Distribution at Another Inflection Point

"Volatility is the new normal. Deal with it."

That wasn't the theme, but it was the message, as executives gathered at the annual ECIA Executive Conference October 28 to 30 in Chicago. Industry analysts, suppliers, and channel executives themselves acknowledged that despite the best technology and planning available to the electronics supply chain, the unexpected still wreaks havoc.

For the third quarter of 2012, that came in the form of an ongoing push-out in global component orders and deliveries. In general, distribution revenue and profits are down, and the supply chain is accountable to shareholders and suppliers when expectations aren't met.

Everyone agrees that the electronics content in products continues to grow and the overall industry is sound. Economic uncertainty and the upcoming US presidential election have many OEMs holding their breath waiting for demand signals to become clear. Additionally, because there haven't been long lead times or component shortages for the past year, customers are comfortable with placing orders two or three weeks out rather than five or six. Yet, supply chain executives have to be focused on current results.

For electronics distribution, the challenge continues to be the value the channel provides to suppliers and customers. Gordon Hunter, CEO of component maker Littelfuse Inc. (Nasdaq: LFUS), provided a supplier's perspective to 300 or so supply chain executives at the ECIA Executive Conference. Littelfuse has positioned its internal structure for stability in production, price, and supply. Yet, the company's sales show sharp peaks and valleys at key inflection points over the past couple of years. The reason? "Distribution," Hunter explains. Littelfuse sells almost all its product through the channel and distributors stock up when they need to and wait until inventory is depleted. During a slowdown -- as in the third quarter -- new orders aren't placed. Sailing isn't as smooth as everyone expects.

Hunter wasn't pointing fingers -- peaks and valleys are a reality of the market. Yet, theoretically, the channel is supposed to smooth those out. Unfortunately, the driver of most component orders -- semiconductors -- still take an average of 16 weeks to build. If orders come in every two or three weeks instead of six to eight, chip makers are going to fall behind, or ahead, of the demand curve. Until the chips are ordered and produced, the rest of the bill of materials is in limbo.

Distributors are trying to get better information at the front end of demand by working closely with engineers. The channel has bulked up its design and technical resources so it is working directly with customers to design boards. Armed with the knowledge of the design, distributors can relay that information to suppliers who can then plan production. The problem is, not every design reaches production and not every component remains stable in the design. The actual fulfillment of the order -- when design hits the production stage -- doesn't always match the design. Both distributors and suppliers are caught off guard.

The channel has executed a number of programs to lessen the impact. Internal systems track the components from the point of design to the point of consumption. This works pretty well for distributors as long as there aren't a lot of changes along the way. However, changes are inevitable, so increasingly, distributors are adopting systems designed to give suppliers and customers more visibility into what happens between the design and fulfillment. At Avnet Inc. (NYSE: AVT), its Control Tower solution provides real-time information on such events, such as engineering change orders (ECOs); missed deliveries; component shortages; price changes; logistics disruptions and other signals suppliers may need. Although access to those signals is usually determined by the end customer, suppliers can use this information to better plan production.

There is a fundamental challenge posed to the channel, however, that will impact these decisions going forward. If OEMs are able to control all of this information, what is preventing them from simply doing it themselves? There are a number of reasons -- inventory management being one of them. OEMs and EMS companies do not want to maintain and warehouse inventory, so there has to be a buffer somewhere. That buffer remains in distribution.

The second issue is the supplier many of which aren't well-equipped to take incoming order information from hundreds of customers; decipher it; and relay the pertinent information to factories. Distributors are still best positioned to interpret demand signals in part because they maintain customers' historic ordering data. However, suppliers continue to challenge the channel to do a better job at this. With all this information available, why are there still so many peaks and valleys?

A number of experts suggest the movement toward big-data -- the ability to capture order information at a very granular level -- will help. For example, if data shows that every time a customer orders an Intel process it also orders a Molex connector, distributors can make an informed decision about stocking Intel and Molex parts. But, for the time being, data also shows that there is a long way to go before "volatility" isn't a harsh reality.