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The Real Phantom Menace

Mark Ellsworth's most recent blog got me thinking (always a bad sign) about the nature of the electronics supply chain. (See: Where Is the Electronics Market Headed in 2012?) This is an industry that's always looking forward, which is part of the reason it is still so vital today. But every once in awhile, a little regression is in order, and I think this is one of those times.

Let's go back to the days when “inventory” wasn't a bad word.

First, I have to admit I'm biased toward hardware — that's how I came up through this industry. Companies build components, components pass though a channel, somebody buys them, and so on. Somewhere out there (let's say at a distributor, for argument's sake), somebody was holding inventory. “You can't make a sale if you don't have the product” was the operating theory.

Then came just-in-time (JIT). The aforementioned components are now shipped just-in-time for consumption on the manufacturing floor. A great idea, even if it is heavily skewed toward the needs of the OEM/EMS constituency. Still, component makers and distributors were holding the physical goods.

But JIT has continued to move up the supply chain. Now, component makers want to build parts JIT for their customers. And that's where the model breaks down. If you take JIT far enough upstream, inventory itself becomes theoretical — nothing is built until there's actual demand. No matter what, it still takes 8 weeks or longer to build a component. If you see leadtimes of less than 6 weeks, it means something is in stock. So until we breach the time/space continuum, JIT only works the closer you get to the end-product.

There's also the dilemma of “phantom inventory.” I learned about this through a practice in distribution called ship-from-stock-and-debit. (The longer a name is, the more complicated the practice.)

Here's how it works: a customer orders X amount of product from a distributor but wants to pay less-than-X price. The distributor goes back to the supplier, who allows the distributor to charge X-minus-whatever. (Authorized distributors are prohibited from undercutting suppliers' prices too steeply.) The distributor has already paid the supplier for the product. The difference in price is reflected in a credit the supplier extends to the distributor toward the next purchase. On the books, this credit looks like inventory, but it is inventory the distributor doesn't have. So the next time the distributor gets an order for X, that distributor may actually have less product on the shelves than the order demands. In a JIT world, that order becomes a signal to the supplier that more X needs to be made. In the meantime, the customer has gone elsewhere for the inventory. The distributor loses all or part of the sale because — you got it — it didn't have the product.

The fact is, most electronics are still built on forecast. This was illustrated late last year after the Thailand flood disaster. Several sources, including EBN's Asia Time contributor Marc Herman, reported that there was no shortage of disk drives prior to the Christmas holidays because those orders — based on forecasts — had already been produced. It was the post-holiday orders that were going to come up short, and the industry is still waiting to see the effect. Many OEMs are putting off those orders until the global economic picture becomes clear.

Will manufacturers be able to respond JIT when demand finally recovers? I doubt it. Lead times will begin to stretch, and so on. A familiar cycle repeats itself.

What I've seen happening over the years is the back-end of the supply chain: the distributors and suppliers scramble to become more flexible, robust, resilient — whatever the word of the day is. All of this effort is expended by dozens of companies in order to meet the needs of one organization — the OEM. I'm not saying this is wrong: the customer, after all, is king. But how much effort has been expended recently by the end customer regarding forecasting techniques?

The last really revolutionary breakthrough I can remember is Dell's build-to-order (BTO) model, which works if there is inventory somewhere in the channel. Maybe there are just fewer OEMs out there, or it is the EMS companies that are making all the forecasting breakthroughs. Maybe my colleague Bolaji Ojo hit the nail on the head when he writes: “OEMs have become so specialized that their ability to see beyond and operate outside of niche products has withered completely.” (See: Another Outsourcing Product: Lost Knowledge.) The fact is, the supply chain has accepted that forecasting is always wrong, and it is up to the supply chain to handle it.

When inventory begins to build, Wall Street starts to worry, and someone gets “punished” for it. It is usually the distribution channel and component suppliers. One exception comes to mind: Research in Motion (RIM), an OEM, is being “punished” by Wall Street for having too many PlayBooks in stock. (See: RIM’s Struggle to Succeed.) But what if that was unfinished goods residing elsewhere? Would RIM be taking all the blame?

If vertical integration can make a comeback, why not inventory? (See: The Virtues of Vertical Integration.)

17 comments on “The Real Phantom Menace

  1. _hm
    January 4, 2012

    It is quite complex process and is really difficult for designer like us to digest it. RIM wrongly got punished. I wish they soon comeout with innovative products.

     

  2. Daniel
    January 5, 2012

    “I'm not saying this is wrong: the customer, after all, is king. But how much effort has been expended recently by the end customer regarding forecasting techniques?”

    Barbara, customer is the king but others are putting a lot of efforts in order to make customer as a king. He may not know such efforts and that too are not accounted anywhere.

  3. rohscompliant
    January 5, 2012

    RIM is a bad example because it's product was rendered obsolete before it hit the market by you guessed it APPLE's new products. My company buys E & O products of all types and resells them. I cannot begin to tell you how many 'potentially great' products are duds by the time they finally hit the market. The crux of the problem is that slow moving giant corporations are extremly slow at rolling out 'potentially great' products ( see HP) that smaller more nimble company's leap frog the behemoths technology to push the latest & greates wizz bang devices that we all want. Case in point i just bot my son for XMAS a Sony VAIO laptop …….it is already obsoleted by the IPAD……..and soon it will be obsoleted by other 'always on' products that will be using SSD's instaed of HD's!!!!

  4. bolaji ojo
    January 5, 2012

    rohscompliant, That explains why RIM postponed the introduction of its next-gen product and operating system. This has been pushed out almost one year. By the time it finally brings these out, rivals like Apple, Samsung and even Motorola Mobility, would be getting ready products that would beat the new RIM products. It's the way of the market and for too long, RIM played in the enterprise segment where new product introduction can take one to two years. In the consumer electronics market six months is a long time.

    Your example with Apple is an interesting one, though. There are people in the market who are beginning to think Apple's products are looking stale compared with the legion of Android devices.

  5. rohscompliant
    January 5, 2012

    A very good point by you!……….These company's should learn from a nursery ryhme that starts; 'Jack be nimble Jack be quick'………….to market that is.

  6. Barbara Jorgensen
    January 5, 2012

    @Jacob: as they say, “It's good to be king”

    🙂

  7. bolaji ojo
    January 5, 2012

    rohscompliant, I love someone who can talk songs and apply it to supply chain. So, here's my contribution from the song “Love will Save the Day:”

    You gotta be

    You gotta be bad

    You gotta be bold

    You gotta be wiser

    You gotta be hard

    You gotta be tough

    You gotta be stronger

    You gotta be cool

    You gotta be calm

    You gotta stay together

     

     

     

     

  8. rohscompliant
    January 5, 2012

    the market (if left to it's own mechanism's and without gvt intervention) does not punish a company. Company's punish and in effect destroy themselves. RIM is reaping what it sow's by not being aware of what it's competition is doing……..'my competitor is the one with a better work ethic than I.'

  9. FLYINGSCOT
    January 6, 2012

    Very interesting article and somewhat scary with the example of distis having credit accounted for as virtual inventory.  Until people accept that things need to cost a little more to secure delivery (ie. inventory is held) I fear the situation will only worsen.

  10. Eldredge
    January 6, 2012

    @Barbara

    Good overview of the issues with JIT approach. A perfect JIT implementation requires perfect knowledge of what deliveries are required when (perfect forecasting), combined with perfect manufacturing (product produced on time with no scrap/rework, or at least with the forecast amount of scrap and rework), and perfect acquisition of the raw materials for making the product. Even within one supplier, perfection in the chain can't be acheived. Now add a few layers of suppliers in the chain, and the imperfections snowball without some level of safety inventories. So part of the supply chain management function is to manage those imperfections, while other functions in the manufactuing cycle work on reducing the imperfections.

  11. Barbara Jorgensen
    January 6, 2012

    Thanks Eldridge. I do see the value in JIT when you have finished goods on hand, such as Dell has with its PC business. I can also see how leadtimes can be accommodated into a JIT model. But there are now so many nodes between the end product order and the raw materials it is impossible to account for all of the things that can throw a JIT system off. Suppliers are also loathe to penalize customers that forecast badly. A “you order it, you own it” policy might go a long way toward more accurate forecasting.

  12. itguyphil
    January 6, 2012

    As my 2 cents here, Dell has even had some issues with that model recently. Throw in a natural disaster or two & that model gets turned upside down.

  13. t.alex
    January 7, 2012

    For this model to be reliable, i guess it is important to have more than one trustworthy supply source for every components. That is not so simple to achieve, anyway.

  14. itguyphil
    January 8, 2012

    t.alex,

    Those are 2 words that take a looooooong time to have faith in in industry:

    trustworthy
    reliable

    Even if you were lucky to be in that scenario, when things go bad, usually everyone in the chain is affected, so there might not be a simple escape route.

  15. Barbara Jorgensen
    January 10, 2012

    Good point about always having an alternative supplier to fall back on. The downside of this, for an OEM, is the OEM has less visibility and therefore clout if it splits its buy between two vendors. But the single-source strategy is also risky.  If anyone has figured out the happy medium, please let us know!

  16. t.alex
    January 18, 2012

    Yes, it is so true. It is even so important to have vendors that will not turn against us during bad times.

  17. itguyphil
    January 19, 2012

    That's the hard part. Unless you are a consistent point of nice revenue for them, you are expendable. Trying to get on that good side is tough when there's so much competition betweem you & the next customer.

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