You Name It, We'll Make It

By Frank Gibney Jr. With Reporting by Daren Fonda/New York, Luis Miguel Gonzalez/Guadalajara, Jane Lanhee Lee/Xixiang, Laura Locke/San Francisco and Jan Stojaspal/Sarvar

In the first week of September, Microsoft officials will watch proudly as the first batch of Xbox game machines begins rolling off seven 280-ft.-long assembly lines at a new industrial park outside Guadalajara, Mexico. There may not be any Frisbees flying around, but the 124 landscaped acres could be any Microsoft campus back in Washington State. There is a screening room larger than the local movie theater and a cafeteria that includes a steak grill and a sushi bar (lunch price: $3)--all crowned by a glass-and-stone headquarters. Inside Building 12, engineers are working to make sure that unlike last year's Sony PlayStation 2, the new Xbox will be in plentiful supply at stores everywhere come Christmas.

But the real beauty of the Guadalajara plant--and the Xbox facility in Zalaegerszeg, Hungary--is that they are not owned by Microsoft. The Xbox is being made by Flextronics, a company that few consumers have heard of but that computer and telecommunications-equipment makers are eager to do business with. Indeed, near Building 12 are 16 production lines for Cisco Systems digital network routers. Other buildings produce Palm Pilots and DirecTV set-top boxes.

It's all part of the grand empire of Michael Marks, the amiable, fast-talking chief executive who since 1993 has driven Flextronics, based in Singapore and San Jose, Calif., from also-ran to pacesetter in the so-called electronics-manufacturing services (EMS) business.

This industry is nobody's new new thing. For several years it has done for companies such as Microsoft what basic contract manufacturers did for such old-economy companies as Nike and Sara Lee--relieved them of the gritty business of making things so they could focus on product development, marketing and brand building. What is stunning is that the EMS industry is booming even amid the smoking ruin of today's tech economy. As they acquire their smaller competitors and buy more of their customers' factories--at fire-sale prices--big players like Flextronics and Sanmina stand to emerge from the tech slump stronger than ever.

For computer and telecom-equipment makers now facing rebellious shareholders and piles of inventory, the prospect of a cash infusion from the sale of their factories to EMS companies is especially appealing. "We used to have to fight and plead for companies to divest assets to us," says Dave Fargnoli, a director of finance at Flextronics. "Now we're in the driver's seat because they are rushing to off-load them." Marks, a salesman to the bone, tells potential customers: "You can be a market-leading company and not make a single thing." Why not, he adds with a grin, let Flextronics make your products for you? "The venture-capital guys won't even give you money for a factory these days," boasts Marks. "They'll tell you to go to Flextronics."

The divestiture trend is a boon to the entire EMS industry, but Flextronics is growing the fastest. It has inhaled 39 suppliers and competitors in less than two years, and its $12 billion market capitalization hovers near that of industry leader Solectron, based in Milpitas, Calif. Both, though, face tough competition from Sanmina, which is based in San Jose and which last month agreed to buy rival SCI Systems, in a stock swap worth about $, 4 billion, plus assumption of $1.5 billion in debt.

In the short term, these megacompanies face a period of adjustment. Flextronics, for one, will have to digest its gut-busting acquisitions. Says Merrill Lynch analyst Jerry Labowitz: "It's a real challenge for any company growing at an extraordinary rate to do three dozen acquisitions in less than 15 months, especially when many of them are in new areas for the company." In the meantime, the big EMS players must also adjust to the economic woes of their customers. In a speech last month, Marks predicted that the telecom industry is "going to get a lot nastier, with a lot of dislocation"--referring to the number of plants (including his own) that are closing and to workers who will be laid off.

At the same time, analysts agree that the downturn will make the EMS giants even more powerful. The EMS business has already grown to more than $100 billion in sales in 2000, from $60 billion in 1998. It is expected to reach $130 billion in sales this year, according to Technology Forecasters Inc., and $260 billion by 2004.

Fewer and fewer famous brands make what they sell. Apple no longer assembles the bulk of the iMacs it sells. Hewlett-Packard, the world's leading brand of personal printers, doesn't make a single one. Nor does Cisco make the complex digital switches and routers that make up the backbone of the Internet. Instead, each of these companies (and the list grows daily) is throwing its financial and intellectual capital into product research, design and innovation--conceiving the next generation of gadgets and services, and marketing them under trusted brands.

In some ways, the name brands--not only the Microsofts and Nokias but also the Kodaks and Gaps--are making a devil's bargain. If some entrepreneur has a revolutionary idea for a videophone or an instant tooth flosser, all he has to do is get Wal-Mart to agree to sell it and then get Sanmina to design and build it for him.

Consider Donna Dubinsky and Jeff Hawkins, the brains behind the ubiquitous PDA, the Palm Pilot. They left Palm three years ago and started Handspring with a scheme for a competing PDA, the Visor. Within 15 months, Handspring was shipping its new Visors, thanks to Flextronics and Solectron. And now the Visor has 7% of the $4.3 billion global PDA market.

The top four or five EMS companies share many clients. What distinguishes Flextronics is its global reach and the breadth of its operations. Marks jokes that he nearly flunked the only manufacturing course he ever took at Harvard Business School, but he made up for it by understanding globalization earlier than most of his peers. He has led Flextronics to locate its factories to take advantage of low-cost, relatively low-skilled labor in places like China, while having more complicated products made in more developed countries in Europe and Asia.

Marks also began consolidating suppliers and clients into industrial parks in China, Hungary and Mexico. Flextronics' park in Sarvar, western Hungary, includes a manufacturer of Styrofoam packaging, a maker of cardboard packaging, a forwarding company and a company specializing in sheet-metal stamping. The new Guadalajara location boasts circuit-board fabricators. And all are connected, on a secure computer network, with design and engineering labs around the world.

In effect, Marks sees his company becoming a one-stop, vertically integrated shop that provides everything from engineering and product design to manufacturing and distribution. "We are a variable-cost manufacturer," explains Marks. "We share the infrastructure among a bunch of customers, so when demand for one product dries up we can switch to something else and we don't get stuck with an idle factory." If the market for handheld computers takes a dive, for instance, the same assembly lines can be used to produce a product of similar size, like a cell phone. That's an efficiency not available to someone who only makes handhelds.

Flextronics got its start in Silicon Valley in 1969 as a "board stuffing" operation back in the days when computer circuit boards were soldered and assembled by hand. In 1990, as recession struck the U.S. and much of the world, Flextronics sold off all its U.S. operations and reincorporated in Singapore; from there it operated a few factories in Southeast Asia and southern China. Flextronics grew steadily through the '90s, leveraging its early presence in Malaysia and China into a solid share of the "enclosures" market--doing final assembly for cellular phones, personal computers and printers. But when the Asian economic crisis hit in 1997, Marks says, "I was all ready to sell it off to Sanmina or Solectron."

Then providence intervened. Swedish telecom giant Ericsson decided that it had become too costly to produce all its wireless switching equipment and, after researching Silicon Valley's contract manufacturers, awarded a $300 million deal to Flextronics (whose revenues at the time were only $400 million). "That launched us in Europe almost overnight," says Marks. "There was no other contract manufacturing going on there, so we were able to move very quickly with other acquisitions."

Last December Ericsson's top brass threw a 50th-birthday dinner for Marks at the tony Stallmastaregarden restaurant in Stockholm. While thanking his hosts and lauding their partnership, Marks launched into a bold new pitch: What Ericsson really ought to do, he said, was jettison all its mobile-phone operations. The next morning he made a formal proposal. Ten days later, Ericsson agreed to get out of the cell phone-manufacturing business. "It turns out that, increasingly, companies want not just a supplier but someone to run a part of their business for them," says Marks. "The Ericsson deal was our big breakthrough."

Flextronics' most sophisticated operations, which manufacture routers for Cisco and wireless base stations for Ericsson, are based in places like Silicon Valley and Sweden, where top talent is available. Its most labor-intensive operations are still in China, where Flextronics mostly makes comparatively simple electronic products, from PC parts for Dell and mouse assemblies for Microsoft to cell phones for Nokia, Motorola and Ericsson.

The company has a leg up in China, where it started relatively early, in the beginning of the 1990s. Revenues in China have grown to $2 billion. And Flextronics has expanded from two locations to a nationwide operation, with relatively simple cell-phone and PDA assemblers in the south and high-end engineering and manufacturing facilities in Shanghai and Beijing.

The most complicated and potentially lucrative market, however, is in Europe, where Flextronics employs 25,000 workers in 15 very different countries. Some, like Germany and France, are heavily unionized, and workers in some parts of Eastern Europe retain the slothful habits they developed at communist state-owned factories. Still, wages for low-skilled factory workers in Hungary are about $2 an hour, versus $15 in neighboring Austria. And wages are even lower in Ukraine, where Flextronics began experimenting with a pilot project early this year. In a corner of what was a dingy Soviet domestic-appliance works in Beregovo, workers now assemble circuit boards for as little as 40[cents] an hour.

Low-cost factories in Eastern Europe allow Flextronics to deliver products to wealthier consumers in Western Europe weeks faster than do factories in Asia or Latin America. "About 70% of world electronics are sold in the Christmas season," says Roger Moore, executive director at the Flextronics industrial park in Zalaegerszeg, Hungary. "If you've launched a new product in August, you really don't know whether it will take off until the season gets moving around the end of October. If you discover it's a real hit, and it is being shipped from China, it won't reach you until it's too late." That's why most of Flextronics' Xbox production is in Guadalajara, near its primary market in the U.S.

--With reporting by Daren Fonda/New York, Luis Miguel Gonzalez/Guadalajara, Jane Lanhee Lee/Xixiang, Laura Locke/San Francisco and Jan Stojaspal/Sarvar