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Inventory Levels Challenged Already

Market analysts are already hammering semiconductor companies that are carrying high levels of inventory, meaning the “new normal” — buffering stock against disasters such as the Japan earthquake — is already being challenged. (See: Is More Inventory the ‘New Normal’?)

Market reaction to inventory buildup will continue to be the single biggest obstacle to the supply chain's pursuit of “comfort” stock that could offset future disruptions. With the possible exception of the distribution channel, inventory is almost viewed as a liability on a company's bottom line. Here is a recent example from the Tech Trader Daily’s Tiernan Ray:

    Nomura Equity Research’s Romit Shah today writes that semiconductor stocks' risk-reward trade off is “not attractive,” given what he sees as weak demand, rising inventories, and estimates for semi-companies that are likely to decline. A recent rise in the Philadelphia Semiconductor Index (PHLX) to 414.94 today, from about 386 two weeks ago, is merely a bounce from what had been an oversold condition. Shah thinks the Philly may drop further, to 340 or 350. As far as demand, Shah notes that US durable goods order data shows that consumer electronics sales peaked in the US in September of last year and have been down every month since then, year over year. The June quarter’s trends in consumer electronics “represent the weakest performance since Q1 of 2009,” he writes.

Even though the Philadelphia Stock Index and the Semiconductor Industry Association reported positive chip sales for the month of June, analysts believe that some chip companies are building inventory in excess of demand.

Ever since an earthquake and tsunami leveled parts of Japan in March, the supply chain has been on pins and needles regarding component supply. Immediately after the quake, many companies began buying inventory in anticipation of possible shortages — Japan is the biggest supplier of semiconductor wafers and related materials in the world.

Many experienced industry watchers — most notably Future Horizons' founder and CEO Malcolm Penn — believe the supply chain has “leaned” itself into a dangerous position by carrying just enough inventory to build to order. (See: Tech Needs a Healthier Supply Chain, Part 1; Tech Needs a Healthier Supply Chain, Part 2; and Chip Market Copes Well, Post Quake: Part 2.) Penn and others have argued that electronics companies have to move closer to the supply chain models of yesteryear, when inventory was built to forecast, leaving a little wiggle room in the event of a disaster such as the Japan quake.

It's true that in the past — most notably the downturn of 2000/2001 — high levels of inventory cost the industry billions of dollars when demand ground to a halt. Since then, the supply chain has improved forecasting and communication practices, so it isn't caught entirely by surprise when supply exceeds demand. Industry executives point to the relatively quick recovery from the 2009 recession as evidence these practices are working.

The industry seems to have evaded the undersupply problem for now — chip inventory that was viewed as too high in December has largely offset any quake-related shortages. So it looks like Wall Street, at least, believes things are returning to normal.

Here's the problem with “normal” — inventory levels in the electronics supply chain are being determined by the financial market and not by companies themselves or operations managers. As long as this is the case, a “new normal” isn't going to appear.

2 comments on “Inventory Levels Challenged Already

  1. Daniel
    July 7, 2011

    Barbara, you are right. After the recent happenings in Japan, most of the companies or vendors are over concerned about supply issues. That means over buffering products, which is causing an overloaded responsibility. The excessively accumulating parts can cause capital damage, which is increasing the investment cost and hence blocking the profit from that investment up to a certain period. Most of the companies are diverting the developmental cost for such activities, and hence reflecting a corresponding drop in their profits.

  2. Jay_Bond
    July 7, 2011

    Inventory levels seem to be an issue in many market segments. Where do you draw the line and have too much inventory that hurts the bottom line? I agree with your comment about how inventory levels are being viewed. I think they should be based on companies needs and sales and not be driven by financial motives. Companies that are doing well financially but don't have the required inventory to meet demand will face financial issues when their sales aren't met.

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