November 12, 2003
Ms. Kay N. Queen
VP Planning
Byte Products
San Jose, CA
Dear Ms. Queen --
On behalf of the team at GA Consulting, let me thank you for the
assignment of developing strategic options for Byte Products. We have
done strategic analyses of a number of electronics firms and have a
staff replete with veterans of the electronic component and personal
computer industry.
It is clear that Byte Products faces these key problems described in
more detail in the attached report:
1. a return on equity of 9.4% that is about half of the industry
average for electronic components at 17.9%, according to U.S.
government data for 2001.
2. a customer base that is highly concentrated in a pair of large
customers, putting the company under continual pricing pressure.
3. a failure to develop standard products to provide additional
leverage to the company's engineering.
4. absence from the Chinese OEM and ODM market, which is a
double-edged sword for Byte Products. On one side, Byte is not
benefiting from sales to the growing OEM/ODM market in China. On the
other side, the company is not gaining the benefit of lower production
costs in China.
Given the strong financial structure of the company and its reputation
for quality, we believe that there are 3 options for Byte Products:
? an aggressive plan to diversify company sales and production.
? a strategic partnership with a Chinese or Taiwanese component
vendor, offering both companies a chance to diversify products and
customer base.
? the merger of Byte Products with a larger vendor.
GA Consulting stands ready to assist the company, Conrad Paulson and
yourself in the implementation of any of these three options -- or
combinations of options.
Best regards,
Mr. G.A. Omnivorous
Enc: Byte Strategic Analysis
--------
BYTE PRODUCTS STRATEGIC ANALYSIS
=================================
INTRODUCTION
-------------
Management recognizes, even without formal studies, that Byte Products
suffers from a narrow customer base. The customer base is dominated
by 2 large customers, which have 85% of sales, and does not include
any sales to distribution or international sales.
Even with the addition of another large computer manufacturer as a
major customer, the customer base is narrow. Further, the products
foreseen in the near future are custom or "job shop" designs that have
a significant portion of their value dictated by customers.
As a result, Byte Products return on equity has recently been $22
million or 9.4% on total equity of $234 million, far below the 17.9%
reported in 2001 for electronic components from U.S. government tax
returns:
BizStats
"Industry Profitability & Return on Equity - U.S. Corporations" (2001)
http://www.bizstats.com/corpgp2001.htm
This strategic analysis explains the causes between the
lower-than-normal earnings for Byte Products and suggests three
possible courses of action. It recognizes that the company's
reputation for quality, its engineering strength and its strong
financial position are all assets that can be used to the benefit of
the company and shareholders.
CUSTOMER BASE
-------------
Though the loyalty of two major computer manufacturers to Byte
Products provides a steady order base, it's the cause of several major
problems. Byte's lack of a diversified customer base is extraordinary
when compared to other component manufacturers.
Even Hutchinson Technologies (NASDAQ: HTCH), a Minnnesota supplier
that sells components to the highly-concentrated disk drive industry,
has more major customers than Byte Products. According to its 2002
and earlier annual reports, its sales are concentrated among 5
customers:
SAE Magnetics, Ltd./TDK... 25%
Alps Electric Co., Ltd.... 21%
Seagate Technology LLC.... 15%
IBM and affiliates........ 13%
Read-Rite Corporation........ 9%
Though Hutchinson is twice as large as Byte, it is comparable in
having a small customer base. (Indeed, the typical electronic
components company has dozens of customers, with few rarely exceeding
10% of revenues.) Yet Hutchinson's ROE was 15.0% for 2002, according
to its recent earnings statement. The prime difference is that in the
early 1980s management made a conscious decision to move away from
custom etched products (and a customer base consisting largely of two
large computer manufacturers: Control Data and Honeywell) to standard
products. Though it has since produced different products (and
considered dozens more) Hutchinson's concentration on a standard
product line has paid handsome benefits as it grew from $15 million in
sales in 1980 to $498.9 million in FY2003.
Another comparable vendor is Vishay Technology (NYSE: VSH), a supplier
of both semiconductors and passive components. Vishay's passive
component business (capacitors, resistors and inductors) produced $268
million in revenues during Q3 -- about the same size and similar in
technology to Byte's business. But Vishay enjoys higher gross margins
of 18.5% (for passive devices) for several reasons:
1. a wide mix of customers, with multiple customers in automotive,
computer, consumer and telecommunications segments
2. worldwide presence, including increased investment in production in
China and low-cost labor areas
3. standard products that can be sold via industrial electronics distribution
PORTER'S PREDICTIONS
--------------------
Byte is in a low-price, low-return situation that's predicted by Prof.
Michael E. Porter's 5-Forces model. In its simplified form, Porter
says that there are 5 things at work to determine a firm's returns:
1. Supplier power
2. Barriers to entry
3. Buyer power
4. Threat of substitutes
5. Degree of rivalry
QuickMBA
"Porter's 5 Forces: A Model for Industry Analysis" (undated)
http://www.quickmba.com/strategy/porter.shtml
Assessing Byte's position, in only one area does the company have a
strong position and even then it can considered to be strong only in
the short-run:
Supplier power: Byte is one of more than 12,400 domestic suppliers of
electronic components -- and that excludes the increasing number of
Taiwanese and Chinese manufacturers. The company has no position in
off-shore manufacturing, where an increasing amount of OEM (original
equipment manufacturer) assembly is occurring for telecommunications,
consumer and computers. Finally, the company is reliant on
custom-design work, precluding development of a patent position or
standard products to lower per-unit engineering costs.
POSITION: weak
Barriers to entry: Having long production runs with two customers is a
benefit. However, without broader distribution or proprietary
products, the company is not in a strong position.
POSITION: average, perhaps slightly weaker
Buyer power: Both major customers are aware that their orders are the
bulk of the company's sales, which has led to aggressive price
negotiations by the two computer companies. Further, their position
is so strong that Byte is now capacity-limited, making it impossible
to increase margins by adding a third major customer at this time.
POSITION: extremely weak
Threat of substitutes: Byte is providing high quality products and
services to its two customers, making switching costs a problem for
the two computer manufacturers. However, as technology advances the
customers are in control of potential integration of functions into
semiconductors or other hybrid components.
POSITION: short-term: a strong position; long-term: much weaker
Degree of rivalry: Byte is one of more than 12,000 domestic producers,
many of whom are larger, have broader product lines, and are a
worldwide presence. The emergence of new Taiwanese and Chinese
component suppliers is further increasing competition.
POSITION: weak
So, the core issue for Byte Products is how to improve its position in
all 5 areas for the long-term. But before we, let's consider major
trends in the electronics industry.
GLOBAL ISSUES
---------------
The International Finance Corporation (a World Bank investment arm)
released a study done with Booz, Allen this past June which summarized
what everyone in Silicon Valley has known for 3 years:
China will be the fastest growing area of electronics manufacturing,
capturing 77% of the growth in the next two years. Electronic
manufacturing will double in emerging markets, according to the survey
of industry executives -- and Byte Products' target market will lead
the production growth.
Computers will contribute 72% of the growth, with consumer
electronics, handheld devices, automotive electronics and
telecommunications trailing those markets. As important as it is for
Byte to diversify, it's critical that the company enter the Chinese
market by selling and possibly manufacturing.
International Finance Corporation (World Bank)
"Electronics Industry in Emerging Markets" (June 3, 2003)
http://ifcln001.worldbank.org/IFCExt/pressroom/IFCPressRoom.nsf/c4d7f6e172a844f085256a5b0078815d/f71da5e2a3aa64f085256d3a00549867?OpenDocument
Development of standard product lines allows a company to broaden its
customer base without the engineering and support resources required
for custom-product manufacture. It also would allow Byte Products to
serve many smaller customers through industrial distribution, which
itself is a $36 billion activity in the U.S. alone.
Electronic News
"Distribution Trends 2002"
http://journals.iranscience.net:800/www.e-insite.net/www.e-insite.net/electronicnews/index.asp@layout=article&articleid=CA185045&pubdate=12_2F3_2F2001
CORE COMPETENCIES
------------------
It is clear from discussions with management and customers that the
company's core competencies are:
? high quality production of electronic components
? strong engineering support for computing applications
? excellent support & customer service
It may make sense to conduct detailed research to determine what
aspect of those 3 attributes are most-important to customers; how
customers value those attributes; and how the company ranks versus
competitors. Offering better value allows a company to gain market
share, increase profitability -- or both.
An introduction to Customer Value Management (CVM) or Relative
Customer Value (RCV) is this presentation by Bradley Gale or you can
see his book "Managing Customer Value: Creating Quality and Service
that Customers Can See", Simon & Schuster, 1994, one of the early
works on RCV.
Customer Value Inc.
" Trends in Customer Satisfaction, Loyalty, and Value" (Bradley Gale, undated)
http://www.cval.com/Intro.html
RECOMMENDATIONS
-----------------
1. DIVERSIFY SALES & PRODUCTION
The company's reliance on two vendors has contributed to
lower-than-average returns on equity and put the company at-risk long
term should either of the customers shift production off-shore. At
the best, freight rates will increase the total costs to the computer
manufacturers, even if Byte Products retains the business. At the
worst, the business will disappear.
In order to strengthen the company's position in the market, it should
see how current products can be standardized and made into a product
family. Should that not be possible, the company should examine 6 to
8 products for manufacturing as standard components. Though it's
likely that only 1 or 2 of the opportunities examined will ever
contribute to revenue, it will give Byte the opportunity to analyze
various types of skills and markets.
It will also have the financial benefit of enabling Byte Products to
achieve all of the following:
? potential licensing of manufacturing -- or joint ventures
? a broader revenue base over which to amortize R&D overhead
? sales to smaller customers through industrial distribution
? a broader customer base to increase Byte's pricing leverage and
production freedom
? development of intellectual property (patents, process designs and
copyrights) for licensing or cross-licensing.
At the same time, the company should take immediate steps to establish
company direct sales in China, Taiwan and Korea -- the three
fastest-growing electronics markets.
2. JOINT VENTURE OPPORTUNITIES
While developing the capability for international sales, Byte Products
should examine joint-venture opportunities with Taiwanese or Chinese
partners. Immediate benefits of a joint venture would be:
? additional production capacity without investment, allowing Byte to
take on a 3rd computer customer
? acquisition of products for sale to current Byte customers
? broadening of Byte's distribution
? potential for investment in low-cost labor markets
A good model for this is in a recent move by the highly-diversified
Vishay, which entered into a joint venture with Walsin Technology
Vishay Technology
"Vishay and Walsin Announce Joint Technological and Marketing
Alliance" (Oct. 31, 2003)
http://www.transzorb.com/company/press/releases/nonrelated/031031partnarship/
For Vishay, it gained access to low-cost capacitors to serve consumer
and automotive applications -- and an additional location for low-cost
production with no investment on its part.
3. MERGER OPPORTUNITY
Pursuit of a merger opportunity is ranked third for a number of
reasons. Given the close involvement of Conrad Paulson's family in
developing Byte Products, it may be the least attractive option.
However, the company would be attractive for potential purchasers due
to its profitability, customer base, reputation for quality, and
opportunities to reduce G&A expenses after a merger.
GA Consulting would recommend the earlier steps of developing new
products, expanding sales and developing joint venture opportunities
before taking this step. Should those measures not increase the
operating returns of Byte Products sufficiently, company may have
already identified potential partners for the business.
Google search strategy:
"Michael Porter" + "five forces"
"electronics manufacturing" + markets
"electronic distribution" + "market share" |
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