The first victim of a low-growth market like the one we are seeing today in the global economy and in the electronics industry is healthy gross and operating profits margins. But there are other issues that business executives must keep an eye on as 2014 evolves.
Paradoxically, a low-growth economic condition can be both a blessing and a curse. The negative part of it is easy; pallid sales and huge uncertainties. On the positive side, though, many companies (Intel Corp. comes readily to mind) take advantage of the lull in business activities and demand to focus on innovation while accelerating productivity and manufacturing improvements for the inevitable market upswing.
A slow-growth environment also fosters – for OEMs and electronics manufacturing services (EMS) providers – the best pricing conditions for components with the certainty of sufficient supplies – as long as manufacturers keep plants humming in what typically translates into a desperate attempt to avoid losing market share.
With suppliers jostling for procurement contracts, purchasers are not only sure of the best pricing but also have clearer visibility into inventory requirements and supply. It’s very easy in such an environment for purchasing to put excessive pressure on suppliers to squeeze out additional cost savings. In other words, suppliers could end up being asked to further reduce thin margins on non-proprietary or multi-supplier sourced products.
In relation to margins, pricing pressure is one major concern in addition to supply and demand swings. For many suppliers, the negotiating environment with purchasing can quickly turn frigid if manufacturers believe buyers were trying to take advantage of the tepid demand situation to win even more pricing concessions. The same applies in distribution too.
This can lead to the fraying of long-term relationships and trust, the next likely casualties of a low-growth economy. Companies can avoid this simply by recognizing the importance of solid relationships to their strategic future and also by keenly watching out for business partners even as they hope to benefit from the favorable pricing condition. Gerry Fay, global president of the Electronics Marketing group at Avnet Inc. (NYSE: AVT), observed as much in an interview last year.
“When you are in a low growth market everybody is looking for ways to grow and generally that growth comes from competing,” Fay said. “Unfortunately, the business aspect of that competition for distribution usually turns into margin-erosion. In our business you generally don’t get gross margin expansion unless there’s an uptick in demand and then you get average selling prices (ASP) expansion.”
The final danger I see from a low-growth environment is even more insidious in that electronic companies have numerous times in the past been caught unaware. Suppliers and OEMs have learned to keep a close eye on their inventories and even stocks at rivals. Not only do they tightly monitor inventory at hand, they also track supplies in distribution, at OEMs and EMS providers. Companies (suppliers and distributors) that are leaders in their fields go even deeper in the supply chain to track end-market inventory and demand conditions. The era of suppliers and distributors trusting and accepting whatever forecasts OEMs provide has long ended; they trust but verify.
The implication today is that inventories in the distribution channel and at suppliers remain very low as Fay pointed out in the interview referenced above. Any slight uptick in inventory gets quickly corrected nowadays if the anticipated demand upswing failed to materialize. Semiconductor companies especially have learned to keep more of their inventories in die form, better known in accounting parlance as “work-in-progress.” Such inventory can be quickly turned into faster-growing products or retained for a longer period without the hefty losses associated with “finished goods” and other less convertible inventory.
Here’s the danger: it takes time to crank up production and turn the work-in-progress inventory into finished goods. Since even distributors have been burned in the past while holding bonded-inventory for supposedly “guaranteed sale”, purchasing professionals at OEMs and EMS providers know today they may not even be able to turn to these saviors for the fulfillment of unanticipated demand. The result is that the pricing advantages a purchaser might have enjoyed during times of weak demand can get swiftly reversed when sales swing sharply upward unexpectedly. That’s when the negotiating edge switches from purchasers at OEMs/EMS providers to distributors and suppliers, planting a nice smile on their faces as ASP shoots higher.
“The one good thing I can say is that if we get any kind of demand there’s not a lot of inventory in the channel so that would turn into nice growth,” said Avnet’s Fay, in reference to the outlook for 2014.
As Fay noted, though, “there doesn’t appear to be any killer application on the horizon” that could suddenly turn the current supply situation from a buyer’s market into a seller’s market. Still, I wouldn’t bet on this condition remaining the same throughout the year and neither should anyone in purchasing. No company likes to be on the losing edge and eventually, weak negotiating positions are either completely reversed or brought into better equilibrium.
At such times, suppliers would remember the companies that stood by them in leaner times and those that squeezed their margins excessively hard. In which camp will your company be?
DISCLAIMER: Bolaji Ojo is editor-in-chief and publisher of Electronics Purchasing Strategies. The views expressed in this blog are those of the author alone who promises to base his sometimes biased, possibly ignorant, occasionally irrelevant but absolutely stimulating thoughts on the subjective interpretation of verifiable facts alone. Any comments should be sent to the author at firstname.lastname@example.org.