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Power Shift Moves Distributors Closer to Center of Supply Chain

The center of power in the electronics supply chain has fractured. OEMs, once by far the dominant players in the system, have wittingly or unwittingly yielded control to other elements of the supply chain, creating a situation where power has become widely disaggregated within the industry.

It's not easy anymore to know which of the four or five groups of players in the industry — OEMs, EMS providers, semiconductor and other component manufacturers, and distributors — now has the most power or at least the ability to coordinate the activities of the other participants without sparking a firefight.

This is not just an academic discussion. For decades, OEMs played the role of arbiters, assigning functions to other players and determining their positions on the supply chain totem pole. This allowed participants to better coordinate their activities by having a single reference point and a mediator when things got rough, which in the cyclical electronics industry used to be every three years or so. OEMs decided who supplied or manufactured what, where and when it would be delivered, and, critically, who had the liability for unused or unwanted components.

Until now. The result of EBN's latest poll demonstrates how massively power has shifted from the old guards and become widely dissipated among participants in the industry, benefiting some groups and leaving the old masters a pale shadow of what they once were. Component suppliers, including semiconductor companies, were seen by more than 40 percent of respondents as having “the most power today in the high-tech supply chain,” followed by OEMs, with 18 percent and distributors 17 percent. Contract manufacturers bring up the rear with 14 percent. Almost 10 percent of respondents said they were not sure who now wields the most power within the industry.

Here's why this shift matters and what it means for the industry's future. Primarily, it marks the first sign many of the industry's once weakest players have shifted their focus and steadied themselves enough to win respect and validity. It also means the days of one set of players playing others against each other may be over for good. OEMs can no longer use their purchasing power to force corrosive price concessions on suppliers. In any case, the ranks of suppliers have become so thin, and the survivors have become so artful at defending margins and improving productivity, the pressure has become less intense.

A little bit of the industry's more recent history will serve us here. Component suppliers were crushed during the harrowing recession of 2000 to 2001: Many vendors folded, especially communications IC suppliers; others were acquired for less than one-third of their capitalization at the peak of the expansion; and sales atrophied, resulting in a savage, price-driven tussle for market share. Interconnects, passives, and electromechanical companies were badly hurt during this process; many OEMs refused to honor procurement contracts, including those presumed ironclad.

Felix Zandman, chairman of passives supplier {complink 6199|Vishay Intertechnology Inc.}, told me in an interview at the height of the crisis that many contracts “were not worth the paper they were written on.” Even so, Zandman's company hauled some customers to court to enforce its rights. It succeeded in at least one instance, but many of Vishay's biggest customers got off scot-free — pursuing them would have jeopardized future business relations, conceded Zandman.

That scenario is unlikely to be repeated today. Suppliers have become more astute and no longer rely solely on forecasts provided by OEMs, EMS providers, or even research firms. They still review these numbers but regularly look deeper into the supply chain to gauge actual end-customer requirements. By coupling this with OEM/EMS provider forecasts, suppliers have developed better insight into their own production requirements. Fab expansion activities are also now based on more than forecasts; sometimes suppliers would rather crank up existing facilities above the sustainable level of 95 percent or more than install new equipment.

What has resulted is a tighter supply chain with little margin for error. Whether the industry will pay a price for this in the event of a sudden surge in demand is unclear, but the power disaggregation means the risks will be shared more evenly. That's maturity, by the way.

One group that has done fairly well in this situation, and perhaps even better than components suppliers, is distributors. Like the semiconductor industry, distribution has also gone through the wringer. Many of the smallest players — and even midsized companies — have been gobbled up by the two largest players, {complink 453|Arrow Electronics Inc.} and {complink 577|Avnet Inc.}. The consolidation and reorganization of the sector hasn't been all about reducing the number of players, however. Survivors have also moved more deeply into the supply chain. Distributors now offer design or design support services, vendor management, subassembly, logistics, and other product management functions.

These higher-margin services have made distributors essential constituents of many OEMs' supply chains. They've also helped distribution push up margins. EBN poll respondents may be right in suggesting chip/component suppliers are now more powerful than any other group within the industry, but my feeling is distributors will also be moving on to a higher weight division.

10 comments on “Power Shift Moves Distributors Closer to Center of Supply Chain

  1. Barbara Jorgensen
    January 4, 2011

    The distribution channel has been trying to prove its value to the supply chain ever since the Internet was poised to cut the middleman–i.e., distributors– out of the equation. This hasn't happened for a number of reasons and the first is distributors provide services no one else in the supply chain wants to. Suppliers, OEMs and EMS companies don't want to hold inventory–distributors do. Suppliers, OEMs and EMS don't want to deal with upside or downside in forecasts–distributors do. Suppliers, OEMs and EMS companies don't want to break down bulk orders even if it means buying more products than you need. Distributors are willing to do this.

    Even if you put services aside, the fact is Arrow and Avnet are now bigger revenue-wise than most of their suppliers. Suppliers used to use their size as clout so distributors and to some extent, customers, did things their way. Now, distributors have enough leverage–and enough alternative suppliers–that no one supplier holds all the cards. The fragmentation in the supplier market is good from a number of standpoints, but clout in the channel isn't one of them. The tail can now wag the dog, but I haven't seen a lot of evidence of that. Distributors are well aware of the fact that their suppliers control the technology and customers control the orders. It's in distributors' best interests to keep both groups happy.

  2. DataCrunch
    January 4, 2011

    I voted on the poll that OEMs have the most power in the electronics supply chain based on the points that Bolaji writes about during their decades of power.  Before reading the article, I wasn’t thinking that the shift of power would be towards the suppliers.  Then I started thinking about a company like HTC, which many of us haven’t heard about until a just a couple of years ago.  HTC devices were often branded by other companies, such as Palm Treo, T-Mobile G1 as a couple of examples.  Now HTC is a powerful brand name with its own identity and has become extremely popular.  Here is where I can see that the supplier is becoming more powerful than the OEM, especially when they potentially start competing with them.    

  3. elctrnx_lyf
    January 5, 2011

    Even I voted for OEM may be because I always worked in such big OEM's who can actually dictate terms to the any big distributors and suppliers. But defnitely there is a power shift since the suppliers and the distributors evolved over the years into more stabilized supply chain. Suppliers shall certainly be thankful to distributors who are able to connect them to the OEM's.

  4. bolaji ojo
    January 5, 2011

    Dave, OEMs still pack a lot of clout in the industry but their ability to simply lay down the “law” and expect unswerving loyalty has been sharply curtailed. By stripping out so-called non-core functions, including manufacturing, and spinning off component businesses, they lost control over the system. Also, as you pointed out, some component suppliers have grown rapidly over the years and are now much bigger than their OEM customers.

    The largest OEMs, for example, Apple, HP, Dell, Lenovo and Nokia can still dictate terms to some extent but even in this case they have to listen to the supplier. Foxconn is one company that cannot be pushed around. It's sales in 2010 should be above $100 billion. It is a contract manufacturer for Apple, HP, Nokia, etc. but it is as much now their equal as it is their supplier. They helped make the company what it is today but they cannot unmake it.

  5. Anna Young
    January 5, 2011

    Well, I am not suprised at the changing of the old guard but I agree that distributors are not too far behind from the corridors of power.

  6. Ken Bradley
    January 7, 2011

    Bolaji, this is a really good and thought provoking article.

     

    I voted for component suppliers primarily because of recent supply constraints, but would vote OEM in more typical times of material availability. I think that the power ultimately resides with the group that controls the design socket win / buying decision. This is usually the OEM unless they abdicate this role to someone else through 3rd party design or the component supplier that has created a product of highly differentiated value that is a “must use” in OEM solutions. Stated another way the power resides with those who create the business flow.

     

    Your comment about the growing power of distributors is at odds with my perceptions and beliefs. While I see the distribution role as important, there are many signs that they are struggling which I would equate to not growing in power. The primary ones are:

    ·         The five year trend in the top 2 distributors’ gross margin is decreasing (15% to 12%). This suggests a reduction in customer perceived value.

    ·         Distributor inventory turns are about three time that of semiconductor component suppliers. This make me question if they are providing the core service of inventory availability as they have historically.

    ·         The distribution model is a western idea, which is not taking hold in Asia. Distribution growth in Asia is mostly from western companies moving there; not from a compelling value proposition that Asia can’t resist.

    Distributors are expanding service as you say by displacing many traditional sales representatives, and offering commodity 3rd party services like design. These services are necessary and important but distributors have tough negotiations with OEMs and suppliers as their margins show.

     

    I am not convinced that their power is growing; I don’t believe they will ever control the flow of business.

     

  7. itguyphil
    January 7, 2011

    Wow, it surprises me to hear the Foxconn #s. I remember someone chatting about them a few years & I had no idea who they were… now 100B. That's impressive.

    I think that they, in the positions that they are in must demand alot of respect while subtly controlling the marketplace. Do you think they have limitations on the vendors that they work with or they choose to only work with such partners?

  8. bolaji ojo
    January 8, 2011

    Ken, I am similarly not convinced that distributors would ever be the top power players in the electronics supply chain. Their role does not dictate this and as you pointed out the margin erosion they've experienced is also indicative of their position. However, they've managed to stem the margin erosion much better than initially thought and they continue to search for relevance in the system.

    I believe that their margins would be even lower if they had not fought back with extra services and also refused to toss in value added services as part of the package, something many OEMs want. I would like to contrast the value proposition and position of distributors with that of contract manufacturers. Sometimes I wonder why EMS providers even engage in the business considering they have among the lowest margins in the industry. OEMs passed onto them the operations they believe offer the least value in the supply chain.

    I would like to know what you think of all these different players and how the OEMs position has changed. I would have expected someone like you who held a critical procurement executive role at a major OEM would have voted for OEMs but the fact you didn't makes me question why we should continue to see them as the alpha male in this pack. Why has the clout OEMs had in the supply chain declined; is this a temporary decline as you stated or will it be permanent and; finally, is the power dispersal in the supply chain necessarily a good or bad development?

    In other words, how will this disaggregation of power affect the ability of any players in the supply chain to influence value and hence pricing? Perhaps you could address these questions in one of your next blogs and help us understand how these changes impact pricing conditions.

  9. bolaji ojo
    January 8, 2011

    Foxconn's ability to influence the supply chain is often limited by the size of the OEMs they work with. Their impact on procurement spending at companies like Apple, Dell, HP and Nokia, for instance, is limited by the fact the customers are themselves huge companies. All these companies pick component vendors for critical and high-volume parts. They like to keep the added savings from purchasing contracts and also maintain control over their component requirements.

    Foxconn is able, though, to get some savings for itself from handling non-critical work and in offering sub-assembly services. It has also been pushing into additional value added services and making acquisitions that would help boost its margins. This is an incredibly powerful company in its own rights but its influence is essentially in the labor area, which is why OEMs value its services.

  10. Ken Bradley
    January 9, 2011

    Bolaji, we seem to be in agreement on EMS and distributor importance and roles. My thinking is biased by my background in telecom as an OEM CPO and previous experience in technology running Nortel’s Semiconductor Group. I will take your suggestion and expand my thinking on power in a future blog but for now I see power, that is who really influences pricing, to be in the hands of those enabling the flow of business and creating the demand. This usually links to value creation and differentiation which is most often tied to design in technology companies.

    While still powerful, I believe the power of many OEMs has weakened in the past 10 years as their products have embraced more and more third party application specific silicon. What now constitutes design in many of these OEMs is re-layout of a reference design from an ASSP silicon supplier who has become the one creating the end system performance, differentiation and value. This is one reason why I raised the power of component suppliers through my vote. This is not a simple equation as there are many factors involved in creating value and differentiation. I believe that OEMs who truly develop their technologies are and will continue to be the strongest, most powerful players in the supply chain stack.

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