Good question and I had to search for data to support my answer.
We are saying similar things: price is based on the market and DRAMS, despite their high technology attributes, are undifferentiated and thus a commodity. The market sets a low price so a supplier must be the low cost producer to meet the price or exit. Meeting the price may result in selling below cost.
When a company can’t compete despite its best efforts, it exits the business or fails. I think DRAMs are no different. We have seen many DRAM companies either fail or exit. It’s also hard to find a pure play DRAM company as most have diversified.
DRAMS are different only over the time horizon for which their business performance needs to be viewed. ADRAM supplier will sell below cost to keep the factory running in tough times. This short term tactic is offset in better times with higher pricing. DRAM suppliers generally maintain positive cash flows and EBITDA when selling below cost because of the high depreciation component from the capital intensive nature of the semiconductor industry. One needs to look over the life of the assets to see if the long term return on assets justifies being in the business. If on a long term basis a company is losing money, there has to be a compelling reason to stay in. Historically DRAMS were a technology driver of the micron race where the new advanced manufacturing platform could be applied to other higher margin products. If there is no compelling technology leadership reason to be in the game and a company can’t achieve the required returns, I believe they will exit either by choice or bad fortune.
Ken, Suppliers seem to get the cost-gross margin story even better than their customers. Nowadays, most component suppliers base their product costs not just on their own manufacturing and SG&A expenses but also by marking themselves against rivals' competing products and the price OEMs are willing to pay. Their gross margins are therefore based on what the market is able to support, hence, we see in the DRAM market, for instance, years during which sales are well below costs of goods sold.
I do have a follow up question for you, though. What happens when a company tries as hard as possible to drive up manufacturing efficiencies but still find itself selling below costs simply because of market doldrum or as it happened a couple of years ago when demand stalled because of problems in the finance market?
Key phrase there "differentiation." There are many examples where a supplier had a great product or solution to sell, yet lacked enough branding traction to be a serious player in the game. It isn't so much what you think of your product or its price; it's what the customer base thinks that's senior to all else. If you've successfully differentiated your organization, product or service, you'll be in a far better position vs. competitors including those twice your size, and you just might quibble less over pricing with your customers too.
It seems like a fairly obvious thing, but it's amazing how many companies lose sight of the importance of cost. Especially in the technology sector.
I did stop and think about what you said about the unnecessary costs associated with poor security of supply. I think this can be somewhat tricky. There have been times in the past where I have sacrificed cost to protect against potential risks, paid more to diversify in order to avoid potentially serious problems if a single supplier somehow failed, for instance. I think there are some decisions I would make differently, in hindsight.
Anyhow, also wanted to say that you had a very good point about the importance of benchmarking. I have found that benchmarking is nearly always a worthwhile process to undergo and you will more times than not find unexpected things that could be improved on.
Yes everything boils down to cost. No matter if you have high revenues if the cost is high margins would be poor. Although there are different measures to redue cost but sometimes its almost not possible to reduce. I know every account holder would love to do that.
I think a supplier’s cost and price are somewhat independent. As such, being able to measure costs does not determine fair market value. Fair market value is determined by what the customer thinks the product is worth, not what it costs to build. I think customers should want to see suppliers with healthy margins that are earned through efficiency and effectiveness and it may be in everyone’s best interest to drive inefficient suppliers out of business. What customers need are prices that make their own gross margin equation work.
Suppliers with healthy gross margins should be able to paint a compelling story as they have achieved this position through efficiency and investment in technology or service delivering differentiation. They probably have a great product roadmap, high quality, exceptional service and fair pricing. This is what customers want to hear. Low margin (in their market space) suppliers probably don’t have much of a fact based story (start up and transforming companies excluded).
Some customers try to make the price equation a cost plus one by trying to model the supplier’s manufacturing cost and assign an allowable (usually low) gross margin. This is an example of a supply chain decision based on cost. It works when the supplier has lost differentiation and has been commoditized. In other words, the supplier has no differentiated value as seen by the customer. If a supplier wants this business, it had better be the low cost producer to compete.
Do you think that a suppliers' ability to measure their costs will help in determining the fair market value for their products or services? How effective are they in communicating this to customers? I agree with you--for customers, it's all about price--but it's also not in the customers' best interest to drive their suppliers out of business. I wonder how many supply chain decisions are based on cost, as opposed to price.
EBN Dialogue enables and encourages you to participate in live chats with notable leaders and luminaries. Not only editors and journalists, but the entire EBN community is able to comment and ask questions. Listed below are upcoming and archived chats.
Thailand Stages a Comeback Join EBN contributor Jennifer Baljko on Thursday August 23, 2012, at 11:00 a.m. EST for a live chat on how electronic manufacturers in Thailand have shored up their supply chain to reduce the impact of future natural disasters.
Microsoft Surface: Potential Winners & Losers What are the implications for the electronics industry supply chain of Microsoft Corp.'s decision to launch its own tablet PC? Join industry veteran and EE Times' systems and OEM expert Rick Merritt on Tuesday, July 3, at 12:00 pm EDT for a Live Chat on this subject.
Join EBN contributor Jennifer Baljko on Thursday August 23, 2012, at 11:00 a.m. EST for a live chat on how electronic manufacturers in Thailand have shored up their supply chain to reduce the impact of future natural disasters.
Peter Drucker famously said "Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window." Yet in the razor's-edge world of electronics—with a lean supply chain and just-in-time demands—the need to know the future is vital.
While no one really can accurately predict the future, we can take guidance from another Drucker saying which is the best way to predict the future is to create it.
You've heard the saying "the No. 1 supply chain risk is your people." That hasn't always been the case. But today's complex global supply chain requires a new type of multitalented employee. It's one who understands, finance, marketing, economics, is savvy with technology, graceful with relationships and can think analytically.
Where are these people? Are universities properly preparing the next generation supply chain professionals? How do train your existing workforce for these new, demanding positions?
Brian Fuller, editor-in-chief of EBN, will lead a 60-minute Avnet Velocity panel discussion that will ask and answer these and other questions swirling around today's supply-chain talent challenges.