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.)