OEM's are usually kept in the dark about where component prices come from, who really controls them, and how to discover the best deals. OEM's turn to contract manufacturers, believing contract manufacturers buy in volume and get better component prices than they can. However, relying on contract manufacturers may not really be the best way to drive electronic component pricing.
Three factors matter a lot in component pricing: your geographic location, your total spend in that components commodity type, and the volume you are procuring, according to Lytica.
Here are two things that don't matter so much: distributors and contract manufacturers.
Surprised? Disagree? Contract manufacturers turn to distributors (and sometimes direct to semiconductor suppliers) for pricing. So to explain, we first need to describe the fundamentals of how electronic component distribution works.
We often hear the terms authorized (or franchised) distributors, and unauthorized distributor (also called brokers or independent distributors). Authorized distributors are usually listed on the semiconductor suppliers website, often under “where to buy”, anyone not listed is likely unauthorized. Authorized distributors have special agreements in place with semiconductor suppliers allowing them access to privileges like passing through specification guarantees, warranty support, preferred pricing, component availability, and factory support.
Two privileges in particular distinguish authorized distributors; stock rotation, and ship from stock and debit programs (called “debit” for short). Stock rotation is the privilege to return non-moving inventory to the factory in exchange for more in-demand products. The debit system is core to how components are priced.
3 Types of Price: Book, Direct & Broken
There are three common types of price for electronic components:
Book Price: This is the price you see online at distributors like DigiKey, Arrow, and Avnet. It is usually separated into volume levels, i.e. 1-50, 50-100, 100-500, etc. In almost all cases this price reflects the suggested price published by the semiconductor supplier. In reality the distributor is paying a set cost to the semiconductor supplier (the “book” cost) and price variance you see online reflects variance in the distributor's profit margin. The semiconductor supplier can only suggest the resale; the distributor is free to adjust the margin however they see fit. The distributor may have a preferred price model for certain OEM's; this means they are adjusting their margin especially for that OEM, but it is still based on the standard or “book” cost they pay to the semiconductor supplier.
Direct Price: This is the price quoted direct from the semiconductor supplier to the OEM (no distributor) in the increasingly rare situations where the semiconductor supplier has agreed to sell direct to OEM's who buy in very large volumes or have strategic value to the semiconductor supplier.
Broken Price: This is the most important price type for production procurement. In competitive bids the semiconductor supplier might agree to “break” the book cost paid by the distributor. This pricing is sometimes referred to as broken pricing, special pricing, contract pricing, or just debit pricing. They are all expressions for the ship from stock and debit program used by almost all semiconductor companies and their authorized distributors.
Ship From Stock & Debit: How Debit Works
Semiconductor suppliers sell inventory to authorized distributors at the book cost. It doesn't matter how many components the authorized distributor buys, they will always pay book price and carry the inventory at book price. This is almost universally true for components of any value, exceptions include low value passive devices which typically don't have a large impact on total bill of materials (BOM) cost.
When distributors have a significant opportunity at an OEM account they turn to the semiconductor companies and request special pricing. The first thing the semiconductor company asks is, “who's the customer?” This usually means, at a minimum, the name and geographic location of the customer. If the semiconductor supplier wishes to extend a special price to the OEM, they issue the distributor a debit number that is to be used only for that OEM. The debit number is an accounting reference the distributor will use when the product ships to the OEM. When the distributor ships an item with a debit to an OEM, the distributors accounting department uses the debit number to claim a credit from the semiconductor supplier. Therefore, the distributor 'ships from stock and debits'.
For example, let's say a distributor has inventory of 1,000 pieces of a semiconductor at a book cost of $1.00. The online prices you see might be $1.50 for 1-10, $1.40 for 10-25, and $1.30 for 25 and up. If OEM Inc. requests a bid from the distributor for 500 semiconductors, the distributor may call the semiconductor supplier and ask if they would like to break book price for 500 units to OEM Inc. The semiconductor supplier agrees and issues a “debit” to the distributor to make the adjusted cost of 500 semiconductors .50. The distributor applies margin to the .50 and sells the semiconductor for .66.
What does the semiconductor supplier care about when deciding whether or not to issue special pricing for an OEM? Where the OEM is located and the size of its commodity spend are the most important factors. Simply put, OEM's with the largest potential spend in the semiconductor suppliers products receive the best pricing.
Region also matters, since some areas are more price competitive than others. Semiconductor suppliers will also favor customers who have strategic value, for example the prestige associated with being on the latest iPhone. The semiconductor supplier also wants access to their products to be as easy as possible for the OEM, so the semiconductor supplier will support whatever authorized distribution/contract management channels the OEM prefers.
The debit system is rarely discussed because it's not in anyone's particular interest to explain it. However, a recent lawsuit between Xilinx and Flextronics shed light on this largely shrouded system. In it's factual claims Xilinx details what is essentially the ship from stock and debit program. You can read Xilinx's description of this system here, beginning at page 8.
The debit system is used because the semiconductor supplier wishes to retain as much control as possible over the price of their products while still getting the advantages of using distributors. If they sold to distributors based on volume purchased by the distributor, the distributors would control the market price of their products, and semiconductor suppliers do not want that. Further, through long experience the semiconductor companies understand that OEM's do not want them to decide which distributor or contract manufacturer the OEM should buy from. Therefore, it is in the semiconductor supplier's interest to make their products available at the same prices to whichever distributor or contract manufacturer the OEM prefers.
Understanding this system is very important to the OEM who wishes to control their pricing and obtain the lowest possible cost. OEM's who understand how the system really works negotiate their pricing directly with the semiconductor suppliers. When negotiating direct the OEM has more leverage than contract manufacturers and distributors because the OEM controls the source selection and design-in decisions. Only an OEM negotiating price directly can threaten to design out uncooperative semiconductor suppliers, or design in cooperative ones. When negotiating direct the OEM can also leverage their overall potential spend with a semiconductor supplier, instead of just whatever line items happen to be in a RFQ.
Negotiating price directly does not mean procuring direct. Once the price is negotiated, savvy OEM's demand their preferred distributors and/or contract manufacturers receive the negotiated price. In this way OEM's assure the best component pricing is available to any partners they choose based on labor cost, quality, service, or other selection criteria.
This is how best in class companies like Cisco and Apple drive cost. But what about small and mid-sized companies? Can they drive cost? The answer is yes, they can take advantage of this system, and in our next article we'll describe how.
What's your experience? Are you one of the savvy OEM's driving cost yourself? Does this perspective motivate you to try something new? Or perhaps you've found an even better method? We'd love to hear from you in the comments section below.