for big bucks to come into India. We assembled a group of experts to discuss the facets of this emerging sector.

veeraragavan.jpgVeeraraghavan V: We have made some progress in sectors where we execute specified jobs which are not sold in significant volumes. Microsoft came to India to provide support service initially, software development came much later. Similarly, contract manufacturing in electronics is a relatively new phenomena.


The term used by the Excise department even today is ‘Job work’, to describe a small time contractor doing a sub-contracted job. Unlike jobwork, contract manufacturing is work of a much larger range . Now the buzzword is EMS. The concept of Electronic Manufacturing Services includes the whole process of ideation of the product to the finished product.


So far as India is concerned, we are a late entrant in this emerging sector. Basically, transportation is a big pain in India. That’s why software succeeded since there was no physical transfer of their finished product. Even the Government relaxed regulations for software exports since there was no shipping of material.


But otherwise in electronic components, if you want to export, it’s a tedious process. The importing process is a fairly smooth one. But if you want to export back a component, the process will take about 4-6 weeks since five different departments are involved in it.


In fact, Taiwan has always concentrated on manufacturing for other countries, while we were concentrating on developing products for India. Right through the 1980s the focus was on how do we develop our own operating system or develop our own PC. The basic idea was that since India itself is a big market, it can afford its own R&D, it can afford its own product and we can afford to cut off ourselves from the rest of the world. So we don’t have real manufacturing expertise in India in a global sense of the word.


But most fundamental problems can be pinpointed to two or three elements. One is that manufacturing is a capital intensive process.


Irrespective of all the things, in advanced manufacturing labour plays a minimal process. For example, if you are producing about one million circuit boards then one million defect free output will finally have a labour content of 1 or 2%. If you want to do one million pieces defect-free, then you have to employ proper methods and technology ie use machine procedures and when you calculate the manpower per unit of the overall cost, it will be as low as 1 or 2%. Now if you have an advantage of 1 or 2% you are no different than the original product. These are fundamental competitive problems.


bijumathews.jpgBinu Mathews: There is a major shift in considering labour as just cheap, it has to be now a cost effective labour. With a couple of majors like Solectron and Flextronics coming in, we have big names in electronic contract manufacturing coming to India.


IT services never had to worry about any production or shipment of material. The whole infrastructure of power, ports, transport and roads was not their concern. Nor do they work through the bureaucracies and the entire gamut of licences, customs and excise duties etc. Materials moving from here to Delhi will probably take 5/6 days in trucks which cover about 250 kms/day. This average is much lesser than that of China or Taiwan where they cover about 800 to 900 kms a day.


The advantage is that now a lot of people look at cost effective and also labour which is talented and not just skilled and semi skilled. There is big difference. If you look at China, it is the semi-skilled and not the skilled manpower which come in with lot of cheap labour. If you really look at comparing the cost of semi skilled labour here, you might have almost similar advantages. Labour is not the issue which is pushing this sector down, but an entire gamut of other issues.


Veeraraghavan: Most of the foreign manufacturers think of setting up production here for the local market rather than the global market. This is a very fundamental restriction which ties down electronics manufacturing. Unlike us the software people will never think that they need to keep the Indian market in mind while producing.


The main reason that companies seek production partners is that they do not want the hassles of manufacturing. They want to handle designing and marketing the product. So their only concern is, “What is the price at which you can give?”


Most times cost of the material itself is quite high. The cost of all metals available in India is much higher than any where in the globe. Moreover, Indian suppliers despite a 100 % advance, they take a minimum of eight weeks to supply the materials.


mohan.jpgMohan S A : I have a different experience in this industry. Contract manufacturing in India was extensively used and is still being used by the colour television industry. In the early phase they wanted to put up a unit in different states to overcome the sales tax issues. Many companies all over India subcontracted. The market started growing and the existing industry did not have the capacity. But the companies did not want to risk enhancing their capacities because they were not sure about the market stability.


But we missed the bus as far as PC manufacturing is concerned. I remember selling lot of connectors to companies like Wipro and HCL, in the late 1980s, since they used to assemble PCs in India. Eventually when Taiwan progressed to the next level of reducing cost and becoming the global centre for making mother boards. Every body thought that it is no longer viable for us to be in the business.


Coming back to the contract manufacturing issue, like Raghavan mentioned, the Indian skilled and semi-skilled labour pool has not been properly utilized. We have not gone to the villages and brought people by the truck loads into the city like China. They built all those factories and also made sure that dormitories were built for the workers. China basically took care of roti,kapda and makaan. They furthered the smart business strategy of giving end-to-end solutions for not only their customers, but also to their workers. It is important to make a viable market in your own country too.


The global markets will look towards the East in any case since China and India are the places with a growing market. Therefore it is not without reason Solectron or Flextronics or JBL have set up shops here without a single customer. It is not easy to make such huge investment decisions without having a customer base. When JBL came into India they wanted an Indian sponsor and only when the Phillips deal went through, they set up the business. Similarly Flextronics came with Motorola and Solectron came with Centum. If you ask, is India competitive, it is absolutely competitive.


Quality management is a crucial factor which crops up when a job is outsourced. Are Indian companies moving up the quality ladder?


Veeraraghavan: I think we need to bring in a lot of precision in what we are doing. One is manufacturing, and the second is globally competitive manufacturing. And that is what contract management is about. The quality has to be really world class so that the product can compete with the best in the world.


For instance, Hindustan Lever gets most of its soaps done by sub-contractors not only for domestic consumption but also for exports. All it does is control the quality and marketing the product.


India as an exporting country has done an excellent job in manufacturing. We might feel that we don’t have quality in consumer electronics or computer hardware but then give it time as the industry is fairly new. Producing quality products is a long term proposition which the automobile industry has achieved now. This sector not only produces components for the domestic market, it also does export all over the world.


But look at the complexity of developing this industry. Investments have been high in this sector to get the supply chain right. That is the only way to develop and succeed.


narendradamani.jpgNarendra Damani: One develops expertise in a particular product or process and that process ten people can utilize. That is what is basically happening in India. Once the product or process becomes popular, the related processes also come into being as maybe an effective supply chain.


Binu Mathews: Take the example of Sundaram Fasteners, despite the infrastructure problems, supply chain and labour management issues, they have done 5 million shipments with zero defect. They are able to deliver that on time continuously for the past five years and winning the highest international award for quality, the Deming Award. Major global automotive companies could have achieved that with all their investment in the supply chain and facilities. I think they have set a good example .


With the changed business scenario, there seems to be a lot of outsourcing happening to the developing countries. But should India focus on getting the jobs or stick to catering to the domestic market ?


Binu Mathews: The domestic customers who have gone with the partnership approach have excelled with respect to buying products at a much lower price from what they could have sourced from China. I can tell from my own experience how we have retained all our customers with us, regardless of the duties which were 100 per cent then and are 5 per cent now. We should have technically gone out of business. Competition has always been there regardless of what you do and unless you prepare for it, you just can’t do business.


Mohan: It depends on the levels of manufacturing. We definitely realize that when we conceive the project we always need to go from the base raw material stage. Of course in those days you had higher duties.


Veeraraghavan: I don’t know if it is true, but I am told that several automotive component manufacturers today are enjoying sales of billion dollars per annum.


The other example I would like to quote is computer manufacturing which is nearly dead. If you had a global market focus when the manufacturing set up was developed most of the problems would have been solved. But the focus was domestic market and in PCs we never had that advantage.


If you understand the essence of these two examples you will get the key to the whole issue. Most of the automotive exporters have excellent contact with all global automotive manufacturers. Added to the domestic needs it makes a lot of sense to manufacture here.


Binu Mathews: I feel the raw material availability is crucial. The share of material availability for auto components to PCs is enormously different. We should have a strong presence as a global player whoever maybe the customer. You must look at both domestic as well as the international market. When you put a milestone of looking at the total global market then only will it make sense. While we have lot of market in India as well as the economics, but it’s a challenge to achieve the price points.


Production of components is happening. But how to move up the value chain?


Mohan: I would like to bring in two elements here. When we talk from a customer’s angle, everybody’s capability to acquire a customer or even tospot a customer is very challenging. Because you don’t have the reach or the investment to make your brand well known among the prospective customers.


The Japanese sorted out this issue of finding a customer by going through marketing agencies who had set up front end companies in the US and Europe in the 1960s and 70s. These agencies told the Japanese automotive manufacturing companies that you focus on the manufacturing side, we will take the product and find customers for you. We should evolve such a model for our small and medium enterprises here.


After the acquisition of a customer is sorted out the second challenge is your ability to move up the value chain. From merely being a purely value added labour job, the Japanese and the Taiwanese made a concerted effort to move up the value chain by offering ODM services (Original Design Manufacturer).


Until few years ago, MNCs like IBM, Compaq, Dell or HP would approach companies from their list of approved vendors and give an order to make motherboards for PCs using a set of components supplied by them. These vendors thought the $5 they got per piece was great, but then they thought to offer product design services also. Then there will not be any need for the MNCs to search for vendors, source the components and assemble them onto the motherboards. So these vendors converted themselves from being contract manufacturers to ODMs.


This process basically released the MNCs from a lot of engineering services which was otherwise tied into producing routine vanilla product like a normal PC and gave them more time to focus on model introduction and marketing. They moved up and used their engineering services dealing with servers and platforms, leaving behind low end products to be designed and manufactured by their vendors. This is the business model adopted by Taiwan and very much duplicated by China. Forty nine percent of mother boards made in China today have origins in Taiwan . But it had a sponsor in 50% of the business actual being transferred from Taiwan to China. This kind of activity is not happening in India.


The third aspect is how will you differentiate yourself in terms of core competence. In India we don’t have core competency. We need to see what are we good at, we may be good in steel production or in automotive components. But we need to be good at giving end-to-end solutions to any of the foreign companies who want to come in. If we deal with India we should be able to get access to Ford-Germany and to Ford-UK. There is a conduit which is being built when we put it in one end and it gets delivered at the other end, so addressing the whole issue.


So is there an improvement in issues like infrastructure and shipping?


Binu Mathews: If you create a good image, business can run smoothly with phone calls, emails and courier packages. But for all of the infrastructure put together, one bad phone connection can ruin the image.


Mohan: From the cost point of view I feel the crucial issue is the facility of consolidated services. On an inbound freight if you import one kg from Germany the cost is Rs 40 in Indian rupees and the outbound back to Germany is Rs 92. So it is 100% more for the same


When I am quoting a price to a customer abroad, assuming that I have equated everything, I am losing out on freight cost. Even if you provide an FOB, the customer will always calculate at landed cost. Many people say no for the landed cost and you will only quote FOB cost. Eventually you end up in losing the game. Even if your product is 10% cheap than China you lose out on the freight charges.


We should have the same benefit like everybody else in the world of negotiating freight rates on certain lines and consolidate all the volumes. When I import some material from Germany I can go and negotiate the freight charges. But the sea freight is not very significant because of the container rates. It is not a problem with the Government, but with the flight forwarders themselves. There is a problem they can solve it if they want to.


Veeraraghavan: I have spoken to a lot of freight forwarders and despite our daily interaction with people from KLM and Lufthansa we cant get better rates. They say this is the IATA approved rates for India and consolidated services are not allowed out of India. Whereas anywhere else consolidated services are allowed by which one can mix and match any cargo in the best possible combination which can be carried in an aircraft.


Mohan: Nowadays we have these International Procurement Offices set up by all major MNCs to locate vendors and facilitate the regular supply. The IPO’s charter is to locate reliable vendors and generate business. But I have seen that their efforts gets diluted since the price they get out of India is very tight. Moreover one IPO office of an MNC competes with another IPO. For the same commodity which can be bought in China at 10 cents they would be getting a quote from India for 12.5 cents.


Binu Mathews: For most of our purchasing we look at multiple supply chain and development. We don not develop a close partnership with our suppliers, the moot word is competitiveness, hence we lose out on the relationship.


Issue BG30 Sep03


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