Move up the value chain or die. That's the challenge for electronics manufacturers across Asia in 2006, as OEM customers put relentless pressure on them to constantly cut costs without sacrificing quality. To differentiate themselves from their rivals and justify prices high enough to make decent profits, Asia's electronics manufacturers must offer unique products and services.

For some, differentiation comes in the form of services performed before the product hits the manufacturing floor, such as writing the embedded software for a mobile phone. For others, it comes during the assembly process, in the form of advanced environmental testing or real-time quality reports to the customer. For others, it comes after the product ships, in the form of repair, warranty or support services. But the aim in each case is to hang on to every precious point of profit.

This mandate has resulted in a blurring of the two dominant business models in Asian manufacturing: electronic manufacturing services (EMS), in which a vendor assembles a product designed elsewhere, and original design manufacturing (ODM), pioneered by Taiwanese firms, which now design as well as manufacture products such as notebook computers for major OEMs.

"Most of the EMS players are turning to ODM" because net profit margins in simple manufacturing have fallen over the past several years to as low as 5 to 10 percent, says Prakash Vaswani, an analyst at market research firm In-Stat. He cited EMS players such as Venture Corp. and Asustek Computer, which are increasingly moving into ODM services.

Working more closely with OEMs on product design can also give manufacturers the flexibility in materials, components and suppliers they need to meet future demands for price cuts from the OEMs, says Jeffrey Wu, an analyst at market research firm iSuppli. Other EMS and ODM vendors are purchasing or merging with component vendors, he says, so they can capture some profits from the components to blunt the razor-thin profit margins in manufacturing.

Some are also providing services such as environmental testing of products or real-time reporting of manufacturing and quality to their OEM customers. EMS vendors "have all seen the outsourcing model grow, and now we're seeing them move from just taking on the manufacturing to also taking on the design of the product on behalf of their customers," says Bob Krysiak, STMicroelectronics' corporate vice president and general manager for the greater China region. "They're moving up the food chain and adding more value to their customers and to their products and services." This allows the end customer, the OEM, to focus on issues such as channel management and branding, he adds.

Such changes require STMicroelectronics, as a component supplier, to move up the value chain itself in its discussions with contract manufacturers. "As they design and make the [product] on behalf of the OEM, they may have more power in deciding" which components go into the product, says Krysiak. Rather than merely discussing logistics issues—such as how many units it can deliver, to which factory and at what price—STMicroelectronics now needs to be able to describe to the contract manufacturer the features and benefits of its processors and other components.

Even as manufacturers move into higher margin design services, Vaswani urges them to "move closer to your end customer. You may need to take up service and warranty service for your end customer, and maybe have your own direct sales so you can find out what the demand is from the market."

This struggle up the value chain takes different forms in different countries, each of which is trying to make the most of its historic strengths while overcoming its weaknesses.

Hanging over every regional competitor is China, which analysts and observers agree will continue to be the premier location for all forms of electronics manufacturing for the foreseeable future. China's dominance is guaranteed, they say, by its huge domestic market, its low labor costs (despite recent reports of rising wages) and its existing ecosystem of components suppliers.

Taiwan continues to be the dominant player in the ODM space, says Wu, "in quite a few product categories, ranging from laptop computers to handhelds to cell phones, motherboards and graphic cards." However, analysts do see Taiwanese ODMs moving more of their manufacturing to lower cost countries such as China or even India as a result of labor costs in Taiwan, which are now three-and-a-half to four times that of China.

On the semiconductor front, says Vaswani, Taiwan has "undisputed leadership in chip fabrication with companies like TSMC [Taiwan Semiconductor Manufacturing] and UMC [United Microelectronics] having almost half the Asian market and continuing to stay strong." In-Stat reports that Taiwan, after years of building up its DRAM and foundry capacity, has the highest density of fabrication facilities in the world.

Korea is "strong in memory chips and will continue to stay so," says Vaswani, "but the memory market is currently undergoing some consolidation. The margins are lower in DRAM" than in other types of chips, he says, "so it's very difficult to sustain for any of the players unless they have scale and all their customers in place."

The country is also seeing new developments on the microprocessor front. Early in 2006, Photronics announced plans for a facility in Korea to support the development and volume production of advanced photomask technologies required to produce semiconductors on 65-nanometer, 45nm and smaller production processes.

Samsung, in addition to dominating the memory chip market, is also boosting capacity of the large displays consumers crave in TVs. In spring 2006, it announced plans to invest $751 million in a new production line at an existing plant in Ulsan that will produce 3 million 42-inch PDP screens a year, bringing the company's total capacity to 7.32 million units per year. Competitor Lucky Group is also moving forward in display technology. A joint venture between LG and Royal Philips Electronics claims to be developing a 100-inch LCD display, the largest yet.

However, Krysiak says that over time, Korean consumer electronics manufacturers will come under pressure to move to China for manufacturing. He also predicts that some Korean semiconductor firms, while keeping fabrication operations in Korea, will move their more labor-intensive assembly and test functions to China.

India is known more for its call centers and other services than for manufacturing, but that may be changing. The Indian manufacturing market was only $800 million in 2005, but Vaswani predicts that it will grow to $2.3 billion by 2009. Its growth has been encouraged by the government's establishment of "electronic hardware technology parks" offering incentives such as duty-free import of capital goods, raw materials and components. So far, Indian companies are limited "to some of the more basic projects, like disk drives and memory modules," says Wu, "products with a low barrier to entry with commoditized design."

Much of the EMS growth in India is driven by foreign companies setting up plants to manufacture mobile phones. As with computer components, much of the new capacity is currently aimed at filling booming domestic demand in India. "You've got margins on the low end as low as $2 to $3" per phone, says Vaswani, so low they would be wiped out by import duties if the phones weren't made locally. But in several years, he sees global giants such as Nokia and Samsung using their new Indian assembly facilities for export as well.

The move by major contract manufacturers into development and design may mean opportunity for India. "EMS providers planning to evolve into ODM players can leverage India's low-cost engineering pool to develop design and R&D centers," according to a May 2005 iSuppli report titled "Outsourced Electronics Manufacturing in India." The presence of chip design centers run by giants such as Intel, Texas Instruments and IBM, as well as local facilities run by electronic design automation firms, provides incentives for EMSs looking to evolve into ODMs to also locate product design centers in India, the report says. It cites D-Link and Flextronics as among the "global EMS players that have already initiated efforts to evolve into significant ODM players through Indian expertise."

Western companies such as Texas Instruments have run semiconductor design operations in India since 1985, a trend that has accelerated since the dot-com crash, says Vaswani. But it was only in early 2006 that SemIndia, a consortium that will receive 25 percent of its funding from the Indian government, announced plans for India's first assembly-test-mark-pack plant. But Vaswani doesn't see India becoming a semiconductor powerhouse to rival Taiwan, for example, because it lacks the reliable supplies of clean water and power needed for semiconductor manufacturing.

Wu says Indian manufacturers will need to significantly increase their technical skills before they are able to climb the value chain by offering service and support as well as product manufacturing. At this point, he says, "they're just trying to develop and grow their overall business model." Vaswani, however, sees brighter prospects for Indian-based services, based on the region's success in back-office service and support operations.

Singapore is headquarters to Flextronics and Venture Manufacturing, but each of those EMS vendors does much of its actual assembly work in nearby, lower cost countries, says Wu. While each is a giant player, neither saw much revenue growth in 2005, says Wu. "All of the contract manufacturers, whether they are Taiwanese or Singaporean, are shifting their manufacturing capacity from their home countries to lower cost countries such as India and China," he says.

Singapore is also home to Chartered Semiconductor Manufacturing, which operates five fabs there. But Vaswani says Chartered has had trouble competing with Taiwanese giants such as UMC and TSMC because the island state "doesn't have that low-cost advantage." Even the major disk drive and storage vendors, which have long had major operations in Singapore and Malaysia, have been moving manufacturing into lower cost countries in the region, he says.

Nevertheless, Singapore's Economic Development Board claims that Singapore produces 10 percent of the world's semiconductor wafers, is home to four of the world's top 10 "fabless" IC design companies and produces 25 percent of the global market for retail point-of-sale impact printers. Leading fabless semiconductor company Xilinx has announced plans to invest as much as $80 million to expand its manufacturing capacity and operations in Singapore.

The board also pointed to an $850 million investment in new manufacturing capacity by hard disk media manufacturer Showa Denko and a $170 million expansion to a glass magnetic disk production plant by Hoya Magnetics. Overall, the board claims that Singapore supplies 25 percent of the world's disk media and that its manufacturing capacity is expected to double by 2008. (Staking out another growing, although nonmanufacturing, market, the board also pointed to the launch of Singapore facilities for a number of gaming and animation companies.)

One pressing need for both EMS and ODM companies, Vaswani says, is to gain a better understanding of the needs of not only the OEMs they sell to, but also the consumers that buy the finished products from the OEMs. "Most of the time, these players...don't have a very good idea of the road map of the OEMs, so they don't know how much demand is coming. They end up, many times, with a glut of inventory," he says. "You need to have a very clear road map of the customer, in terms of demand, and also have an idea of what the end customer needs."

Whatever the strengths, or weaknesses, of individual companies or individual regions are, manufacturers of all stripes "need to create a position not just of low-cost manufacturing, but of service and quality," Vaswani says. "Tomorrow, they're going to have competition from Mexico and Russia, not just Asia."

Robert L. Scheier is a contributor to Electronic Business.