A distribution industry executive reminded me this week of something he said a couple of years ago that has stuck with me ever since: there’s a whole generation of buyers in the electronics industry that has never faced what we call the “A” word: allocation. “That’s neither a good thing nor a bad thing,” said Alex Iuorio, senior vice president, supplier marketing, for Avnet Electronics Marketing Americas. “It just is.”
Alex and I have both been in the industry longer than we want to admit, but his observation got me thinking. Allocation – the practice of limiting the volume of components a customer can buy – was responsible for a whole bunch of industry practices that really messed up the supply chain. It was indirectly responsible for the dreaded Inventory Glut of 2001 when an estimated $13 billion worth of semiconductors that nobody wanted were sitting in the supply chain; Cisco Systems Inc. alone had more than $3 billion of the excess parts. Many executives still wince when the topic comes up: write-offs were in the multi-million of dollars for most supply chain companies.
There hasn’t been a period of extreme allocation and overage since.
If “Allocation” were a game, then players would have to familiarize themselves with some of the rules. These were common practices back in the day components were actually scarce.
To avoid Allocation, players could:
Double-order. One customer places an order with a supplier or a distributor for X number of parts. It then places the same exact order with a second supplier/distributor, and so on. Since distributors and suppliers didn’t communicate very much – they wanted to keep their customers’ identities to themselves – neither party realized the same customer had placed multiple orders.
Play the “Muscle” Card: If you were a big enough customer of a supplier or distributor, you could insist on going to the head of line during allocation. This strategy frequently worked. (But there’s only one Muscle Card per deck.)
Invoke “Arbitrage:” OEMs that ordered too much inventory could resell it in the gray market for more than they paid originally. Buyers could pay a premium for components outside authorized channels.
Of course, there would have to be penalties. If a supplier catches you at Arbitrage, you go to the end of the line during the next round of Allocation.
Other penalties include:
“Ship From Stock and Debit:” If a distributor sells components for less than they paid (to secure a customer or order), they ship-from-stock (fill the order) and debit (take a credit against the next order from the supplier.) This prevents the distributor from taking a loss on the lower-price sale. But it also creates “phantom inventory:” the credit appears on the books as inventory that’s not really there. It creates a paperwork headache for distributors and suppliers and may drive supplier prices down as two distributors compete on price for the same piece of business. Suppliers generally do not like this practice.
The Write-Off: Double-ordering creates inventory in the pipeline. If the pipeline stalls, there is twice as much inventory as there is actual demand. If inventory can’t be sold, the owner of the inventory takes a write-off, or a loss. This eats into profits. To avoid the Write-Off one can shift the ownership of the inventory around. You can use the Muscle Card (force your supplier or distributor to take back the extra) or the Blame Card (“My EMS ordered the parts, not me—it’s their fault.” There’s only one Blame Card per deck) Depending on the skill level of the player, one can avoid the Write-Off.
The problem in Allocation is, nobody wins. The excess inventory in 2001 –created by double-ordering in 1999 and 2000 — hurt OEMs, EMS, distributors and suppliers. Everyone took a hit. Component makers vastly cut back on capacity that hasn’t really returned. Small and midsize distributors were gobbled up by larger ones. OEMs sat around with finished goods that had lost their value because prices and demand had declined. Companies closed and people lost their jobs. The tech industry really hasn’t bounced back to 1999 levels. And suppliers, distributors and customers stopped trusting one another.
The supply chain has improved as a result of the Glut: forecasts are now checked against historic patterns and over-ordering is flagged. IT systems are more sophisticated and software/algorithms keep a close watch on supply and demand signals. Companies have adopted JIT and BTO models, so just enough inventory is out there at any one time. And buyers haven’t really had to play the Allocation game for a decade.
It’s unlikely that the supply chain will ever see the likes of 1999-2001 again. Communication has gotten much better, and hard lessons were learned. But the system hasn’t yet factored human nature out of the equation. Buyers became concerned in the aftermath of the Japan earthquake/tsunami and the Thailand floods. Will buyers panic again when supplies get tight? Will the temptation to double order override common sense? Does the current generation of buyers need to worry about Allocation? Probably not, but I’d keep the rule book handy just in case.