Assembly economics

The truth of the matter in the IT space is that economics count for everything, says Andrew Seymour.

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By  Andrew Seymour Published  October 29, 2007

"We see the establishment of this plant as crucial in helping us to address the particular needs of small to medium businesses in the Kingdom and around the region," enthused an HP representative ahead of the opening of the vendor's first Saudi desktop PC manufacturing plant in 2003, not forgetting to mention that this "highly significant" venture would naturally bolster the size of the local PC market.

It's hard to believe that the representative in question - or any other HP official for that matter - would ever have envisaged that a project that promised so much would experience a shelf life of just four years.

Locating reliable output data for the number of units built at the Riyadh-based factory isn't easy. HP announced at the launch that it expected to manufacture 80,000 PCs a year, but more speculative reports since suggest that more than 200,000 units were being churned out per annum. Whatever the truth, such details will hardly matter over the coming weeks as HP scales down production and transitions to a supply chain model that will see desk-based products making their way into the region from Eastern Europe and the Far East.

As the only large international PC vendor to have conclusively developed such a significant local PC assembly initiative in the Middle East - other vendors are configuring desktops locally but not to the same extent - news of HP's U-turn deals a severe blow to the region's aspirations of being perceived as a source of computer products, rather than just a hub.

Aside from serving up the bog-standard line that "adding value" to its customers will be better achieved through an alternative logistics arrangement in future, the primary reason given by HP for ending local desktop PC production in the Middle East remains the shift in market demand from desktops to mobiles.

I have to admit I find that explanation hard to swallow.

It certainly isn't a great advert for HP's reputation as an industry bellwether if it was unprepared for a major form factor trend that analysts have been predicting for years. The enduring pattern of increased mobile PC penetration, and its anticipated impact on the desktop market, is not exactly a topic that lay undiscovered four years ago when HP opened the plant it now deems surplus to requirements. Perhaps HP bosses were so excited by the prospect of assembling desktops in the Middle East that they forgot to read those expensive IDC reports detailing the future direction of the PC market.

Recent data reveals that around 60% of the Saudi PC channel is made up of notebooks, a figure that is more consistent with Western European markets than the Middle East and illustrates the pace of development in the Kingdom. Does that explain why HP could have been caught on the hop? Maybe the vendor knew the shift was occurring, but just hadn't foreseen the speed at which it would happen. Then again, maybe not, when you consider that even as recently as last year the company was still hailing the plant's significance and even outlining details of its enlargement.

Participating in a roundtable event during April 2006, Anil Ghandi, the former general manager of HP's Personal Systems Group in the Middle East, announced that the factory would become a "hub for regional production of desktop PCs", supplying parts of Africa as well as the Middle East. "HP was the first multi-national to establish a PC assembly plant in the Kingdom, demonstrating our ability to anticipate the market potential before our competitors," boasted Ghandi at the time. "By listening closely to our customers' needs we have been able to predict demand levels and ensure our capacity to supply grows ahead of this demand."

So what do those words mean now? That even as recently as 18 months ago, the market shift involving desktops and notebooks still hadn't sunk in at HP? No, what it suggests to me is that HP, in similar vein to every other IT player in the market, hadn't bargained for the dramatic modifications in customs regulations that were introduced in Saudi Arabia earlier this year. For those who need reminding, most categories of computer equipment were exempted from import duty at the beginning of January.

To its credit, HP openly admits that ongoing changes to import regulations have influenced its decision to end local assembly in Saudi Arabia, but perhaps these changes have played a more significant role than it will ever be willing to acknowledge. Certainly a more significant role than the shift in demand from desktops to notebooks anyway.

Leaving aside the twin benefits of shorter production and transit times, HP has previously gone on the record as estimating that assembling PCs in Saudi can work out at between 6% and 15% cheaper than importing, depending on the product specification and type of components used.

Let's assume that advantage is actually closer to the 6% end of the scale given we are essentially talking about commodity IT products and must also make allowances for the overheads involved. The removal of the 5% import duty - which is what happened in Saudi earlier this year - would virtually wipe out the financial advantages gained from assembling locally, regardless of the tax break granted for such an activity. From a vendor's point of view, that changes the rules of the game overnight. Suddenly, importing becomes just as practical as local assembly.

So when HP says the shift in market demand from desktops to notebooks sparked its decision, I find it hard to believe. Let's not overlook one point here. HP is a public listed company, and public listed companies live and die by the strength of their balance sheet. If the economic advantages of assembling locally are eliminated, or at least drastically reduced, then the incentive is less appealing and decisions need to be made.

Put yourself in HP's shoes. It clearly makes more sense to exploit its global supply chain and make use of factories in other parts of the world that have the capacity to prosper from even greater economies of scale than it is persevering with a facility that no longer offers the advantages it used to. Especially if it is convinced that such a move won't harm its competitiveness and relationships with customers, which HP obviously is.

Forget about adding customer value and all that ancillary PR speak, the truth of the matter in the IT space is that economics count for everything. It is certainly a blow to the region as far as manufacturing is concerned, but a decision of this magnitude has always been on the cards since the new import regulations quietly slipped into force earlier this year.

It will be interesting to see what happens in the coming months as HP graduates to its new supply chain model. There is no doubt that the channel will still occupy a central role at the heart of HP's desktop PC strategy, but will the vendor be able to match the order time, improved response support and access to customised technology that the soon-to-be extinct assembly line in Saudi used to promise customers?

HP changed the name of the game when it announced plans to begin assembling desktop PCs in Saudi Arabia four years ago. Subsequent events have forced it to head in the opposite direction and seek out an alternative model. Its profitability and position at the summit of the regional PC sector depend on it.

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