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Flex Forward

Flextronics’ Michael Marks says that outsourcing can only get much, much bigger.

  For Michael Marks, outsourcing is not a dirty word. “It’s ridiculous,” he says of the backlash against moving U.S. jobs overseas. “Outsourcing is good for America. The unemployment rate is lower than when I got started in this business.”

Marks has strong views on the subject because he runs Flextronics International, the world’s largest outsourcer of electronics manufacturing jobs. More than just a cheap labor play, the Singapore-based company has devised sophisticated logistical, supply and design methods that enable clients to reduce fixed assets and product development time. Flextronics has 95,000 employees in 29 countries, half of them in China and the rest in low-wage centers such as India, Poland and Mexico.

But most of Flextronics’ customers are all-American: Dell, Microsoft, Motorola, Palm, Hewlett-Packard and Xerox. Most consumers have probably used a Flextronics-built product sold under a popular brand name.

Marks, more than anyone else, is responsible for the outsourcing trend in the tech industry, in what has now become a $100 billion electronics manufacturing services industry. With $14.5 billion in revenues, Flextronics two years ago surpassed the $11 billion U.S.-based Solectron to become the industry leader.

Marks continues to drive ahead. Flextronics is negotiating with the Canadian telecom giant Nortel to outsource virtually all of its telecom manufacturing and supply-chain management, a contract expected to be worth more than $2 billion in annual revenues. If Marks clinches it, and many think he will, it will be the largest contract won by Flextronics.

Will the current accounting crisis at Nortel derail the deal? Talking on a satellite phone aboard his company’s Lear 60 jet somewhere over the Midwest, Marks gives a hedged answer. “We did have some pause in the discussions, but hopefully we’ll get the deal done,” he says. Others think that’s being coy. “The deal still makes strategic sense for Nortel,” says Deutsche Bank analyst Chris Whitmore, based in San Francisco. “The scandal doesn’t change the benefits associated with outsourcing to Flextronics.”

If the Nortel deal goes through, it will be significant for Flextronics in another way. Much of its current business is focused on consumer and business sectors, and Marks would like to do more in telecom infrastructure, now that the sector is recovering. “They want to go more into telecom to become less consumer oriented,” says David Scott, a Morgan Stanley analyst in New York.

The deal is typical Marks: It helps Flextronics grow fast, and Marks likes to move fast. He spends two-thirds of the year on the road, racking up about 400,000 miles of travel€¦quot;at least four months a year in Asia and Europe, the rest in the Americas. Although Flextronics is officially domiciled in Singapore, Marks stays close to the tech industry by being based in San Jose.

It was in 1994 that Marks took the helm of Flextronics, which was then Singaporean-owned, backed by $15 million in Silicon Valley venture capital. Marks knew the company well; he had run its California plant back in 1989, quit and then rejoined as a member of the board in 1993 while heading another small tech firm in Silicon Valley.

At the time, Flextronics was losing money on $93 million in revenues from two factories in Asia. Although the company ranked 22nd in its industry, Marks believed that outsourcing in general and Flextronics in particular had a future. So he quit his other job and became CEO in January 1994. Within seven months, he listed the then-private company on Nasdaq, paid off the venture capitalists, announced record results, and oversaw two acquisitions.

Marks’s timing was excellent. The electronics manufacturing services industry boomed for nearly a decade, growing an average of 20 percent a year until the downturn, when it fell 15 percent. Yet Flextronics has grown much faster, 60 percent a year in the same period. It took Marks five years to build the company into the industry’s fourth largest, and three more to make it to the top, fueled in part by 78 acquisitions€¦quot;one every 45 days, on average.

A Vision of Partnerships
To see Flextronics’ speed to market, visit one of the company’s factories in Senai, Malaysia, just next to Singapore. Young Muslim women in headscarves tend five neat rows of machines spitting out about 1 million radios for the XM satellite radio company, its entire annual output. At one end, the women feed in various parts, while at the other emerge radios ready for shipment via a deepwater port 10 minutes away. “Our defect rate is less than one-tenth of one percent,” beams factory supervisor S. Parameswaran. This is one of three electronics factories in the area, producing items such as PDAs, cell phones and printers.

The Senai plant is an example of how Marks revolutionized the industry. Flextronics and other companies used to operate on a short-term basis, providing supplementary manufacturing to help tech companies pump up their output, for example, right before Christmas. Marks envisioned an industry in which manufacturing outsourcing firms would become partners with their clients, taking over the entire manufacturing process and provide services such as logistics and design. “Marks is usually two or three years ahead of everyone else in the field,” says analyst Whitmore.

Since Flextronics specializes in manufacturing, it can be more efficient than its clients, saving them money. Driven by that logic, Marks sees very little to stop the outsourcing trend. “It’s inevitable,” he says. “Companies have no choice.”

And Marks expects Flextronics to grab a big slice of any new business. Although Marks doesn’t make specific forecasts, he has said $21.5 billion in revenues is possible in a “few years.” Wall Street agrees. A consensus of analyst forecasts compiled by Thomson Financial shows Flextronics hitting $16 billion in its current fiscal year, ending March 31, and $19 billion after that€¦quot;a 36 percent growth in two years and not far from $21.5 billion.

Marks insists that’s only scratching the surface. “The global tech manufacturing industry is worth about $800 billion, and most of it hasn’t been outsourced,” he says. Japan, for example, does $250 billion worth of business in electronics and outsources very little. Flextronics, for example, gets only $1 billion from its Japanese clients, including Seiko, Epson and Casio.

Flextronics has joined the outsourcing boom in India by opening its first design center there, with a staff of 700. “I could expect 3,000 to 5,000 people there soon,” says Marks. And, in an ironic twist, Marks even thinks Indian companies could outsource to Flextronics. “In five years it’s not hard to see India as a design center and an internal market for us,” says Marks. Even Chinese companies, he says, could become clients of Flextronics.

How? Simple. Flextronics is already well-entrenched in China, operating 18 factories that represent half its business there. The company owns all of its Chinese factories except for two joint ventures inherited in an acquisition. As a result, it can manufacture in China as cheaply as any local firm. Marks argues that if Chinese companies want to compete with U.S. and European rivals, they’ll consider Flextronics’ services.

Marks often defies conventional wisdom. He was among the first to foresee that an electronics manufacturing company could go from merely doing another company’s dirty work to managing a complex relationship involving not just manufacturing but also logistics and supply-chain management. He also invested early in China and used that advantage to help Flextronics overtake slower rivals. He grasped the importance of building industrial parks to lower costs, where the factories making parts are clustered around the factory doing the final assembly, and doing it on a scale never before seen in electronics manufacturing outsourcing.

Growth in Multiple Directions
Flextronics is not only the largest company in its industry, it is also one of the best managed. It turns over its inventory 13 times a year, one of the highest turnover rates in the industry. Its return on invested capital is 22 percent, also one of the industry’s highest. The company had operating income of $272 million, a respectable 2 percent margin (in a low-margin industry) and is cash rich with $830 million on its balance sheet, a cushion against the volatility of tech cycles.

Flextronics is bound to gain simply because the sector seems certain to continue growing. Some estimates have the electronics manufacturing outsourcing industry, now at $100 billion, more than doubling by 2007. Not only will the market continue to grow, says Marks, it’s also going to spread in two directions. First, he says, it will push out into industries beyond technology, such as medicine, aerospace and defense. And, of course, there’s plenty of growth left in tech.

The second growth will be in businesses related to outsourcing, such as logistics, he says. Flextronics entered the logistics market six years ago; now it’s a $1.5 billion business. “We aren’t trying to be UPS, but our customers are asking for this,” says Marks. Then there is reverse logistics, a fancy name for doing repairs. The company did not make any money in this market last year, however, Marks expects about $100 million in revenues this year.

Another potentially profitable area for Flextronics is original design manufacturing, in which companies outsource design instead of manufacturing. The two industries, being related, have started to merge. Electronics design outsourcing companies are doing manufacturing and vice versa.

Flextronics started its design business this year and expects it to reach $1 billion within a year. Marks hopes to have a $4 billion design business within five years. What gets him€¦quot;and Wall Street€¦quot;excited about original design manufacturing is that its margins (7 percent) are higher than those in pure manufacturing outsourcing (4 percent). That means design work could deliver half of Flextronics’ profits even if it was only a third of revenues. “The key is to go from a manufacturing model to one that’s design and manufacturing,” says analyst Chris Whitmore.

As he did with manufacturing, Marks is using acquisitions to get into the design business. Last year, Marks paid $80 million for Microcell, a cell phone designer. Marks says he’ll look at about 50 companies over the course of a year and maybe buy “three or four” of them. Unlike the manufacturing industry, which is about managing factories, design is all about managing creative designer types. That difference could be a challenge, Marks admits: “We are learning how to manage this business.”

Another trend that will continue is consolidation. The top five electronics manufacturing outsourcing companies have 40 percent of the market; the top 10 have 60 percent. “There are really only 10 companies of any size,” says Marks. Within a few years, he expects that number to narrow down to eight. “We’ll be like the global auto market, with maybe eight global players,” he says. Singapore used to boast a handful of independent electronics manufacturing outsourcing companies five years ago and those have all been acquired save for one small survivor.

One change Marks can’t anticipate is his own role in the company. Worth some $100 million, on the strength of his ownership of 2 percent of the company’s shares, Marks is rich enough to retire. At 53, he’s old enough. He’s just not ready to walk away. “The transition will be when I’m in my sixties,” he says.

Marks has always run a flat organization, with about a dozen key executives for the entire company. “We’re a tight group,” he says. When in San Jose, he’ll often get together with some of them for basketball games in the company’s gym. “They most definitely don’t let me win just because I’m the boss,” he quips.

Marks hates meetings, memos or other signs of bureaucracy. “Mostly, it’s lots and lots of emails,” he says, of how decisions get made, combined with a grueling travel schedule. And Marks is well known for giving his executives the authority to move fast and make big decisions€¦quot;committing up to $2 million without his approval on new plants and equipment.

Ultimately, the biggest challenge for Marks will be managing growth and complexity. His informal style worked well when the company was smaller and less spread out. But now that Flextronics is pushing hard on so many fronts, it could risk losing the flexibility and focus that are its hallmark. Making that management shift could be the key test facing the peripatetic Michael Marks.

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