Distributors Headed for Cutthroat Competition Over Design Contracts

The channel has always known that the stakes in demand-creation programs were high, but a recent report actually puts a price tag on a semiconductor design win.

“A design win in a high-value consumer electronics product could make $100 million or more during the life of the device,” says Jordan Selburn, principal analyst for consumer platforms at iSuppli Corp. This figure, of course, is for semiconductor sales over the product’s lifetime, but still, that’s a nice annuity. (See Despite Consumer Electronics Surge, Chip Suppliers Face Cost Challenges.)

The iSuppli report goes on to say that competition for design wins in the consumer market is going to get more cutthroat and this pressure is going to force the chip market into further consolidation. This has a number of implications for the distribution channel, which derives revenue from helping suppliers secure design wins.

1. Competing with each other
Demand creation programs that reward distributors for getting a supplier’s chip designed in to an end product will become more competitive. Distributors already compete against one another for design wins, often over the same product. The prize is a preferred price or a higher profit margin when the distributor finally ships a production order to a manufacturer. Distributors may have to make either price or margin concessions at the order fulfillment stage in order to secure a win at the design stage. (See The Cost (Not Price) of Being Global.)

2. Competing with suppliers
Upside: iSuppli expects to see more consolidation in the semiconductor supplier base because chip development costs are so high. This could be a positive for the channel. To support design-win activity, distributors must hire engineers. Since distribution’s business model is sales driven, engineers are expensive because they don’t actually generate sales. Fewer suppliers means distributors won’t have to spread their engineering resources too thin.

Downside: Consolidation among chipmakers also carries risk for the channel. Since fewer chipmakers are competing for design wins, the survivors could focus more of their own engineering resources on demand creation. Design opportunities for the channel could dry up as suppliers elbow their distributors out of the way.

Outcome: Competing with each other
Distributors competing with one another is nothing new. Going head-to-head over an account happens all the time. Whether this will drive prices or margins down is up to chipmakers -- distributors can only slash prices so low before they have to back the supplier. Suppliers recognize it is in nobody’s best interest to drive prices down, so I think they’ll be careful about supporting price or margin concessions.

Outcome: Competing with suppliers
I think this is going to break the same way it always has: Distributors will get small, and emerging accounts and suppliers will target a few large OEMs. Even if there is consolidation at the supplier level, these same suppliers have been steering more demand creation business to distributors over the years. Distributors can cast a wide net over the customer base and reach a lot of small and emerging OEMs. There is always a chance that one of these customers will be the next Apple Inc. (Nasdaq: AAPL) or the next Nokia Corp. (NYSE: NOK). But until that happens, suppliers are largely uninterested in them. Customers that need a lot of hand-holding but buy low volumes of products are usually left to the channel.

And what about the OEMs? Whether it’s a supplier or distributor that assists them with a design, they are going to place their fulfillment orders where it makes the most sense. This could be a distributor or it could be an EMS/ODM. OEMs will always try for the highest level of service at the lowest possible price. Here again, I think the channel has the advantage. Most suppliers aren’t equipped to handle the constantly changing needs of a factory or manufacturing operation. They’ll leave that to the distributors. As for the EMS/ODM providers, they focus most of their efforts on buying commodities. They may use their leverage to drive commodity prices down, but high-value chips usually maintain their price. These are the places where distributors will focus.

Distributors have become accustomed to handing competition at both the supplier level and at EMS/ODMs. As long as they’re calling on the next Apple or the next Nokia, their demand creation programs will stay relatively intact.