Facing Distribution Challenges in China

Western companies are so accustomed to viewing China as a competitor that it's easy to forget China is a customer of many US and EU-based technology businesses. Global corporations often get slammed for moving operations to the Far East, but as General Electric CEO Jeff Immelt has said, a publicly traded company would be doing its shareholders a disservice if it didn't have a presence in the largest consumer market in the world.

Even after decades of operating in China, Western businesses still find the environment challenging. In many ways, customers in the region are the same: they want an efficient, cost-efficient supply chain. When China-based OEMs were asked by UPS/IDG what their pain points were, the responses in the white paper "Asia Change in the Chain" looked very familiar:

When respondents were asked about weak links or persistent pain points in their supply chains, risk management, managing inventory, and end-to-end visibility were listed most frequently.

These are the same issues cited by companies that don't have a significant presence in China. Yet China's vast geography, business practices, and culture aren't always a good fit with Western supply chain practices.

End-to-end visibility seems to be particularly elusive. Part of that challenge is the structure of the supply chain itself. Information has to pass through a lot of stopping points between design and manufacturing in electronics. A seemingly simple matter -- tracking a device throughout that process -- is a classic example.

Typically, a distributor will assist a supplier by getting its device designed into an end-product. The design, prototyping, and bill of materials (BOM) rationalization are usually done in one location -- for example, Dallas. The OEM decides to use an electronics manufacturing services (EMS) provider in Shenzhen to manufacture the end product. Numerous disruptions can occur. A single component might not make it to the factory floor and delay production. In order to minimize the loss from idle manufacturing lines, an alternate part might be used by the EMS provider. The substitution information may not be sent back to the supplier and distributor -- or be sent too late to make any difference.

The effects of this simple move then expand exponentially. Suppliers build products based on distributor and customer forecasts. A last-minute swap usually means suppliers have already manufactured their devices. The original supplier may end up with excess inventory while the alternative supplier's stock runs low. According to UPS/IDG, Asian manufacturers say:

Inventory is often poorly managed -- either there is far too much across the extended supply chain or it performs poorly (the wrong things in the wrong places, or significant obsolete stock).

There's another challenge in China that doesn't occur as frequently in the EU and US: concern about IP. What an OEM designs into its product reveals a lot about the product itself. Pricing information is also shared throughout the supply chain. China does not view IP as something private or unique: at best, it's public property; at worst, it can be exploited to deliver a knock-off. According to UPS/IDG, visibility in China is on a "need-to-know" basis:

Visibility remains elusive for most companies, usually because it has been viewed as a non-cost-justifiable blue-sky vision. Recent progress across manufacturing has been made by viewing visibility in the context of specific use cases such as supply chain traceability or supply interruptions.

Failure in these two issues -- visibility and inventory management -- has an effect on sales. Suppliers whose products are designed into a product expect large production orders will be placed. Distributors that assist in the design get compensated through these orders in the form of a higher profit margins or preferred pricing. If the orders don't materialize for one reason or another, suppliers and distributors both lose sales.

There is also a scenario in which the supplier benefits but the distributor does not. If a device can't be delivered by Distributor A, OEM/EMS companies may turn to Distributor B. Either way, the supplier sells its product, but its distribution relationship may be strained.

Distributors that are headquartered in the West tread lightly when it comes to imprinting their practices in the Far East. Broadline distributors, which sell a wide variety of components, aren't the norm in China. Components makers in that region are often aligned with smaller firm that resell only a few product lines. The one-stop shop model that works well for OEMs in the US and EU may not be possible overseas. As a result, OEMs and EMS companies engage with numerous partners in China to fulfill a bill of material.

It's likely that China will begin to move more toward Western practices for a single reason: cost. As wages and other costs go up in China, companies will seek more efficiency such as paring down their supplier line cards. In upcoming posts, I'll look at other challenges and possible solutions to supply chain complexity in China.