The Customer Sneezed: What Happens Next?

This is as good a time as any to determine how immune your company is to events in the larger economy and, more important, how it fits into the customers' supply chain. The latest second quarter results indicate electronics equipment manufacturers are not immune to a softening global economy, which means component suppliers, contract manufacturers, distributors, and other vendors are hurting too.

Companies like {complink 3847|Nokia Corp.} have announced disappointing results, and even {complink 379|Apple Inc.}, until now (and perhaps even now) the darling of the investment community, posted weaker-than-expected June-quarter results. If OEMs are feeling so much heat, what is happening within their supply chains? Which companies are toppling over? Which ones are coping resolutely? And what are the factors determining the level of impact on suppliers? Further, how are suppliers and other supply chain support service providers responding to the changing needs of the OEM customers, and what can be done to both share the pains and assure continuity of supplies when demand strengthens again?

These are not idle questions. A good understanding of the value a customer places on its extended supply chain is critical to success for all parties involved in a business relationship. This knowledge reinforces the kind of support structure and other resources a supplier or distributor is willing to put in place and maintain during times of demand weakness, and it also allows for longer-term planning on both sides. Failure to put in place such contingency plans can result from one or both parties declining to provide sufficient information about their current exposures or refusing to provide forecasts that would help partners in their own demand and supply planning.

Research firm IHS Corp. noted this in a recent report highlighting semiconductor buying patterns within the electronics industry. News reports focused on the more striking part of the report — that is, the part about how Apple is the biggest consumer of semiconductor in the high-tech industry. Apple, according to IHS in a press release, “is not only the world's leading original equipment manufacturer (OEM) in terms of semiconductor purchasing, the company also is increasing its buying at a faster rate than other top firms, solidifying its hegemony over the chip market.”

That's good to know, but it represents merely another factoid in a market already chock-full of titillating but irrelevant data. What's more important to the electronics supply chain, in my opinion, is OEMs' semiconductor spending patterns in the consumer electronics and automotive markets. In its report, IHS asks questions that I believe all members of the worldwide electronics supply chain, especially suppliers, distributors, and contractors, should be asking as the economy continues its current zigzag performance. They include the following:

  • On which customers should I focus my selling resources?
  • To what degree does my OEM customer outsource, and how does that affect my selling process?
  • Where should we align our resources — technical support, sales support or customer service?
  • As a buyer of semiconductors, how does my market power compare to other OEMs?

These are not questions anyone can answer for your company, and your enterprise can't develop a plan in response to them without some input from business partners, customers, and even end-users. Chip suppliers and manufacturers of other electronic parts that have developed best-practices recognize the critical role components distributors play in helping them respond to developments at the OEM customer. Ignoring input from distributors can actually be destructive to your business considering their reach (the top distributors have literally tens of thousands of customers) and impressive knowledge of demand patterns.

One other way to use distributors at a time like this is to leverage their presence in multiple regions and markets to expand the customer base. The biggest OEMs that buy billions of semiconductors, interconnects, passives, and electromechanical components often go directly to manufacturers and use distributors only to buffer their stocks or during periods of supply imbalance. As a result, their presence can result in a distorted view of actual market realities.

To avoid such opacity in market conditions, focus on generating information from all corners of the supply chain. Even as companies report results and complain about the demand weakness in the global economy, it is extremely difficult to determine how your business would be affected by these developments by focusing solely on the major customers. Cisco, for instance, is forecast to remain the No. 1 buyer of semiconductors in the Americas in 2012, but its position is certain to change in the near future, according to IHS. But what exactly does that mean for all its suppliers, contractors, and distributors?

“Cisco leads Apple in the US because it maintains a larger number of design centers there,” IHS said in the press release. “The company also has higher spending on consumer electronics-related chips for set-top boxes, and it makes large semiconductor purchases in support of its business in wired communications equipment in the region.”

A closer look at Cisco's fiscal third-quarter results for the three months ended April 28, for instance, indicates the company may be struggling in the wired communications sector and — similar to other OEMs — is cutting back on inventories, which means suppliers may get reduced orders for the near future. How are Cisco's suppliers and distributors responding to this move?

It's inevitable that an OEM's supply chain will feel some impact when the enterprise is either unable to meet its sales numbers or experiences rapid and unexpected demand surge. Each member of that company's supply base will both react differently and be affected to varying degrees. What separates winners from losers is how much information they have about the customer and the level of preparedness.

To answer the question at the top of this page, when an OEM customer sneezes, the supply base is certain to catch a cold — some will be knocked out flat, while others will quickly bounce back. There's a lot of sneezing going on right now. Is your company prepared?

8 comments on “The Customer Sneezed: What Happens Next?

  1. bolaji ojo
    July 31, 2012

    Rich, Trust you to put it bluntly!

  2. Barbara Jorgensen
    July 31, 2012

    It is interesting to listen to earnings conference calls and understand just how interconnected the supply chain is. OEMS are hurting and they are cutting costs. So are their suppliers, distributors and presumably EMS companies. Now, if corporations were vertically integrated, would the damage be as extensive?

  3. ahdand
    July 31, 2012

    Well this is a good sign for the future of Nokia since that will make them think diffeently.

  4. bolaji ojo
    July 31, 2012

    Barbara, Great question: “If corporations were vertically integrated, would the damage be as extensive?” Simple answer: It would be but the extent per company would depend on the level of integration and the exposure depending upon which market they participate in. I wouldn't want to be the executive holding both the components and end-equipment bucket right now.

    In the current climate the burden is unevenly shared but it's not on a single firm. It also means suppliers are looking more carefully at end-market data to determine their potential exposures and responding more swiftly.

  5. dalexander
    July 31, 2012

    @Bolaji, is there a ratio other than book to bill that distributors can calculate how much stock to keep on their shelves during boom or bust time? Can distributors share the risk with their suppliers such that they can return goods that are in less demand suddenly? I do not understand the inner workings of an electronics distributor and it would be great to have someone from a distributor comment. To me, managing a stock level through thick and thin times, would be a very daunting time. The cost of carrying inventory could become disproportionately high if the big chips stop moving off the shelves as anticipated. Seems to me that a lot of cash could be tied up in non-moving inventory at the distribution level.

    August 1, 2012

    I reckon we are in a period of long term flu and most companies are already taking whatever precautions they can.  There is talk of a triple dip recession in Europe just now and it is likely to continue for some time to come.

  7. Barbara Jorgensen
    August 1, 2012

    Hi Douglas: I can answer that. Distribution uses a number of metrics in its planning process: the book to bill; days sales outstanding (DSO) and inventory turnover. The btb is a measure of future demand; DSO of customer financial health; and inventory turnover, volume (vs. sales). Distributors have gotten better at reading between the lines and not just taking customer orders at face value. Inventory turnover in electronics averages about 6-7x per year, and even when prices go down, that rate indicates shipments are still going out the door.

  8. ahdand
    August 6, 2012

    Well you cant always judge like tha but you do have a valid poin but things can change in seconds isnt it ?

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