In this week’s Finshots Markets, we talk about contract manufacturing, Dixon Technologies and why the company has been making all the news of late.

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The Story

Dixon is a contract manufacturer. In fact, they are the biggest manufacturer of LED TVs in India producing stuff for the likes of Samsung, Panasonic, Xiaomi, TCL, OnePlus and many more. They also manufacture lighting products for companies like Philips, Havells, Syska, Bajaj, Wipro, Orient and more. They happen to be the leading contract manufacturer of semi-automatic washing machines for clients like Godrej, Samsung, Lloyd, Panasonic. And they also dabble with manufacturing mobile phones. So if you haven’t heard of Dixon yet, think of them as a leading contract manufacturer in India.

And look, contract manufacturing isn’t a new enterprise. We’ve been doing it for decades now. However, companies can choose to put their own unique spin on it and Dixon for instance operates on two different models.

First, you have the OEM (Original Equipment Manufacturer) model. It is what most people think of when they hear the words contract manufacturing. In this particular case, Dixon sources parts, components and other materials to assemble the final product based on the client’s specification. The client meanwhile is responsible for deciding how the final product ought to look and feel. Dixon is simply the executioner and the client — the original mastermind. The second option is called the ODM (Original Design Manufacturer) model. Using this route, the company can choose to flaunt its creativity. The client simply wants a polished product and Dixon has the flexibility to germinate the idea, design the product from scratch, choose raw materials and even fiddle with certain technical specifications. So you can see how a company could earn better margins on the latter ODM model.

Unfortunately, most companies have a clear vision for what they want. So a bulk of Dixon’s work transpires through the OEM model and not the ODM model. Case in point — Washing Machines. Currently, the company produces all of its washing machines using the ODM model, however, the entire segment contributes just 9% to the total revenue. So you can see how Dixon still makes most of its money by being an Original Equipment Manufacturer.

And look, you might think this sounds very boring especially considering Dixon doesn’t do anything really innovative. But bear in mind, contract manufacturing is booming right now. Companies no longer want to invest big money in production facilities when they can get equally decent products made from somewhere else. Foxconn has been manufacturing iPhones for Apple since 2007. And Foxconn is based in China. In fact, as it stands, they are the largest smartphone maker in the world. You could turn around and ask — Why doesn’t Apple manufacture their own phones? Surely, they have the resource and the expertise to do so, right?

Well, of course, they do, but offloading the manufacturing responsibility to someone like Foxconn lets them focus on innovation and customer experience. That is what they’re really good at. And so, it makes sense for large technology companies to partner with the likes of Foxconn and Dixon. And since there are so many companies looking to outsource production, Dixon’s numbers have exploded.

Their revenue numbers have grown six times between FY13 to FY20 — from 726 crores to 4,400 crores. Net profit has grown by a whopping 24 times from 2 crores to 120 crores. The growth has been so remarkable that since its listing in September 2017, the company’s share price has grown by 570% from Rs 531 to Rs 3,600. It is quite remarkable.

However, contract manufacturing isn’t exactly a glamorous business either. You have wafer-thin margins here since there is barely anything differentiating you and your competitors. Sure, some companies are better at executing projects, and relationships are very valuable in this line of business, but it’s still not enough to carve a long term competitive edge. And in the OEM business, margins don’t exceed 3–4%. So the only way to make money here is by working on bringing in new clients. However, roping in new clients is easier said than done. The big companies that are already working with other OEMs have no incentive to switch. Unless that is, they screw up big time. So you’re effectively looking for new companies trying to venture into newer territories or those that are trying to build scale. And as we already pointed out — It's not easy to spot them.

For instance, Dixon derives 50% of its revenue from just two clients and 80–85% from just five clients. This tells you that companies value relationships when they dabble with contract manufacturers. These clients are likely to stick with Dixon unless something drastic happens. However, this huge dependency on a concentrated portfolio of clients can be a death knell if the relationships soured. So it cuts both ways. Also, the fate of Dixon is intertwined with the fate of its clients. If the clients don’t make money, Dixon doesn’t make money. So while it does seem like the company is posting spectacular numbers right now, it’s imperative to remember the risks involved in contract manufacturing.

All said and done, Dixon still has big aspirations to grow and succeed. The next big focus is likely going to be smartphones. The company as it stands is the biggest manufacturer of feature phones in the country. They have the capacity to produce 32 million units. But feature phones are dying a slow painful death and smartphones are pervading all walks of life. And while the company still produces 3 million smartphones right now, they want to up it to 20 million units in the next couple of years.

To this end, they have also bagged orders from Motorola worth an estimated 3000 crores and another order from Nokia which is expected to fetch them around 4000 crores. And while production is likely to begin this quarter, it seems like a decent start. So yeah, Dixon has a lot going for it and it seems poised to do well. But like all high growth companies, they still have to contend with some very real existential threats and we will just have to wait and see how the company progresses from here on in.

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Until then…

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