The Supply Chain Learns a Painful Lesson

The rise of the dotcom companies in the late 1990s brought both opportunity and disaster for the electronics supply chain. Suddenly, anyone with a computer and a modem could buy electronics components and sell them online.

Companies that were able to procure excess inventory -- parts that suppliers didn't need, EMS companies excess orders, and even items distributors couldn't sell -- were bought and then aggregated by brokers. This inventory was then put up for auction to be sold to the highest bidder.

This wreaked havoc in the supply chain. During periods of shortages, hard-to-find components were available in the open market for as much as double the original price. Open market players began to buy low and sell high. Component makers were suddenly inundated by customers that couldn't get the products they needed or were paying twice as much as they used to. Electronics parts were being sold like commodities and companies were making money through arbitrage.

This created a huge problem for franchised distributors that are authorized by suppliers to sell their goods. Franchised companies bought parts at a fixed price, added a margin, and also passed supplier warrantees along to customers. They added value to suppliers by becoming advocates for their products and to customers that didn't buy in lots big enough to warrant supplier prices. The ultimate effect of the dotcom boom was to drive prices down during oversupply and drive prices up during shortages.

Additionally, because geographic barriers were broken down, companies could buy components anywhere in the world. The incidents of counterfeit components entering the channel increased dramatically because any company that seemed to have a legitimate operation was buying and selling electronics parts.

In the chip market, leading players such as Motorola tried to protect channel partners. Excess components most often were sold in the open market by OEMs that didn't use as many parts as expected. Motorola put out the word that if it discovered OEMs were selling excess parts in the open market they'd fall to the back of the line next time they sourced from authorized channels.

Unfortunately, this was somewhat of an idle threat. In many cases, OEMs couldn't return those parts to suppliers or distributors and could either write off the inventory as a loss or sell it for pennies on the dollar. Armed with this assurance, OEMs would double-order parts knowing they could find an outlet. Another dynamic in the market was driving component production up to record levels; the dotcom boom brought prosperity to the tech market.

Even though many dotcoms didn't manufacture anything, the demand for computers, enterprise systems, communications gear, workstations and PCs appeared to be never ending. Sometime after the bust that happened in 2000, a supplier confided to me: "We never questioned the demand signals that were coming in from customers. We saw it as manna from heaven."

The purported Y2k bug was also driving tech sales. At the time, it was believed that computers would re-set their calendars once the millennium arrived and systems would go back to Day One, wiping away all previous programming and data. Between the years 1999 -- the height of the dotcom boom -- and 2001, the electronics supply chain found itself with an estimated $13 billion in excess chip inventory alone. OEMs and EMS companies had double or triple ordered for fear their supplies would be cut off.

These companies turned to distributors to take this inventory back, but distributors were already bloated with inventory. Moreover, some of this inventory didn't come though the authorized channel; it was bought from brokers. Authorized distributors were under no obligation to accept this inventory. Negotiations with once-secure customers turned very ugly as this inventory hung in limbo. OEMs and EMS companies could write down millions of dollars of inventory as a loss, or try to push it back into the market.

Suppliers were also siphoning inventory. Distributors were often the first stop for suppliers when they needed to move product off their shelves and distributors reached a broader customer base than component makers. If Customer A didn't need DRAM, for example, Customer B usually did. Between 2000 and 2001, nobody needed any inventory. The losses were enormous.

Since this debacle, suppliers and distributors have worked together to prevent another such disaster. First, distributors began to track a customer's order history as well as new orders. If a customer suddenly bought more parts in a month than it ever did, distributors flagged that order and dug deeper. Suppliers also began to share more information with the channel. Suppliers would provide the orders they received from customers; forecasts that came from customers, and how much capacity they planned to use.

Supplier contracts tightened up. Distributors and suppliers clarified who "owned" the inventory once it left the suppliers' warehouse. Sometimes it belonged to the end customer and a distributor was storing it. Sometimes it belonged to the distributor. Sometimes it still belonged to the supplier that didn't have room for it in a local warehouse.

Customer contracts also tightened up. Components that were proprietary -- manufactured by chip makers for one or a few customers -- became non-cancellable/non-returnable (NCNR). Distributors put strict parameters around "you buy it, you own it;" consignment inventory and vendor-managed practices. The channel also made a concerted effort to eliminate the broker market and auction houses.

The concept of reducing costs, rather than the focus on price, began to take hold in the electronics supply chain. Suppliers, distributors, and customers finally found that collaboration, rather than confrontation, could lead to the cost reductions the channel had been striving toward all along.