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Why the Supply Chain Is Stronger

During yesterday's chat with Matt Sheerin, senior equity research analyst and managing director at Stifel Nicolaus & Co., readers (astutely) questioned his assertion that supply chain companies are in better shape now than they were before the recession hit in 2008-2009.

With events such as Japan's earthquake/tsunami, the wild swings in the stock market, and entire countries drowning in debt, it is hard to see how this can be the case. Here's Sheerin's take:

    First, balance sheets are quite strong — the distributors all generated a ton of free cash flow as revenue fell (they just worked down inventories and receivables) — and many companies lowered their fixed costs dramatically — so as revenue came back, we saw a big jump up in profits.
    On [distributor inventories], yes, all of the [distributors] got ahead of themselves, but they are pretty quick to work them down, hence the pain the suppliers are enduring right now.

We didn't have the time (or typing capability) to go into too much detail yesterday, so I thought I'd supplement Sheerin's observations.

When things turned ugly in 2008, suppliers immediately cut back on staff and capacity. Usually, their response to shifts in the market mirrors the market itself — dramatic cuts followed by dramatic rampups. That didn't happen this time. When the electronics market appeared to begin recovering in early 2010, there was not a lot of hiring, and capacity expansion was extremely cautious. Net result: Suppliers don't have a lot of overhead right now, and costs are more aligned with revenue as it begins to slow down.

Distributors also cut staff and kept a tight rein on inventory. They also built up cash reserves and focused on internal efficiency. For example, even though the market was tanking, {complink 577|Avnet Inc.} went ahead with two new state-of-the-art distribution centers. Distributors recognized a while ago that everything associated with an order — managing inventory, pulling, packaging, and delivering — incurs costs along the way. Simplifying the process saves costs.

{complink 453|Arrow Electronics Inc.} invested in reverse logistics: services that take excess or unused inventory off shelves. This helps the customer's balance sheet, and distributors often can return unused inventory to suppliers. They also can sell it to another customer. This better use of inventory helps prevent buildup within the channel.

Finally, customers have made an effort to be more transparent with their suppliers — both component makers and distributors. Customer forecasting is at best an inexact science, but suppliers have learned to use historic purchasing trends as a reality check against recent orders. To make this work, customers have to trust their suppliers to use this information wisely (not to share it with competitors, for example). Customers also have to be receptive when a supplier flags an anomaly. Again, this type of activity helps avoid inventory buildup in the channel.

The end result is a supply chain that corrects itself more quickly than ever. In the most recent earnings period, global distributors Arrow and Avnet said their inventories began to build in anticipation of customer orders. Those orders began to slow in late June and early July. As a result, distributors are already looking at the mix of inventory they carry and are not buying a lot of additional stock. Suppliers may be feeling the pinch — some of that stock is still sitting on their shelves — but the channel is pretty confident inventory will correct itself within the next quarter.

The supply chain is understandably cautious going into the second half of the year, Sheerin says. “We are modeling both the Sept. and Dec. quarters to be below seasonal for component/semiconductor suppliers and distributors due to this correction, but demand will ultimate dictate how it plays out.”

The supply chain still has a lot of imperfections, and EBN's readers, bloggers, and guests will continue to point them out. But most supply chain companies are not repeating the mistakes of the past, so the industry has positioned itself to weather the next market storm.

5 comments on “Why the Supply Chain Is Stronger

  1. AnalyzeThis
    August 24, 2011

    I participated in the chat, and yes, one of my key takeaways from it was perhaps my lack of perspective: as rocky and uncertain as things in this space are, we are better off now than we were a few years ago.

    And as you mention, many companies have used the downturn as an opportunity to optimize: when things are going well, there's sometimes little incentive to become leaner! Also, there are obviously opportunities to use the downturn to your advantage by making long-term investments in your company at a long-term at a lower cost than during the boom times.

    Anyhow, there is still plenty to optimistic about. I still think the next couple of months may be interesting, but if we all step back and look at the bigger picture… I do agree that we are stronger and in a better position than when, as you say, “when things turned ugly.”

  2. mario8a
    August 25, 2011

    HI DennisQ

    I also participated on the chat and I agree with you we need to see in the next couple months the behaivor of the supply chain and the market on the holiday seasons.

    maybe we need another hour of livechat

  3. Tim Votapka
    August 25, 2011

    Necessity levels due cause some interesting advances.

  4. Barbara Jorgensen
    August 26, 2011

    DQ–not lack of perspective, just the focus on the day to day. It's easy to lose focus on the big picture when the next deadline is always looming. That's why communities and chats are so great–everybody gets to share their perspective. Our readers and moderators are closer to the trenches than I, so i rely on you folks for a reality check. And reality is, the day to day is a challenge

  5. Himanshugupta
    August 28, 2011

    Barbara, while reading the article something caught my attention. The article says that when things turns to better in 2010 then there was not lot of hiring, which would mean that the work load on the existing employees would be high. How did suppliers balance the work pressure? Was there some bench strength to absorb the fluctuation in the supply chain. 

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