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Hon Hai Precision

You Are Your Own Greatest Enemy


You Are Your Own Greatest Enemy


When it comes to "destruction" Hon Hai has no match. The company attacked the supply chain with low prices and forced the world's top brands to cry uncle and place orders. It is now up to CEO Terry Gou to guide Hon Hai to its next breakthrough.



You Are Your Own Greatest Enemy

By Elaine Huang
From CommonWealth Magazine (vol. 558 )

"In the process of consolidation, the supply chain concept no longer applies; rather a global value chain concept has taken over. Every company should have a position globally that creates value for itself, or risk being eliminated."

These words were spoken by Hon Hai Precision Industry Co. CEO Terry Gou at the 2003 Asia Technology Forum.

That year, Gou presided over successive lightning quick acquisitions across Scandinavia, South America and Asia, becoming Taiwan's first business chief to complete mergers on three different continents within a single year.

With that flurry of action, he ascended to the top of the global electronics manufacturing services (EMS) realm.

A decade later, Hon Hai now has annual turnover of NT$3.9 trillion, more than the combined revenue of Taiwan's top 10 manufacturers. So big is the company's reach now that four out of every 10 consumer electronics products are made or assembled by Hon Hai.

Terry Gou has proven Hong Hai's position in the global value chain, making the entire world's technology sector reliant on it to one degree or another.

Over the last two decades Hon Hai has collected the top honors in CommonWealth Magazine's "Most Admired Company Survey" 12 times in the computer sector category, also distinguishing itself for its performance in the "International Operations" indicator.

So how did Hon Hai Precision make its way to the EMS throne?

Professor Ji-Ren Lee of the National Taiwan University Department of International Business, describes the Hon Hai model in a nutshell as "a sort of rapid imitation innovation."

Tracing the arc of Hon Hai's expansion over the past 20 years, the company's ascent has moved from computer cases and barebone motherboard assembly toward system assembly.

Gou invariably chooses to enter markets late, mounting a rapid frontal assault by undercutting market prices. As Hon Hai gets stronger, it eliminates competition while increasing customer dependency.

 "When prices drop to where there is no profit to be made, that's when Hon Hai starts making money," remarks Kirk Yang, director of Asia ex-Japan technology hardware research at Barclays Capital.

Forward Consolidation, King of Connectors

The keystone of the Hon Hai empire was a little connector.

When the personal computer industry took off in the early 1990s, driving demand for parts and components, Gou focused on the production of connectors.

Like a computer's nerves sending signals around the machine, connectors must be highly precise. And molds are the key to achieving precision in the manufacturing process.

Gou, who got his start by making plastic injection molds, purchased equipment from Japan and threw himself into the development of new molds, even more aggressively securing international patents for connectors.

American and Japanese manufacturers held a stranglehold over the global connector industry at the time, leaving computer assemblers no choice but to source expensive connectors from those major international makers.

But Gou developed a strategy to beat the international suppliers' model of selling one connector at a time, bundling connectors and selling them together to assemblers. "The cheapest way is to sell them in sets. Assemblers realized that Hon Hai's prices were cheaper than American suppliers and jumped ship," relates a former Hon Hai employee.

Using disruptive pricing, Hon Hai steadily climbed the ladder to become Asia's largest connector manufacturer.

Hon Hai's emergence acted as a counterbalance in the connector market, breaking the stranglehold long held by US and Japanese firms.

Getting into connectors established the core competence Gou needed to launch his EMS enterprise, and developing and producing molds provided the foundation that subsequently facilitated Hon Hai's vertical integration.

Every Customer an Adversary

Gou has previously observed that there are two types of integration in manufacturing: one is developing competition with subcontractors, known as forward integration; the other type, developing competition with customers, is called backward integration. "There is greater room for development with backward integration," he says.

In 1995, with turnover exceeding NT$10 billion, Hon Hai undertook the most critical battle that would eventually propel it to the top of the EMS realm, as Gou went back in the supply chain into casing production. It was also Hon Hai's first step into the world of backbone computer systems.

The next year, with orders for iMac casings secured, Gou set his sights on getting orders for US$499 computers from Compaq, then the top name in PCs.

To break into Compaq's supply chain, Gou flew to Houston every two or three months over a period of two years to pitch Hon Hai to Compaq's headquarters and eventually got his hands on his first blueprint.

At that time, construction was still undergoing on Hon Hai's Longhua facility in Shenzhen, China. Nevertheless, Gou braced himself and went after orders first before having to contract the production out to other casing manufacturers. In the meantime, work was proceeding at the Longhua facility, and when it was ready to go he brought all the orders over to his own casing production facility.

With a handle on external PC cases, Gou's ulterior objective – the biggest headache of the PC supply chain – finally emerged, and Hon Hai went into the "barebone" assembly business.

There are 11 levels in the computer assembly process, and barebone refers to partial assembly directly preceding completion of computer system assembly. Hon Hai would assemble the PC together to a certain point before handing it off to local companies like First International Computer (FIC) and MiTAC for system assembly. This type of service offered greater added value.

Gou knew well that only by constantly becoming bigger could he attain a competitive price advantage and retain customers by strengthening services.

Hon Hai's backward integration into the barebone stage set the supply chain abuzz with speculation that Terry Gou would end up moving into system assembly and motherboard manufacturing to become everyone's competitor.

Just as the notebook computer sector was taking off, Hon Hai got into the motherboard business, marking another backward integration gambit for Hon Hai and confirming the supply chain's greatest fears.

Hon Hai exceeded NT$100 billion in turnover for the first time in 2001, surpassing Taiwan Semiconductor Manufacturing Co. (TSMC) to become Taiwan's biggest manufacturer. This marked a quantum leap for the company compared to where it was five years before when it went into casing manufacturing and had annual sales of NT$10 billion.

Designed in One Place, Manufactured in Three

More integrated than ever, Hon Hai in 2000 entered a period of "parts- components- barebones systems- systems" integration, establishing a comprehensive manufacturing platform and steaming full speed ahead toward becoming an EMS empire.

Apart from PCs, in order to win orders in the mobile handset and telecommunications realm, Terry Gou acquired Nokia's OEM casing manufacturer and Motorola's plant in Mexico, and spent NT$30 billion to acquire Acer Computer subsidiary Ambit Microelectronics.

"The classic tactic for EMS manufacturers is to get orders by purchasing a plant, which amounts to taking over an entire force," relates Shang-Jen Kuo, vice president of TaiSol Electronics.

Venturing into system assembly, Hon Hai also counted among its customers the top four PC makers along with Apple and Sony. Whenever Gou went abroad, the bosses of other major technology producers got nervous, instructing their regional managers to keep track of his movements for fear that they would be the next one to lose orders.

Hon Hai ascended to the top of the EMS heap in 2004 when it surpassed previous leader Flextronics International. Hon Hai also went all out to compete against the supply chain, manufacturing parts, cases, and motherboards. It was as though customers were buying parts from Hon Hai and then Hon Hai was assembling them for free.

Gou established his "designing in one place, manufacturing in three" model, setting up warehousing dispatch centers near his customers to help reduce the volume of materials they needed to stock. That way, deliveries could be dispatched directly from Hon Hai's warehouse.

"Hon Hai's prices are low, with rapid delivery times and close proximity to the end market. Major international manufacturers are left with little choice but to place their orders, and can only keep doing business with Terry Gou," admits a supply chain executive.

Connectors, heat sinks, motherboards, and system assembly plants in the supply chain have all become "Hon Hai victims." Smaller businesses have been either marginalized by industry competition or squeezed completely out of the market.

Despite making enemies of everybody, Hon Hai became Taiwan's first trillion Taiwan dollar enterprise, manufacturing or assembling on a contract basis a full 40 percent of all consumer electronics products in the world, which is akin to controlling the manufacturing lifelines of all the world's major brands.

"If he had remained in parts manufacturing, Gou would never have reached this sort of milestone," offers an executive at a parts manufacturer.

Hon Hai's Next Move?

Now with annual sales of nearly NT$4 trillion, Hon Hai is facing a growth bottleneck, while competitors like Pegatron are gradually grabbing a bigger share of Apple's orders.

Gou is aggressively searching for new sources of growth, such as obtaining a 4G license to penetrate the telecom sector. Gou also has his sights fixed well beyond Taiwan to the vast realm of emerging markets.

Pointing at the Cloud and Internet of Things roadmap, which encompasses education, home control, health care, e-commerce, and the automotive industry, Gou told shareholders gathered at a shareholders meeting of his ambitions to move into high-tech services. However, no discernable progress has been made in this area to date.

"If they don't move into these areas, the company has no future. Gou still has the chutzpah to keep searching for the company's next opportunity," says Robert Cheng, director of Merrill Lynch's Taiwan research department.

Terry Gou has completed his journey to become the king of electronics manufacturing services. In the the future, his greatest challenge will remain noone other than Terry Gou.

Translated from the Chinese by David Toman