Working Harder and Smarter in Asia
By Gary N. Davis
Managing Director
Davis Consultants Asia Sdn. Bhd.
In late 1997 the disk drive industry began a cyclical descent into an abyss of red ink, plant closures, employee layoffs, and consolidation. Was this a repeat of cycles we have witnessed in the past? Likely not. The familiar cycle of boom-to-bust-to-boom has not been evident; at least insofar as profits are concerned and the series of consolidation announcements that began three years ago seem to continue. Why is it different this time? This article will explore that and how, the difference has led to a remarkable shift of strategic focus on the factories in Asia where over 90% of disk drives and much of their major components are manufactured. We will also discuss some of the initiatives, and early results of that focus.
Worth noting is that the market has had unit growth demand throughout the last three years. So if demand had not appreciably dropped off, what did happen? One answer can be found in a simple statistic. In the eighteen month period preceding September 1997, the industry started, or finished, building over 1.5 million square feet of new factory space to make disk drives, heads, or media. All of this capacity was installed in Asia. In hindsight this clearly led to excess capacity and resulted in levels of competition that weighed heavily on profitability. In an article in Business Week magazine dated February, 1998 one writer was prompted to call the industry's situation as being in the midst of a "profitless plenty".
Much of the new capacity was built by newly emerging Asian based competitors such as Samsung, Fujitsu, Toshiba, and Hitachi as they ramped up production in Southeast Asia, following, at last, their U.S. counterparts. Their resulting gains in market share were vexing the confidence and the operating statements of U.S. firms that had traditionally dominated the market. They brought new capabilities to the game, especially in manufacturing, which strengthened their hand in the market. Specifically they had advanced experience and knowledge of automation, a crucial and strategic technology to disk drive makers today as parts have become smaller, and more susceptible to damage and contamination. They had this experience base simply because they made the early commitment to the capital and development programs necessary and they did not make early commitments to locate in Southeast Asia, preferring a strategy of keeping the technologies close to home where they could be well nurtured by their creators.
There have been other factors in the prolongation of the retrenchment in the industry. Perhaps most notable was the emergence of the so-called sub $1K personal computer. Led by companies like Dell, PC suppliers began to cater to the first time internet users with low cost PCs. They were abetted by lower costs of components resulting from the Asian economic meltdown that had commenced with the July, 1997 meltdown of the Thai Baht. But they also found a willing partner in the disk drive supplier base eager for market share. The result was a large shift in demand to the lower cost segment of the disk drive industry, a difficult segment to record high profits in. To exacerbate the demand curve, Dell, and other PC suppliers placed metrics on the disk drive makers for performance in supply response (just-in-time) in order to successfully pursue their own build-to-order, direct business models. Dell called this "virtual integration". In a recent speech Michael Dell revealed that his company operated with just six days of inventory. The various disk drive suppliers were clearly put in a position of accepting the challenge or moving out of the way. There was never any choice. One disk drive operations executive located in Asia told us "the importance of the rapid growth of the internet and the evolution of the build-to-order direct business model cannot be understated. For those of us in the supply chain it fundamentally altered the landscape. Demands were made of us that were unheard of just a few quarters before. It placed enormous strain on systems that had been in place for some time, and would clearly no longer be sufficient. We had to change." To illustrate this anecdotally, we spoke with an executive at a disk drive manufacturer on a Tuesday morning when he shared that he was readying a furlough of part time personnel due to a lack of factory orders. By the following Monday he was canceling the planned furlough and seeking additional workers.
In addition to responding to a new way of doing business, the disk drive industry added some of its own fuel to the fire by virtue of exemplary performance. In an effort to remain competitive, virtually all the disk drive makers poured enormous energy and resources into their development programs. The result has been an acceleration of the areal density of disk drive recording by 100% or more over the last 24 months. Product cycles shortened, and the race to be the first-to-market of higher density products still rages at a higher clip then ever. The first-to-market position is critical as the winner could lay claim to slightly more profit margin before the rest of the pack caught up and forced prices down. This could often make or break the profitability of a new model range.
The impact on the disk drive factories in Asia was enormous. In the past, these factories were receivers of a lateral pass of product designs and instructions from their respective design centers based in the United States or Japan. Often, pilot build programs were conducted in the design centers, and the manufacturing personnel would receive training in a real manufacturing environment before the pass off to their home factories in Asia. A given program, including process steps, assembly procedures, test methods, servo write specifications, and, in many cases, the equipment required, would be handed off with a set of instructions. Now, with compression of schedules, there was little allowance for the time that was previously involved for new product transfers. Compounding the tasks, the leaps from product to new product were greater in scope, often involving more complexity at every step of the manufacturing process. As an example of this schedule compression, one manufacturer arbitrarily mandated that the schedule for qualifying new heads and media for any given program had to be reduced from 14 weeks to 6 weeks. Needless to say the mandate did not mention anything about reducing the level of surety required regarding the performance of the heads and media selected. As a result of all these factors a great revamp of operational strategies has been underway in the disk drive industry.
In early Spring of 1999, Bill Watkins, President and COO of Seagate Technology, made a remarkably candid presentation to the audience at IDEMA's Diskcon-Asia symposium. In it he talked about Seagate's vision and the program Seagate was internally calling "Factory of the Future". His presentation discussed a study of the market undertaken by Seagate which concluded that the foremost factor in disk drive buying decisions was price. Finally the cat was out of the bag. As exotic and as challenging as the technology was, the industry's customers bought primarily based on cost. Furthermore there was little else available to differentiate between competitors. Watkins went on to reveal the high points of Seagate's plan to make itself over. Not surprisingly these points were focused on achieving the lowest possible cost to manufacture and depended heavily on higher levels of automation, a distancing from vertical integration towards a more virtual business model, a stepped up supply line management program, and a move towards a common platform in which components for all product lines could share common features. By implementing the latter, the same heads and media could be used across the product line to achieve scale and process uniformity. He underscored that the highest levels of quality were a given, and could not be sacrificed. Seagate would implement a sweeping Six Sigma program not only corporate-wide but throughout its supply chain as well.
Watkins' revealing talk publicly signaled a major re-focus on the way disk drives were made. The results have been remarkable. In a recent discussion with Michael Stears, Senior Vice President of Seagate's Asian disk drive operations, he pointed out that in the calendar quarter ending July 1, 1998, Seagate had averaged 74 units shipped per employee. By Q1, Calendar 2000 that figure had risen to 170 units per employee. In that same time period employee head count had fallen from 106,000 world-wide to 61,360. In other words, unit production had increased 32% while head count was reduced by 42%. This incredible performance was evidenced, in varying degrees, throughout the industry. For example,Tom McDorman, Kuala Lumpur based Vice President of Engineering, Asian Operations, at Western-Digital Corporation, told us that his company's consolidation into Malaysia "has resulted in a 50% increase in output per person, a doubling in output per square foot yielding, an overall 50% reduction in labor and overhead costs, as well as a more concentrated focus on product yield and quality, resulting in a higher consistency of quality and reliability of our products."
How was this remarkable productivity improvement accomplished, even while the technology itself introduced new challenges to the manufacturing floor?
While the disk drive industry has provided a windfall to consumers in terms of price and performance ratios this has clearly not all been due to sacrifice of profit margins. For one thing, the rapid improvements in recording density has led to a reduction in the number of components required to build a disk drive in capacities the market needs today. (See Chart) Reduced parts count improves handling time, yield, and reliability, not to mention reduced scrap rates.
The result on manufacturing costs have been impressive and are likely to continue to improve according to DataQuest, a division of the GartnerGroup, a market research firm that follows the data storage Industry closely. (See table that follows)
However, reduced parts count alone could hardly account for these achievements. Seagate's management put in place a new global information automation system. Dubbed C-Track the system generates thirty gigabytes of new data per day. Included in the data flow is information about inventories, scheduling, process yields, supplier performance, transportation, demand status and provides a host of management reports to the people charged with access responsibility. The team responsible for it's commissioning may have turned to some surprising examples to study how best to implement a system of that magnitude. Pointing out the new paradigm defined by Seagate's management that states "its not about managing inventory and productionits about managing information" Bob Smith, Vice President of Seagate went on to say "its like the fresh flower industry in Holland where timing is critical to the product chain and global in scope".
Clearly none of this would work without cooperation and performance within the supply chain. The relationship between supplier and disk drive maker has become more seamless then ever. With interaction between organizations occurring at all levels, often electronically, it is no longer a case of funneling everything through sales organizations to the materials departments of the drive maker. One seasoned veteran of the disk drive industry in Singapore told us" think of the entire supply chain as a virtual store".
The component suppliers have faced rapid change as well. For example Seagate sent teams of people to the supplier base to commence training their personnel in the tenets of Six Sigma for example. Six Sigma technically means a failure rate of 3.4 parts per million; however, the term in practice is used to denote more than simply counting defects. Six Sigma can now imply a whole culture of strategies, tools, and statistical methodologies to improve the bottom line results of companies. "The implementation of Six Sigma virtually changes your whole operating philosophy" said one component supplier. To many of the suppliers the make over has been traumatic and not all have survived. Consolidation has been the greatest among the component suppliers. To the survivors however, its hardly business as usual. The demand for lower cost components as unit demand declined has been problematic. In addition the demand for just-in-time deliveries requires shipping into regional hubs where ownership does not transfer until the customer pulls the inventory for use. The cost of that inventory remains with the supplier until the pull. The resulting investment, in terms of real dollars, is non-trivial.
Automation figures heavily into the manufacturing equation for most drive makers. This has been driven by the more exacting handling requirements as well as requirement for much cleaner operations. Additionally new methods of in-line testing, inspection, and handling are being deployed. However, high levels of automation tend to be contrary to the need to rapidly deploy new product programs in the race for first to market advantages. "Its all about time management" said one disk drive executive." Its not just time-to-market but also time-to-volume, time-to-quality, time-to-response, and time-to-retool".
Thus another strategy enters the mix called common platform. The idea is deceptively simple. Traditionally the drive industry targeted market segments such as the low-end desktop, high-end desktop, and corporate server markets with differing product lines. This meant that the entire design, production, and management of a product line had to be replicated for each segment. By designing in components and channels that are shared across these product lines, flexibility could be built in and economies of scale achieved. Currently most of the focus is on the components but eventually the entire assembly process will be targeted. Virtually all the disk drive makers are moving in this direction and various levels of progress have been reported. It is safe to say that the industry is closing in on the point where media and head wafer starts do not have to be differentiated. But true merger of products into a single class is likely a long way off.
Has the industry decline in employment led to displacement? Not in Singapore according to Lai Yeow Hin, Deputy Director of the EDB (Economic Development Board) in Singapore. There is enough demand from other industries, such as semiconductor and communications, to absorb the losses in employment they have observed in the disk drive industry. He also indicated that the EDB is taking an active interest in the nascent Network Attached Storage market that holds so much promise. "Singapore is a perfect location for the kinds of activities these companies will pursue. They will require available talent in software development and integration skills which we believe Singapore is positioned to supply. Furthermore, as a regional hub for the expected market growth in Asia we are extremely well positioned." His remarks mirror a strategy that is being pursued by the drive makers who are similarly seeking to climb the "value chain" with initiatives in this market space.
Deputy Director Lai may have a reason to feel a certain amount of pride when thinking about the drive industry in his country. In May of this year Seagate announced that it had the most popular disk drive family of products in history with its U-Series which are aimed at the desktop segment of the market. The first of this series, the U-4 was designed entirely in Seagate's Science Park development facility in Singapore and is the first drive designed entirely in Southeast Asia.
Other regions such as Penang, Malaysia and Thailand may have fared less well. But there have been successes as well. In Malaysia Read Rite and AMC disappeared from the local landscape but Western Digital commenced a massive hiring program to supports it operational consolidation into Kuala Lumpur. Vice President McDorman pointed out "Western Digital has been operating in Kuala Lumpur, Malaysia for over 26
years. The consolidation into Malaysia was as natural as it was strategic. Lower overhead costs as well as an optimal site and facility made it the natural location of choice. From a strategic perspective, tax incentives were advantageous, however the real advantage is the ever increasing number of our strategic supplier partners relocating to Malaysia, ultimately resulting in lower costs to Western Digital."
Meanwhile, in Thailand where Seagate has cut employment levels and further cuts are expected, both Fujitsu and IBM have invested in expansion.
With the shift in strategies at the factory level we expect to see greater competitiveness amongst these regional centers for high technology manufacturing. Availability of local supply lines, skill levels of the work force, and available transportation will largely influence the outcome. These measurements will join tax incentives and will likely overtake labor rates as key selection criteria.
As the disk drive industry continues with major structural changes and changes in the way things are done it may be there is not a moment to lose. Most forecasts, while predicting continued mild double-digit growth in the PC industry, give greater importance to the role of two emerging markets that appear to be positioning for extraordinary growth. Both seem presently hobbled by available communications bandwidth. Specifically the markets are the nascent consumer electronics market and the networked storage market. Forecasts for both suggest that these new segments may well consume available factory output if just a small percentage of the growth that is forecasted occurs. In one of the more interesting forecasts we have seen, Gartner Group shows the forecasted demand in terms of Internet information packets, those little bundles of electronic pulses that represent data when parsed and broadcast over a network line. According to Gartner Group the volume of Internet data packets that will have to be routed and stored by servers and storage systems could increase from approximately 1,000 per second in 1999 to 300,000 per second by 2005.
It seems likely that disk drive storage will come to a period where all the investment and innovation will be rewarded with extraordinary demand growth. Whether it is accompanied by renewed profits still is not as clear and is largely dependent on the success of the strategic initiatives in Asia. So far, the results are impressive. In an article in Insight Magazine, the journal of the International Disk Equipment and Materials Association, Mark Geenen, President of TrendFocus closed by saying "The hard disk drive industry has long been global in nature. This will not change. What is changing is the balance of power, and that is increasingly tilting towards Asia." Mike Stears of Seagate said it this way: "The center of competence (in the disk drive industry) is shifting to Asia." We could only agree and note that the real battle for market dominance is in Southeast Asia as well.
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