If you've determined that your products must adhere to Europe's Restriction on Hazardous Substances (RoHS) but you're not quite there yet, you have two choices: pray for an extension on the July 1, 2006, compliance deadline or break out your checkbook.

"The industry wide effects of RoHS include the increased cost of equipment, training, component unit cost, materials pricing, inventory and write-offs and the risk of poor execution due to complex product transitions," says Steve Delaney, CEO of EMS provider Celestica. Delaney says the biggest impact will be on companies whose products must comply with RoHS but are either doing nothing, hoping for a change in the legislation or planning to abandon the European market.

When an industry is required by legislation to turn over every component, assembly, product and process, the effects are going to be huge, he adds. "At least one source has said this transition will cost the industry $20 billion over the next decade. Others say this estimate might even be a little conservative."

As major providers of outsourcing services to the global electronics industry, EMS vendors such as Celestica, distributors and other supply chain companies will handle the bulk of RoHS-compliant components and materials channeled around the world. These companies must also provide documented assurance that no banned substances—including lead, cadmium or mercury—were used in manufacturing, assembly or production. If something gets by them, it's their OEM customers who will take the heat.

Like many others in the supply chain, Celestica has shelled out millions of dollars to comply with the edict, which currently affects only Europe-bound electronics. Few of the companies interviewed for this article would be specific about actual costs—most don't talk about environmental and similar investments, for competitive reasons. But research and consultancy group Technology Forecasters Inc. (TFI) estimates that individually, RoHS compliance will cost OEMs 2.5 percent to 3 percent of their cost of goods sold (COGS). (See below, "Costs to OEMs"). Geoffrey Bock, an engineer with compliance testing/certification group TUV Rheinland of North America, believes that the cost is even higher: 3 to 5 percent of COGS.

RoHS has generated a fair amount of grumbling as the industry prepares for the July 1 deadline: even though many companies don't sell into the European Union, they are feeling the effect of the transition (see below, "You think you're exempt? Think again"). Even companies that have embraced the initiative admit they've incurred costs they'd have preferred to avoid. "There are two types of expenses: those we predicted we'd see and invested resources in and those we didn't predict," says Dan Shea, chief technology officer at Celestica. "The latter we could have done without."

Still, smart companies are trying to balance the downside with the upside: Many are offering new RoHS-compliance services—such as "green" manufacturing or bill of materials (BOM) analysis—they expect to charge a premium for. They also expect to attract new customers whose own compliance efforts may be lacking. Early adopters of RoHS stand to benefit from an 11th-hour scramble as OEMs realize—belatedly—that their solders contain lead or that they can't get the components they need. So how are supply chain companies turning lemons into lemonade?

First, the expenses. Costs vary, depending on the role a company plays in the supply chain. Chip maker Fairchild Semiconductor, for example, spent less than $1 million to convert, because its efforts were focused on identifying, developing and qualifying lead-free plating material that can be used on existing manufacturing lines. EMS providers, on the other hand, have had to invest in manufacturing equipment to accommodate the requirements of lead-free solders, including higher melting temperatures, new fluxes and hotter ovens. Price tags for a single piece of manufacturing equipment, such as a wave solder machine or a new solder vat, can run in the millions of dollars.

Celestica began its RoHS preparations six years ago, says Shea. "A change of this magnitude was a big deal, so we knew we had to start early," he says. "We knew there would be a few years of evaluating different solders and fluxes. Then we had to evaluate how those affected the rest of the food chain—are we getting reliable solder joints, are we wounding other parts, does our equipment have the capacity it needs?" The company, he said, had to set aside "millions of dollars" for this process assessment.

Celestica began upgrading the equipment at its manufacturing sites during 2004 and 2005. Many of its wave solder machines had to be completely replaced. "You can't mix and match leaded and unleaded solders," says Shea. The company also had to upgrade or replace the ovens that harden solders onto printed circuit boards. "Anything that was new we purchased on the assumption that we needed the higher thermal capacity—anything three years or older needed upgrades." Across the globe, Shea estimates, Celestica spent millions of dollars on equipment upgrades.

Distributors didn't face much of an equipment issue: Their pocketbooks were hit hardest by investments in IT. Component distributors are effectively the warehouses of the electronics industry, and as such they stock and carry data on hundreds of millions of SKUs. Their problem? Some suppliers are identifying their RoHS-compliant devices by assigning them completely new part numbers. Some are not—leaded and unleaded devices share a part number but are differentiated by a symbol, increasing the risk that the products can be mixed up. Compliant and noncompliant parts have to be separated, for several reasons: storage (unleaded components are sensitive to humidity), compatibility (many leaded components cannot withstand the high melting temperatures of lead-free solders) and liability (OEM customers can be found noncompliant if leaded parts slip through).

Like many EMS companies, distributors have dropped a bundle on systems that will enable them to manage inventory by renumbering parts: taking a supplier's part number, changing it for internal use and then changing it back again when a customer orders that part. NewarkInOne, which has an average of 185,000 part numbers, has spent "millions" on IT, according to executives.

Distributor Avnet has spent millions as well, says Jim Smith, senior vice president, warehouse and distribution worldwide, at Avnet Logistics. But Smith warns that the supply chain's biggest expense may be yet to come (see below, "RoHS Implications for the Supply Chain"). Suppliers continue to produce both leaded and unleaded parts, because certain segments of the electronics industry are exempt from RoHS. A sudden shift toward widespread RoHS adoption could leave the supply chain sitting on billions of dollars' worth of leaded parts that nobody wants, forcing companies to take huge write-downs on this inventory. "There might be billions of dollars' worth of pending liability in this inventory," Smith warns.

Toshiba America Electronic Components (TAEC) has already been transitioning customers to lead-free components. "Even with crystal-clear communication and close collaboration, these customers ended up with excess or redundant inventory," says Stephen Marlow, executive vice president at TAEC. "For two of our customers, that represented a loss equal to 5 percent of their revenue," he says (see the online commentary at www.eb-mag.com).

All of these companies have spent money on training employees to ensure compliance—in some cases, by visually inspecting parts. At Solectron, for example, workers involved in materials management are trained to differentiate RoHS-compliant and -noncompliant parts through part numbers, symbols and other characteristics. "I'd say from a human resource standpoint, we have 200,000 man-hours invested in RoHS," says Solectron's Castro.

TUV Rheinland's Brock says many companies have had to increase their workforce simply to deal with RoHS: NewarkInOne CEO Paul Tallentire concurs. "We have put extra people into our warehouses to go look at the items-we are not taking the suppliers' word that something is lead-free," he says.

And at Celestica, customer-facing employees are learning how to educate customers on the impact RoHS will have on Celestica's costs and pricing. So far, most companies are reluctant to pass RoHS-related costs on to customers, even though compliant motherboards, for example, will cost between $4 and $5 more per unit to manufacture. Experts say that at some point, price hikes may be inevitable.

Brock and others say service providers that are ahead of the game can see green by being green. Celestica, NewarkInOne and other companies expect to recoup their compliance costs and possibly even profit from the effort. "Many small and midsize OEMs don't have the resources to invest in RoHS compliance," says Brock. "They are going to turn to third parties."

EMS companies and distributors, for example, are providing BOM "scrubbing," a service that reviews a company's BOM, identifies noncompliant parts and recommends or procures alternatives. Companies already receiving such services from their partners probably won't see a price increase, but new customers will likely pay a premium.

"EMS companies are charging for these services, and they should charge for them," says Pamela Gordon, principal at TFI. "The ones that are the best at these services will get the revenue."

Shea and Castro report that they've already seen an incremental increase in business and that requests for RoHS-related services are on the rise.

NewarkInOne is not yet charging for such services but hopes its offering will attract new customers. For example, the distributor is going to great lengths to inspect and test incoming components, keeping a supplier track record. Suppliers with a high frequency of errors—parts marked compliant that aren't, parts that are mislabeled or mismarked, documentation that is inaccurate and even parts that fail chemical testing—are deemed "high-risk."

"We have put extra people into our warehouses to go look at the items—we are not taking the suppliers' word that something is lead-free." —Paul Tallentire, NewarkInOne

EMS companies also expect to benefit from front-end services such as design. Solectron, for example, is providing "design for environment" services. "We have teams all over the globe to help customers with the transition to RoHS: We will assess their current products as well as designing in changes," says Castro. There's "big money" to be made for companies that can help OEMs design environmental compliance into their products at the front end, not just in component selection but also in figuring out how to maximize the product's reuse and recycling value, according to TFI's Gordon.

"From our perspective, it is a strategic advantage for us to engage with an OEM at the point on which we can have the most influence—the supply chain—and there's a good chance we can secure that company's manufacturing business as well," says Castro.

But the real money, experts says, will be made on industry procrastinators—companies that realize belatedly that they have to be RoHS-compliant. "There are a lot of companies that don't outsource right now but don't want to have to go through the RoHS compliance process themselves," says Shea. "We think they'll outsource."

In fact, says Gordon, outsourcing may be less costly than do-it-yourself compliance—OEMs that already outsource have spent less, about 1.8 percent of COGS, on RoHS. Other companies may discover that their current EMS supplier isn't RoHS-ready and will switch to one that is.

For some companies, ROI won't come in the form of new services or higher prices but from increased efficiencies. Chip maker Freescale, for example, has culled its product portfolio and isn't manufacturing as many devices as before. As the company began planning for its RoHS-conversion inventory needs, it pinpointed products with waning demand or other undesirable characteristics. "RoHS gave us the opportunity to identify those products that should not have been in the portfolio to begin with," says Griffen Tejgeman, program manager for Freescale's corporate RoHS effort. Additionally, as the company began to examine the materials it was using to manufacture its semiconductors, it found that it could consolidate some of these purchases. And revising its database helped identify some past input errors, which it has since corrected.

And finally, some companies are just looking on the bright side, says Ken Stanvick, principal of consultancy Design Chain Associates. For example, the RoHS requirement that companies state the chemical makeup of their product has prompted many companies to unite disparate computer systems on one platform so such information can be aggregated and tracked.

"Many of these businesses grew through acquisition and didn't take the time to get their act together," says Stanvick. "Executives are realizing, 'If I have to go into four divisions and understand how four different businesses are operating and put in different compliance procedures for all four businesses, it's going to cost me money.'" Smart companies, he says, are looking for best practices and implementing them throughout a single system.

Getting everybody onto a single platform also provides the opportunity to find redundancies and eliminate them. "Some of these companies found they were purchasing the same part under four different part numbers," says Stanvick. Consolidating such purchases usually leads to volume discounts. Some companies are reducing their vendor lists, weeding out those that have had quality or delivery problems in the past. "If you have a supplier that won't provide materials disclosure information, I'd be getting a new supplier," says Stanvick.

Companies interviewed for this article say that right now they don't have enough data to assess whether their compliance efforts will add to the bottom line. "We expect to have a better handle on this as we get deeper into 2006," says Shea.

However, although RoHS-compliance cost assessments to date have been largely internal, Wall Street is beginning to pay attention to the impact the edict will have on the industry. In July 2005, Credit Suisse First Boston reported that although "companies stand to incur significant costs developing regulatory compliance over the next 12 months…Celestica and Jabil Circuit stand to benefit from the initiatives because both companies have been incubating lead-free modules since the late 1990s and now boast lead-free SMT lines in multiple facilities globally." CSFB reiterated "outperform" ratings on Celestica and Jabil, with respective target prices of $16 and $34.

But Shea, Delaney, Tallentire and others say any RoHS-related upside is really beside the point. Although some electronics companies are treating RoHS compliance as voluntary, smart companies are treating it as a fait accompli. "This isn't just an EU thing," says Brock. "China is considering similar measures, as are most states in the United States."

Ultimately, he and others say, the electronics industry is going green, and everybody will have to shell out for compliance at some point. Rather than looking at the cost of compliance, companies should consider the cost of noncompliance. "The cost of not complying with RoHS is unthinkable," says NewarkInOne's Tallentire. "The cost in terms of customer service problems and the cost of losing customer relationships are simply unimaginable."

Do you think the RoHS issue has been over-hyped and the transition to green will go without a hitch? Send your thoughts to feedback@eb.reedbusiness.com.