Surviving & Thriving in a Downturn, Part 1

Distribution isn't for sissies. That was clear to the hardy entrepreneurs who pioneered the sector in the 1920s by offering parts to the nascent radio industry.

Their successors today at the industry's leading players have also learned that playing in a highly cyclical market like electronics requires constant flexibility and vigilance combined with the willingness and ability to generate better information about demand patterns by looking deeper into customer sales patterns.

None of this acquired insight has made the distribution market immune to the vagaries of the electronics market or the larger economy as demonstrated in the results recently posted by the leading industry players. From Apple Inc. (Nasdaq: AAPL) to Google and Amazon, the industry is reeling from slowing economic conditions worldwide. Many of the results that have been announced for the third quarter trailed expectations and the forecasts for the rest of the year have been similarly unappealing.

In this environment, the ability to see deeper into the supply chain and give B2B customers a better idea of ongoing demand is invaluable. Distributors by fact of their position astride the global electronics supply chain can give their two customer groups -- component suppliers and OEMs/EMS providers -- deeper insight than either can accurately obtain on their own.

That's why if any sector of the electronics manufacturing industry has learned how to survive and emerge better from a market downturn, it's distribution. The biggest distributors -- Arrow Electronics Inc. (NYSE: ARW) and Avnet Inc. (NYSE: AVT) -- especially occupy an advantageous position because they represent hundreds of component suppliers and sell to literally hundreds of thousands of OEMs, contract manufacturers, and assemblers.

What this means is that distributors merely need to look at their own internal order patterns, match these with anecdotal reports from the industry, talk to customers, and then wave a wet finger in the economic wind and the pattern of current and future demand would emerge. Distributors do this all the time, believe me.

Why, you ask? Because they don't want to be left holding a sad bag of unsalable parts when demand drops suddenly as it had happened in the past. While distributors have the rights to return unsold parts, we all know the reality is quite different. Some of the parts may have to be scrapped and the distributors could be the ones saddled with the task of getting rid of unwanted components.

Despite their sensitivity to market conditions, distributors themselves get regularly buffeted by the nasty winds blowing through the economy. As middlemen, and (better yet) the critical glue holding together all segments of the electronics manufacturing supply chain, distributors are often amongst the first to feel the heat of a downturn and also typically the last to finally climb out of the economic mess. They have, as a result, developed keen sensitivities to market changes as well as the mechanisms for keeping operations in trim conditions throughout the downturn.

Coincidentally, the same alertness to market developments that help distributors identify weakening conditions ahead of others have also given them the ability to sense an upturn early in the cycle even though they may not be the immediate direct beneficiaries. Take the current economic environment and its impact on corporate earnings. If industry players believe the recent weakness is a fluke, they should probably reconsider that assumption as Rick Hamada, CEO of Avnet, observed recently while presenting Avnet's recent quarterly results to investors.

Here's what Hamada said in response to an analyst's question about the weaker-than-expected results Avnet reported for the 2013 fiscal first quarter ended Sept. 29:

Tracking the revenue declines with so much back weighting on the computer business in particular... now we've seen that twice in a row. I'd say once can be an anomaly and at 2 times now, you've got to call a trend. There's something different here. And again, you can see that factored into our December guidance.

In other words, market conditions are not optimal. For those able to read the tea leaves, this doesn't mean Avnet is facing a situation unique to the company. What Hamada didn't say in so many words is that a trend is emerging for the entire market. Avnet, he said, is already taking steps to counter the perceived market weakness. In my opinion, that's the message the market should be taking from this development.

My next posting will review how distribution combats a market decline and lay the plan for benefitting when a recovery begins.