Quanta’s Leap

The contract manufacturers that move to China aren't simply cutting costs and raising productivity. They're moving up the value chain -- and forever changing the way that big brands run their businesses.

The result is a natural erosion of margins. Gross margin from designing and manufacturing notebooks used to approach 20 percent, but in the last two years alone, Quanta has seen it decline, from 12.5 percent in 2001 to 8.8 percent last year. Morgan Stanley puts it at 7.1 percent for both 2003 and 2004. While Li admits that he is having difficulty keeping the margins up, he insists: “Of course I’ll try to sustain it, but we prefer to focus on the net profit, instead of the margin.”

Then again, that too, is in question. Since gross margin plays a huge role in profitability, Quanta’s struggle in upholding it shows in its declining profit growth. Credit Suisse First Boston (CSFB) estimates its net profit to grow 22 percent this year to NT$13.2 billion (US$386 million), 20 percent in 2004—and 4 percent in 2005. This is all the more stark given that its chief competitor, Compal, is doing well on both fronts.

Compal’s gross margin was steady at 8.7 percent from 2001 to 2002, when the company won contracts, most notably from Apple Computer, at Quanta’s expense. This year, this is even expected to grow to 9.5 percent, according to Lehman Brothers, one of the many research houses that consider Compal to have a better margin management strategy. Its net income, too, will sustain a healthy uptrend, growing 12 percent this year, 15 percent in 2004, and 14 percent in 2005, according to CSFB.

Investors have taken notice of the underdog. Once a second fiddle to Quanta, Compal shares are now high-flying. Year to date, share prices have risen 65 percent, compared to Quanta’s 62 percent. “Between the two companies, we feel that over the past six quarters, Compal has managed to meet their guidance, in terms of margins and bottom line, and in most cases, even exceeded them,” says Su of UBS. “Quanta, on the other hand, has in the past had a few more surprises, like last quarter when the margin was lower than expected.”

The China Factor

How Compal managed to sneak up on Quanta is a validation of the textbook logic of going to China. “We were able to generate high margins because we went to China sooner than our competitor,” says Gary Lu, CFO of Compal. Until late 2000, Taiwanese notebook manufacturers were forbidden from producing in China. But since Compal started out as a producer of CRT monitors, its move to China began as early as 1997, says Lu. Because of this, the company was able to experience how to deal with bureaucracy, and more importantly, build relationships with suppliers.

By the time the ban was lifted, Compal was able to begin assembling its notebooks in China in no time—the first quarter of 2001. In contrast, Quanta only started its move to China early last year, and production started in July. This has two implications. First, Compal’s gradual move to China was cost efficient. “Compal decided on an open system: if you want to be my supplier in China, you have to shift your production to China,” says Tseng of Merrill Lynch. Lu claims to have spent a mere US$60 million since moving to China in 1997.

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