Outsourcing electronics manufacturing. (Electronics).

Contract manufacturing of automotive electronics received a big endorsement this spring when the French auto parts maker Valeo agreed to enter into a significant manufacturing partnership with Jabil of St. Petersburg, Florida -- an electronics manufacturing service company. The contract includes

a three-year parts supply agreement between the two companies. To implement the agreement, Jabil will acquire Valeo's electronics manufacturing operations in Meungsur-Loire, France, and those in Wemding, Germany. And further, Valeo will transfer to Jabil production of switches, detection systems, and printed circuits, which Jabil will produce at its own plant in Chihuahua, Mexico.

By turning manufacturing of these products over to Jabil, Valeo will be able to concentrate more fully on design and development, so it can better distinguish itself from the competition. This new-found ability to focus on product development is a key to profitability and will allow both businesses to work to their strengths to produce products that are better than the competition's.

Top tier suppliers receive two other major benefits when they use outside manufacturing. Most important, top tiers can walk away from some significant major fixed costs, especially the cost of capital associated with financing manufacturing facilities, tools and equipment. Fixed costs are especially difficult to swallow when sales are cycling down. Material costs, which are variable, can also be brought down, given the clout of some of the largest contract manufacturers with their suppliers.

Another big benefit that comes with using contract manufacturing is the opportunity to reduce labor costs. Top-tier suppliers can be more competitive if they can step away from high priced union labor. As part of its acquisition of Valeo's Meung-sur-Loire facility, Jabli will take over employment contracts of all 750 people who work there. Besides supplying the parts, contract manufacturers often purchase their customers' manufacturing facilities and take on their employees. Officials from labor and government scrutinize such arrangements.

A few months prior to the outsourcing announcement issued last March, Valeo Electrical Systems Inc. (VESI) field for voluntary reorganization under Chapter 11 of the US bankruptcy code. Part of the deal will transfer VESI circuit board manufacturing done in Juarez, Mexico to a Jabil facility in Chihuahua, Mexico. The deal with Jabil is likely part of the restructuring that is following Valeo's Chapter 11 filing.

The contract adds about $300 million worth of annual sales to Jabil, bringing its total automotive electronics sales up from $215 million in 2001 to at least $515 million in annual sales, once Jabil begins manufacturing the Valeo products this year. Jabil's current automotive customers include Visteon and Johnson Controls Inc. Besides the new business with Valeo, Jabil is close to a deal with Delphi to handle some of their manufacturing.

Despite the promise of outside automotive electronics manufacturing, only five percent of Jabil's sales in 2001 came from the automotive industry. The vast majority of sales come from the computing and communications industries. Compaq, Hewlett Packard, and Nokia are among the company's largest customers. Jabil sales were $4.3 billion in 2001 up 21 percent from the prior year.

In the first quarter of 2002, Valeo had sales of $2.3 billion, down 5 percent from the first quarter of 2001. In Q1 of 2002 net income was 0.8 percent of sales compared to minus 6.6 percent of sales in Q1 of 2001.

The deal between Valeo and Jabil should lead to similar arrangements as other top tier suppliers realize the benefits of outsourcing electronics manufacturing To decide if contract manufacturing is for them, top-tiers must think through their competitive strategies and determine which are their core competitive strengths.

PAUL HANSEN is a strategy and market research consultant ant in Rye, N.H. He publishes The Hansen Report on Automotive Electronics, a business and technology newsletter. [www.hansenreport.com]