Customer revenue dominance in mid-tier EMS: three EMS providers discuss the unwritten rules of percentages.

Look back in the history of most major Tier One EMS companies and you'll find that their acceleration from a regional player to a multinational, leading EMS company was driven by one or two key customers, followed by further growth driven by a combination of key customer growth and large-scale acquisitions. But in today's mid-tier market, that model is not necessarily followed.

One advantage of having a large percentage of business tied to a single customer can be economies-of-scale in servicing the account, revenue predictability and the development of tightly knit partner arrangements, which can lead to large-scale--and mutually beneficial--expansion. The disadvantages can be unexpected business downturns if a key customer changes strategy, systems and processes that align with the key customer but don't necessarily appeal to the entire market, or loss of smaller customers which may perceive their needs are not as important to the EMS provider as those of the major customer.

As a result, many mid-tier EMS companies limit the percentage of business that any single customer represents and achieve economies-of-scale via a focused number of markets that require specialized expertise.

To better illustrate this, representatives at three mid-tier EMS companies were interviewed, including:

Christopher Allen, vice president of sales and marketing, Circuit Service (circuitservice.com).

Todd Baggett, vice president of business development, EPIC Technologies (epictech.biz).

Larry Fleming, sales and marketing manager, Syncro Corp. (syncrocorp.com).

Circuit Service has two manufacturing facilities in the U.S. and China. EPIC has five manufacturing plants in the U.S. and Mexico. Syncro operates from a single U.S. facility.

Q: Does your company set maximum limits on the percentage of business a customer can represent within your annualized sales revenue?

Allen: There is an unwritten rule to stay below 15 to 20% for any single customer. There are times this is violated due to spikes in business, but we have never turned away business as a result.

Baggett: Our goal is to have no customer represent greater than 25% of our company revenue.

Fleming: Yes.

Q: Does any account represent more than 30% of annualized revenues?

Allen: No.

Baggett: For 2006, we have one customer at 33% of revenue. By 2007, that customer will be less than 25% of total company revenue by virtue of new business wins with other customers.

Fleming: No, our largest customer represents less than 25% of our total business.

Q: What advantages/disadvantages do you see to your business mix strategy?

Allen: We believe in diversification so if a customer leaves completely, it does not put the company in financial distress.

Baggett: EPIC has a nicely diversified business portfolio across the segments of medical, industrial controls, automotive and consumer.

Fleming: Our strategy of medium volume/medium-to-high mix has worked well for the markets we serve. However, our selective approach impacts our opportunities in higher volume markets; i.e., consumer electronics and telecommunications.

Q: Does your business model have industry cluster preferences and if so, do you offer specific services/quality or certification/capabilities that are required by that industry?

Allen: We do not target any specific industry, but rather the whole industrial market so some clustering does occur. We offer specific certifications when appropriate.

Baggett: EPIC is a strong player in the medical segment and we like the margins and economic stability currently associated with it. We have FDA registration and ISO 13485 certification in all facilities for the manufacture of medical products.

Fleming: We focus in specific markets that typically expect ISO certification and Quality Control Plans, Process FMEAs and PPAPs with each new product launch. Based on our growth in RF-related products we have a greater focus in markets with this technology requirement; e.g., utilities.

Q: What advantages or disadvantages do you see with your business strategy relative to industry cluster preferences?

Allen: Diversification.

Baggett: We have chosen industry segments that best fit and appreciate our Lean manufacturing model in general, although there are always exceptions. Within our targeted cluster, the EPIC manufacturing model clearly sells as a strategic differentiator for us.

Fleming: By focusing in our key markets, which include medical, industrial, utilities and automotive, we have established an effective model of transitioning complex projects. We also feel our experience in these markets represents a competitive advantage.

Q: Do you have other comments on account diversity or preference for dominant accounts?

Baggett: EPIC targets to have no more than 20 to 25 total customers and no customer greater than 25% of revenue.

Fleming: We have been careful to principally serve markets that best fit the culture of our organization. Each EMS provider has a certain set of value drivers. The key to a successful relationship is a proper match of EMS value to the customer's specific needs.

A Preference for Service Focus

The common thread running through the answers is a focus on development of specific manufacturing or service delivery competencies and a track record of project complexity relevant to specific target markets.

Within Tier One EMS companies, OEMs are often buying into large economies-of-scale or specific combinations of capabilities and geographic reach. But in selecting mid-tier EMS providers, large OEMs are often shopping for responsiveness and service focus for projects that do not fit easily into higher volume models. Smaller OEMs in niche applications are often shopping for suppliers who will value their lower total volume of business or who have handled projects with similar complexity. Proximity to the customer's facility can also be a selection factor.

There are challenges to mid-tier EMS providers pursuing this strategy. First, industry-specific processes and certifications require infrastructure development. For example, it is cost-effective to pursue FDA registration and ISO 13485 certification for a cluster of customers or even one large customer, but may be challenging in terms of available manpower and resource allocation prior to development of a strong base of business.

The second challenge in a model focused on customer diversity is account acquisition. This is challenging in two respects. First, focusing on a diverse base of smaller accounts can require a larger sales force, greater travel expense and longer sell cycles. If the model is successful, that can translate to more new customer project launches which carry a high overhead cost. Longer term, the benefits can equal out with more momentum generated by a cluster of growing accounts than would be generated by a single new, large account. Multiple accounts in several industries also offer a hedge against business downturns which may more heavily impact business models dependent on one or two industries, or one or two dominant accounts.

How much is too much in terms of customer revenue dominance? The written and unwritten percentage rules discussed here are common to many EMS providers. The right answer is driven by internal analysis of factors such as:

* Existing OEM business base and management's network of OEM relationships.

* Available internal infrastructure for handling account acquisition, project launch, program management and industry-specific support efforts.

* Specific manufacturing or engineering competencies within the EMS provider.

* Attractiveness of existing business model to likely targeted industry groups.

* Patience of investors relative to revenue/margin growth speed associated with the selected business growth strategy.

The key to successfully deploying growth through customer diversity strategy is understanding the needs of targeted markets, aligning a service delivery mix with the most critical needs and being able to demonstrate a track record of operational excellence in actual service delivery. Companies that do this develop a sustainable growth model.

Susan Mucha is president of Powell-Mucha Consulting, Inc., an EMS consulting firm focused on training, branding and strategic planning.

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