March 2, 2000

WSJ

How a Need for Speed Turned Guadalajara Into High-Tech Hub

By JONATHAN FRIEDLAND and GARY MCWILLIAMS
Staff Reporters of THE WALL STREET JOURNAL

GUADALAJARA, Mexico -- On trips back home to California, Brad
Knight likes to pop into the local Circuit City store.

He'll stride down the aisles, stopping in front of a stack of Sony Web TV
set-top boxes. He'll pause at a counter full of 3Com PalmPilots. Then, he'll
check out the Hewlett-Packard printers to see how they're selling. On his
way out, he might straighten a rack of Johnson & Johnson blood-glucose
monitors. And he'll do it all with a sense of pride: That's because all these
products came out of his Guadalajara factory.

Mr. Knight opened the one-million-square-foot facility here in 1997 for his
employer, Flextronics International Ltd. In its first eight months of
production, the plant had $12 million in sales; revenue is now $140 million
a quarter and is growing 68% annually. And Mr. Knight just bought 75
acres of nearby cornfields to triple the plant's size. The tall, sandy-haired
manager says his Guadalajara experience shows "that the standard
manufacturing model for the high-technology industry isn't standard
anymore."

Indeed it isn't. A revolution has swept the nuts-and-bolts ends of the
information-technology business. Companies such as Flextronics, Solectron
Corp., Jabil Circuit Inc. and SCI Systems Inc., barely known just a few
years ago, have emerged as highly efficient manufacturers and supply-chain
managers that operate factories around the globe. The electronics giants
whose names their products carry -- Compaq Computer Corp., Telefon
AB L.M. Ericsson and Cisco Systems Inc. -- are just as quickly getting out
of the business of making things, concentrating instead on developing new
products and persuading consumers to buy them.

Soaring Exports

Ground zero of this structural shift is Guadalajara, a graceful city of 3.3
million known for its fiery tequila and its mellifluous mariachis. Since the
North American Free Trade Agreement took effect in 1994, contract
manufacturers, their suppliers and some of their customers have invested
about $2 billion here. Over the same period, Guadalajara's electronics
exports have soared fivefold to $10 billion.

While that's still a drop in the bucket compared with the electronics
industry's world-wide annual sales of $600 billion, Mexico's No. 2 city is
on its way to supplanting China and other Asian countries as the principal
manufacturing center for electronics products sold in the U.S. Guadalajara,
the capital of Jalisco state, "is the convergence point for several different
trends at a time of intense change in the way business is being done in our
industry," says Charles Parks, SCI's senior vice president in Mexico.

One of these trends is the explosive growth of contract manufacturers
themselves, both in real and relative terms. According to BancAmerica
Securities, their revenues as a group are projected to grow 20% annually
over the next few years, reaching $149.2 billion in 2003, compared with
$60 billion in 1998. By then, their share of global electronics output, now
less than 20%, is expected to double.

Fueling this structural change is the accelerating life cycle of new electronics
products -- often just a few months from conception to obsolescence. That
makes it tough for even deep-pocketed companies such as International
Business Machines Corp. or Philips Electronics NV to invest the sums
needed to produce their new products globally and still provide a decent
return on shareholders' investments. Instead, they are letting contract
manufacturers do it for them.

Globalization was supposed to mean that most of the world's
manufacturing jobs would gravitate to low-cost Asia. But nowadays,
technology companies can't afford the two weeks it takes to deliver their
products from Asia to the U.S., or vice versa, by ship, and air freight on
such long hauls is prohibitively expensive. That means locating factories
close to customers, and that's why "the old wisdom of locating in the
lowest-cost part of the globe just doesn't apply anymore," says
Christopher S. Gopal, a supply-chain expert who recently left consulting
firm Ernst & Young LLC and is now a vice president of communications
start-up Cmetric Inc.

Following the Leaders

Hence the new focus on Guadalajara. Seven of the 10 biggest electronics
contract manufacturers have set up shop here. Their futuristic factories,
some of them encompassing dozens of buildings, have sprung up on the
farmland ringing the city. Flocking in behind them are suppliers of stamped
metal, molded plastic and logistics services.

As darkness falls each day, planes owned by cargo handlers Federal
Express and United Parcel Service take off from the airport here for a
short hop to U.S. cities, their bellies full of modems, routers and other
essential paraphernalia of the Information Age. "What you are seeing here
is what happened in Taiwan and Malaysia in the late 1980s," says Mr.
Knight, the Flextronics manager, "but in a supercompressed format."

"Chinese labor is cheaper, but the real issue now is speed," says Alejandro
Gomez, Solectron's general manager here, as he surveys the construction
of a hangar-size truck-docking facility for Solectron's vast Guadalajara
plant. When the docking facility is completed, trucks will be packed with
goods that have already been vetted by Mexican customs to be delivered
directly to the airport tarmac a few miles away. "The faster you get
something through the production chain, the longer it will be on the
market," Mr. Gomez says.

Sergio Garcia de Alba thought this fact could work to Guadalajara's
advantage when he took over as Jalisco's secretary of economic promotion
in 1995. At the time, the city was suffering the devastating aftermath of
Mexico's 1994 peso devaluation. Traditional local industries such as
shoemaking were in trouble. Banks were folding. And thousands of
workers were being laid off.

Economic Promise

One bright spot was the electronics industry. Lured by tax breaks, a
plentiful supply of golf courses and the city's springlike climate, IBM,
Motorola Corp., Eastman Kodak Co. and Hewlett-Packard Co. had all set
up plants here in the 1970s and 1980s. In general, they imported
components from Asia, assembled them into printers, computers and other
products, and then shipped them off to the U.S. Not much value was
added in Guadalajara. But for Jalisco, the electronics industry was the
most promising source of jobs that weren't subject to the ups and downs of
the Mexican economy.

"We saw the electronics industry changing from a high-end, complicated
and specialized manufacturing business into one which was essentially a
commodity business with a big emphasis on cost containment," says Mr.
Garcia. "That's why we focused on attracting the contract manufacturers."

Mr. Garcia had several things going for him. The peso devaluation had
made Mexican labor about 40% cheaper in dollar terms. Nafta meant that
manufacturers could feel secure that they wouldn't one day face punitive
U.S. tariffs on their products. And a privatization and
infrastructure-spending binge by the outgoing administration of President
Carlos Salinas de Gortari had cut transit times to the U.S. border 600
miles away. Jalisco Gov. Alberto Cardenas sweetened the pot by making
low-cost state land available for new investors to build on and by offering
subsidies to companies for giving workers technical training.

Guadalajara also benefited from the fact that it isn't too close to the U.S.
Employee turnover in border cities such as Tijuana and Ciudad Juarez can
top 100% annually, and workers, who arrive there from southern Mexico,
are often poorly educated. Guadalajara, by contrast, has a more stable
and better-schooled work force. The city boasts seven universities and
dozens of technical schools, a critical consideration for contract
manufacturers, who use more sophisticated machinery than other kinds of
assembly operations. "Here, we get the best and the brightest," says SCI's
Mr. Parks.

Mr. Garcia's sales pitch was well-timed. In the mid-1990s, global demand
for information technology was soaring as personal computers became
more affordable and wireless telephony became ubiquitous. The fall of
communism in Eastern Europe and the rise of free-market policies in Latin
America were opening up new markets. What's more, some big
technology companies such as IBM and Apple Computer Corp. had
recently been shaken by costly marketing miscalculations.

One-Stop Shopping

More practical issues also came into play. Humberto Uquillas, Jabil
Circuit's manager for new-business development here, recalls a U.S.
customer who was buying 40,000 circuit boards a month from plants in
Scotland, India, China and Mexico. "This guy was on planes all the time.
He never slept. He was miserable," Mr. Uquillas recalls. "Finally he said,
'Why should I be doing this to myself if I can do it all in Guadalajara?' "

By the mid-1990s, the electronics industry was coming to the conclusion
"that customers could care less who actually makes a product," says Jabil
Circuit President Tim Main. "What they care about is size, quality and
price."

Looking out over the ranks of workers assembling Cisco Systems
networking gear and other products at his Guadalajara plant, Flextronics's
Mr. Knight explains why operations like his can survive on razor-thin
margins. High-technology giants such as Cisco "face the cost of the factory
set-up, the learning-curve problem, the potential for big, expensive
miscalculations," he says. On the other hand, Flextronics, which is based in
San Jose, Calif., can scale up and down at will not only in a single factory,
but in several scattered across the globe. "If one of my customers loses
market share," says Mr. Knight, "I can make it up with the other guy who
has taken that market share away."

That doesn't bother Cisco. In an effort to stay ahead of rivals such as
Lucent Technologies Inc., it is introducing new products almost daily and
replacing them with newer models within a year. To keep up with this
manic pace, it has woven a tight-knit group of contract manufacturers into
its design and production schemes. Take its experience with
ultra-high-speed communications gear. In 1998, it acquired a small
company that specialized in digital subscriber line, or DSL, technology.
Cisco knew customers including U S West Inc. would want to rapidly roll
out DSL services, and needed a supplier able to deliver tens of thousands
of DSL devices almost overnight.

Crucial Relationships

Carl Redfield, Cisco's senior vice president of manufacturing and logistics,
says that after acquiring the DSL technology, the company immediately
turned to its contract manufacturers. "We needed that high-volume
expertise," he says. Cisco's relationship with these contractors has become
so intimate that they not only alert it to problems, but also collaborate
among themselves to fix potentially costly glitches.

That kind of cooperation led Cisco to bet its future on its contract
manufacturers. While today it gets 35% of its revenue from products built
entirely by contractors, it expects as much as 65% of its business "will go
that way in the long term," Mr. Redfield says. Given that Cisco's biggest
market is the U.S., a lot of that business will end up in Guadalajara.

That presents some challenges for local manufacturers. The cargo and
customs infrastructure is already buckling under the strain of exploding
demand. And in spite of all the schools here, there is a growing shortage of
managers and, particularly, of logistics personnel such as master
schedulers. The electronics industry now employs 60,000 workers in
Guadalajara, up from 5,000 in 1995.

Mr. Knight, for one, is trying to cope by training his own people. He
recently got permission from Mexico's Education Ministry to run his own
junior high school and high school at the factory because he can't find
enough graduates to fill a shop floor set to triple in size over three years.
"Some of our guys two years ago were managing a $1 million
manufacturing operation," he says. "Now they are each responsible for $40
million in sales. Not a lot of people can handle that kind of growth."

Write to Jonathan Friedland at jonathan.friedland@wsj.com and Gary
McWilliams at gary.mcwilliams@wsj.com