Many readers have weighed in about the Xilinx-Flextronics suit (See: Xilinx Sues Flextronics for Alleged Fraudulent Chip Resale and The Multiple Dangers of Component Resale) and have made a number of good points I’d like to share here. First, it does not appear that the channel, authorized or independent, was involved in the transaction. Although it is common for OEMs and EMS to sell excess into the open market, this isn’t the case here. As one reader points out, it appears to be a pure sell-for-profit move. Here’s why both original component manufacturers (OCMs) and their authorized channel partners are against such a practice:
OCMs try to maintain their price and profit margin levels in the supply chain. OCMs have determined the price of their components (based on cost to produce) and have put their brand behind their products. Most OCMs would argue that years of R&D and intellectual property are behind their brand and price. Additionally, OCMs extend warrantees and guarantees on their products’ performance: all of which is reflected in the price.
As part of an authorized distribution agreement, most OCMs require distributors to promote their products in the market. Distributors are trained on these products, invest their own cash in their inventory, and pass the OCM’s warrantees onto their customers. In short, distributors have skin in the game. Additionally, if distributors want to sell components below the price they paid or that the supplier set, they often have to go back to the component maker for the OK. The difference in price is reflected as a credit.
OCMs and distributors invest both time and money into providing and supporting branded products. For a number of years now, they’ve had a hard time making a profit on these products. Profit margins have steadily been declining, components have been plentiful and the economy uncertain. When another party—whether an OEM, EMS or broker –makes a profit on resold products, it directly hits both the OCM and the authorized channel.
On the other hand, once an EMS or OEM buys a product, shouldn’t they own it? In some circumstances, that’s the case. But the “you buy it you own it” practice isn’t that common in the supply chain. Many sales are based on credit; inventory is set aside as consignment; and prices change by debit or credit practices within individual transactions. Some customers get preferential pricing based on volume. Within the EMS channel, EMS companies buy parts on behalf of a customer. The argument of which party owns those products is ongoing. In most cases, the OEM takes “ownership.” EMS companies don’t like to hold inventory because it sits on their books.
Another reader pointed out that the buying and selling of components into the open market hasn’t been a boon as of late. Few components are sold at a high discount and few transactions carry a high margin as supply is plentiful. With a few exceptions – concerns of shortages were voiced following disasters in Japan, Thailand and more recently, the Hynix fire – that’s true. But open market prices did edge up on disk drives and memory following these disasters.
Finally, if Flextronics remarked components to make them appear to be a higher-margin product, this is a classic case of how counterfeits enter the supply chain. Many readers point out that if suppliers and distributors took back the products they sold, this wouldn’t happen. Let’s say that Flex tried to return the products to Xilinx or a distributor. Hopefully, chip companies and distributors test all of the products coming back to make sure they are authentic. (Reputable independent distributors do.) However, products that are sold through authorized channels are assumed to be authentic, so that testing may not happen. If those returned products were resold by Xilinx or a channel partner, counterfeits would have passed through the authorized channel.
Since the case hasn’t been adjudicated yet, nothing is certain. But if Flex did buy the components, remark them and sell them to a customer, you can see why Xilinx is taking action. As Flex did nothing to add value to the sale, Xilinx has lost profit. Counterfeits also endanger the Xilinx brand and possibly Xilinx customers. If Flex bought the parts on behalf of an OEM customer that makes the situation worse: it used preferential pricing of one customer to make money from another.
Normally, a customer that does this would jeopardize its relationship with its suppliers. But Flex is one of the biggest EMS in the world and as such buys billions of dollars’ worth of components every year. What are the chances suppliers will shun Flex? With the exception of Xilinx, I don’t think many will. As to a solution, returns could be the answer to the problem of excess. But resale for profit? If this indeed the case, Flex has opened up a whole new level of debate regarding “ownership” of components. It will be very interesting to see this suit play out.