One charter of a trade association is to examine and if possible rectify industry policies and practices that don’t make sense for its members. But there are several issues in the electronics supply chain over which members of the same trade association may never see eye-to-eye.
Distributors and suppliers – both members of Electronics Components Industry Association (ECIA) – most often work in concert to increase component sales and service the massive customer base that is electronics manufacturers (OEMs and EMS). As the theme of this year’s ECIA conference illustrates – "Shift Happens" – current market conditions are challenging this spirit of cooperation. Avnet Electronics Marketing Americas President Ed Smith – also an active ECIA member – outlined a number of these issues frankly and candidly at this year’s conference. At the risk of aggravating customers, suppliers and other supply chain partners, Smith outlined three problems pervasive in the channel that may put partners at odds:
- Counterfeiting. Smith highlighted an issue that everyone knows about but few acknowledge: customers – OEMs and EMS – create an environment in which counterfeiting thrives. The temptation to sell unused inventory into the open market to recoup costs is huge for big consumers of components. Once this inventory enters the channel, it is often mixed with other components and continues to circulate through various sales depots. If that inventory remains unsold, customers will try to return that inventory to distributors. Counterfeits enter the authorized channel, Smith says, in spite if the industry’s efforts to distinguish authorized distribution from the unauthorized market. Authorization is one way suppliers keep their brands pure, but distribution can only go so far in managing counterfeits. As long as customers sell inventory into the open market, suppliers’ and distributors’ control is limited. Customers, Smith points out, are not held accountable, for buying and selling in the open market.
- Margin erosion. Profit margins erode over time as technologies age. But in the channel, margins have been eroding because component supply has been ample and foreign competition remains fierce. In electronics, component makers traditionally set profit margins and the parameters under which distribution can raise or lower prices while preserving their margin. But because all margins are under pressure, some suppliers have kept distributors’ margins stable and are retaining any upside distributors may achieve. Smith recommends customers – and the competitive market – determine margins. But channel practices make that strategy very difficult.
Historically, channel relationships have been stacked in suppliers’ favor because the value of a franchise, or authorization, can make or break a distributor. Without a franchise, distributors are effectively forbidden from selling a suppliers’ brand in a specific geographic market. Globalization has blurred the lines in terms of authorization: most notably non-authorized distributors advertise the sale of components they are not franchised for.
Additionally, customers expect to be able to source all products in all locations, so many distributors are authorized by the same suppliers. So instead of pushing a specific brand, distributors now promote solutions that combine a variety of components. This had put suppliers and distributors at odds. There are two primary reasons:
- Demand creation. The concept of demand creation – under which distributors are given incentives for getting a supplier’s product designed into an end-product – is intended to offset distributors’ expense of hiring engineers. The ongoing cost of supporting engineers has outstripped the reward distributors receive for a design-win. As a result, distributors focus only the top-technology (or top-margin) brands they manage, which is usually only a small portion of their linecard. Suppliers that don't receive the focus of distributors may be at a disadvantage in the marketplace. Suppliers also have difficulty developing policies that adequately reward distributors for their efforts. Since demand-creation compensation is usually based on the profit margin of volume sales, the distributor that wins the design must also fulfill the order. This does not always happen.
- Ship from stock and debit. This practice is one way suppliers reward a distributor design-win with a higher margin. By allowing one distributor to sell components (ship from stock) at a slightly lower price than competitors, distributors can pocket the difference in as profit. “Ship from stock” has since become a standard industry practice for all transactions with variations in price. Instead of continually exchanging cash as prices rise and fall, suppliers extend a credit (or debit) to distributors on their next purchase. Processing this transaction – which requires constant inventory and price updates, applications of credit, shifting margins and the creation of phantom inventory – is costly for the distribution channel. Any upside is margin is eroded by processing costs.
These issues have been debated by suppliers and distributors for decades. In general, suppliers and distributors agree that the systems that manage demand creation, anti-counterfeiting and ship from stock are imperfect and should be revised. Individual suppliers have made efforts and headway to assist distribution by standardizing prices worldwide and vigorously defending their franchises. The market reality is that customers have been reaping many of the benefits of supplier-distributor practices. Suppliers and distributors are both hesitant to pass on costs -- such as those related to engineering and transaction processing -- to customers in the form of price hikes.
Smith charged his fellow distributors, their suppliers and the association with addressing these problems before margin erosion forces many players out of business. For the front end of the supply chain – meaning component makers, distributors and many services suppliers – this means having some very uncomfortable conversations with customers.
This isn’t unprecedented: when the industry found itself with $13 billion worth of excess inventory back in 2001, suppliers and distributors invoked practices and policies that discouraged the double-ordering that caused the excess. Both suppliers and distributors suffered from an overage that required they write off billions of dollars’ worth of inventory. If the issues Smith highlights are equally painful for distributors and suppliers, together they may take steps to correct practices that in the current market no longer make sense. Shift is happening in the customer base, but the supply chain isn’t keeping pace.