Outsourcing used to be a straightforward proposition: contract manufacturers produced the goods; logistics providers handled the logistics. Today, we find contract manufacturers advertising logistics services and 3PLs offering packaging and light assembly.

The shift in activities is due in part to the strategy of postponement that spreads traditional manufacturing activities further down the supply chain. Cell phones are a prime example. According to Theresa Metty, chief procurement officer for Motorola, the cell phone maker had more than 100 hardware configurations, four housing colors and 30 different software versions. Add to that customization for different carriers, languages, power cords, batteries, etc., and the complexity becomes enormous.

To reduce the complexity and the risks of obsolescence that go with it, Motorola has rationalized its product offerings and delays product differentiation such as adding software or customizing for the language and carrier until the last minute. In fact, industry experts estimate that cell phone manufacturers today invest more time and money in localizing and customizing phones for the consumer market then they do in manufacturing the hardware. This postponement strategy has moved traditional manufacturing activities further down the supply chain and accelerated the blurring of the lines between electronic manufacturing service (EMS) and 3PL service.

The question of which type of service provider an original equipment manufacturers (OEMs) should use is now more confusing than ever.

Outsourcing in electronics manufacturing began in the 1980s, and made huge gains in the 1990s, when expensive new technologies like "chip shooters" and wave-soldering machines became standard equipment for circuit board assembly lines. Instead of making the capital investment themselves, electronics companies realized it was more cost-efficient to outsource the work to contract manufacturers who could spread the investment cost across several customers. While OEM companies like IBM, Hewlett-Packard, NCR and Ericsson redirected their focus from manufacturing to design and marketing, contract manufacturers like Solectron took off. Solectron's stock soared, appreciating by a factor of 280 times from 1989 until peaking in October 2000. And electronic contract manufacturing industry revenues grew overall to $106 billion in 2000 from $22 billion in 1993.

In 2001, the bubble burst. Solectron stock dropped 77% from its 2000 high point. The industry shrank 13% to $92 billion by 2002, and has been challenged ever since.

The main reason for this downturn is the collapse of the high-tech sector, specifically semiconductors and telecommunications - the two largest customers of electronic manufacturing services - which created overcapacity among contract manufacturers. Add to this the decrease in profit margins for key sectors of high-tech manufacturing. When margins began to plummet, OEMs put the squeeze on their contractors to lower prices and contractors were forced into price competition with one another rather than simply competing against OEM in-house costs. The earnings before interest and taxes (EBIT) over the years for Sanmina-SCI, a leading contract manufacturer of electronics, tells the whole story.

To counteract margin erosion, contract manufacturers are exploring new territory using two distinct strategies. One approach is an effort to broaden the customer base by reaching out beyond the traditional mainstays of computer and peripherals manufacturing. The other strategy is expansion into such higher margin services as product design and logistics.

Automotive and medical manufacturing are two industries high on the list of targets for contract manufacturers. According to Joe Minville, senior director for business development for global automotive markets, Flextronics has been doing business in the automotive industry for about eight years and is now making a push for more. Solectron is expanding its business in both automotive and medical manufacturing. The company currently produces airbag control modules, car audio and navigation systems, engine and ignition control modules, X-ray equipment, ultrasound monitors, MRI scanners, surgical robotic systems, and other products. Such contract manufacturers as Sanmina-SCI and Jabil are following suit.

The other direction for contract manufacturers - one that is truly reshaping their business - is expansion into non-manufacturing services that yield higher profit margins. Many contract manufacturers have already expanded their service offerings to include product design. Operating as original design manufacturers (ODMs), they work generally in one of two ways. The ODM designs a product and offers it "off-the-shelf" to an OEM for sale under its own brand name. Or, at the other end of the spectrum, the OEM takes specifications to an ODM and negotiates for the ODM to design and manufacture the product. Between these two extremes lies a range of ODM/OEM collaboration.

Contract manufacturers are also expanding into the realm of logistics, offering sourcing, component purchasing, and such traditional logistics services as warehousing and distribution. Flextronics chief executive Michael Marks says, "Design and logistics are where the value proposition is - not manufacturing." Flextronics maintains logistics operations centers in which basic products get the finishing touches of firmware, memory, and peripherals based on customer orders. The company is banking on the vertical integration of services from production to warehousing and shipping as the wave of the future. As part of that strategy, Flextronics purchased Irish Cargo Express for $50 million in 2000, and has already grown it into a billion dollar business.

This strategy brings contract manufacturers into direct competition with 3PLs, which have a long history with electronics companies (especially those involved with computers and peripherals). To counter contractor inroads into this key market segment, 3PLs are expanding their services as well. A recent survey by the International Warehouse Logistics Association found that 11% of the organization's members offer manufacturing services, up from 2% in 1994; 74% provide assembly services, up from 69% in 1994; and 74% provide packaging services, compared to only 17% in 1994.

Many 3PLs are providing product completion activities including light assembly and packaging along with logistics. Menlo Logistics has moved into light assembly, packaging and other value-added services that support postponement. It performs these postponement duties for Hewlett-Packard inkjet and laser jet printers in North America. 3PL providers Kuehne & Nagle and FM Logistics have set up a joint venture company, Cologic, to provide product completion, product planning, purchasing, and other logistics activities to the high-tech industry in Europe. Cologic now handles final manufacturing services for HP printers in Europe, adding the software, firmware, country-specific cords, and packaging to basic printers manufactured in Asia.

One-stop-shopping has natural appeal to OEMs, but it also has its drawbacks. The biggest concern is that an all-purpose provider can easily transform into a direct competitor. Consider the case of Motorola and BenQ. BenQ is an ODM that specializes in consumer electronics and mobile phones, and Motorola is one of its largest customers. Faced with pressure from OEMs to lower prices, BenQ launched its own brand of mobile phone handsets to increase its profits. BenQ's brand has captured the second largest share of the market in Taiwan - second only to Motorola.

In fact, contract manufacturers lower the barriers to entry and make it relatively simple for new competitors to emerge. For example, Ingram Micro, a large IT product distributor, recently tapped Solectron to manufacture both branded and non-branded built-to-order PCs. So OEMs may face a whole new breed of competitors emerging out of their own supply networks.

The risk of nurturing a future competitor is not the only downside of relying on a single supplier. It is much harder to maintain competitive pricing and performance with a single supplier -- putting all your eggs in one basket has always been risky. Compare the fates of Nokia and Ericsson when in March 2000, fire destroyed a Philips plant in Albuquerque that made RF chips for mobile phones. Nokia quickly shifted orders to other suppliers while Ericsson, which had eliminated backup suppliers to cut costs, was forced to cut back production and cede market share.

In spite of these concerns, many OEMs - especially those with strong brand names and little fear of upstart competitors - continue to push for the single-source model.

A strategy that alleviates the competitive concerns associated with relying on one provider, but also provides the convenience of one-stop shopping, is for 3PLs and contract manufacturers to form partnerships to win an OEM's business. For example, Sanmina-SCI Corp. joined forces with the UPS Supply Chain Solutions division to provide services as part of a $3.6 million deal with IBM. Toronto-based contract manufacturer Celestica Inc. now partners with four 3PLs: FedEx, Exel Logistics, Kuehne & Nagel, and Panalpina. According to Paul Blom, Celestica senior vice president for worldwide supply chain management, the move was spurred by the need to provide OEMs with a fuller range of services - in other words, to deliver one-stop shopping.

As the services of 3PLs and contract manufacturers continue overlap, how do OEMs decide which suppliers to use for which tasks? Beyond the simple strategy of one-stop shopping, one place to start is with the traditional competencies. Electronics contract manufacturers have established skills at managing automation and mastering volume, while 3PLs excel at managing labor and mastering flexibility. These legacies favor a division of responsibility in which the contract manufacturer mass produces the common platform and the 3PL customizes and delivers it in or near the local market. This also has the advantage of keeping any single player from holding all the cards.

This is the first of several columns highlighting investigations from Georgia Tech's Executive Master's in International Logistics (EMIL) program. Co-author Dr. Amy Ward, together with her colleague, Prof. Anton Kleywegt and their PhD student, Jinpyo Lee, have been exploring the evolving relationships among contract manufacturers, logistics service providers and original equipment manufacturers.