Distributors and suppliers continue to be concerned about eroding profit margins – a topic discussed at the recent ECIA conference. The margin challenge for distribution was highlighted today during a conference call Arrow Electronics Inc. held with analysts. The company said it disengaged with a large customer based in Asia, a move that was material to Arrow’s Q3 component business results.
The bottom line for Arrow: the relationship failed to reach the volume levels that would have allowed Arrow to meet its internal financial expectations. Overall, Arrow's global component sales for the third quarter increased by 3 percent year over year to $3.47 billion. (See: Arrow Sales Advance in Q3).
Large component buyers often provide forecasts that distributors use to determine how much inventory to hold in anticipation of production orders. Distributors usually pay upfront for these purchases, tying up critical capital. Additionally, when a customer reaches a high enough volume business, distributors and suppliers provide preferential price breaks based on the volume level. The customer Arrow dropped never reached the volumes it forecast. As a result, the pricing model wasn’t sustainable for Arrow and very likely its supplier partners as well.
“As usual in this type of engagement a customer commits to a pricing structure which requires inventory to be held,” said Mike Long, CEO of Arrow. “The volume didn’t come in and the relationship didn’t work. It was a pure business decision and ultimately will not impact Arrow’s ability to engage in similar future deals.”
The distribution channel in general has been struggling on two fronts. First, prices in Asia tend to be lower than in the rest of the world so distributors have less chance to reap a reasonable profit margin. Secondly, suppliers generally have control over the component pricing and margins that distributors can offer. When the cost to service a customer outstrips the potential profitability of the engagement, the business doesn’t make sense for the distributor and often, suppliers as well.
Long told analysts this was a single engagement that doesn’t reflect on the long-term business environment in Asia-Pacific. Distributors continue to be bullish on the region even though it tends to have prices and margins lower than other regions.
The low-price low-margin dilemma was discussed at the Electronic Components Industry Association conference earlier this week. Avnet’s Electronics Marketing Americas President Ed Smith pointed out that distributors have little control over margins and suggested margins be dictated by the market. Distribution and supplier practices make the execution of this strategy difficult, but Arrow’s example may provide a strong dose of reality for the supply chain. In order to serve customers, channel partners have to be profitable. (See: Distribution: Some Policies No Longer Work).
No supplier or distributor wants to disengage with a customer, but it has been happening across the channel. One solution is to raise prices, which the supply chain is reluctant to do. A more welcome option would be a market uptick that would raise all boats equally. Forecasts for the fourth quarter continue to be below “normal” seasonality, though. So for the time being, normal also means continued pressure on profit margins.