Top 20 Electronics Supply Chain Myths

Electronics manufacturers are used to harsh cyclical downturns often caused by their reliance on unverified assumptions about industry fundamentals. Even the biggest chipmakers, OEMs and other leading supply chain players have fallen victims to these myths, many of which sound quite believable and continue to be propagated by some top industry executives.

Bursting any of these unproven, collective beliefs won’t be easy; many of them have been around for so long that they’ve attained an elevated level of respectability and “unquestionable accuracy”, according to Ken Bradley, founder and co-owner of supply chain analytics and pricing intelligence firm Lytica Inc. Bradley, a former chief procurement officer at the now defunct telecommunications equipment vendor Nortel Networks, has focused Lytica on helping electronics industry executives avoid complications arising from these myths, including erroneous pricing assumptions, for example.

Senior procurement executives often believe they are paying optimal pricing for components whereas that’s far from the truth, Bradley said in a previous interview. He expounded on this issue in a recent contribution to Electronics Purchasing Strategies where he noted that unfounded myths – about demand forecasts, for instance – often create “embedded inefficiencies” that can only be dispelled if executives query such assumptions and request supportive facts from suppliers, customers and supply chain partners. (See: Take the Embedded Inefficiencies Test).

Ken Bradley, CEO, Lytica Inc.

“There is new information available [today] along with better tools and improved practices that were not available 10 years ago,” said Bradley. “What everyone does, and how they do it, needs to be re-examined in the context of today’s environment, not one’s comfort zone. What was efficient 10 years ago may not be efficient today.”

The comfort zone Bradley referred to in his article encompasses many myths about the effectiveness of certain practices in the electronics industry. These myths often determine where and how companies invest R&D resources, who they partner with, where they site manufacturing and distribution facilities, how they collect, analyze and treat sales forecasts and into which segments of the industry they expand offerings. These beliefs, once embraced by the senior management of a company, can even determine the mix of employees, including the ratio of design engineer to other workers, for example.

Electronics Purchasing Strategies identified a bunch of these myths. They range from myths about the design and supply chain, to who has the greatest leverage within the industry and the evolving manufacturing system of the semiconductor sector that’s pitching the integrated device manufacturer (IDM) model of companies like Intel Corp. and Samsung Electronics Inc. against the fabless IC model used by others, including Qualcomm Inc. These issues will continue to determine not just the products that are introduced but how enterprises perform depending upon how much senior executives believe they are valid.

The list of Top 20 Electronics Supply Chain Myths follow:

It’s the OEM’s Supply Chain: OEMs were at the heart of the electronics supply chain for decades and dominated discussions within the industry. That era has since passed without anyone regretting its demise. OEMs are still central to the supply chain and their voices carry a lot of weight within the system. However, many of the services that once made OEMs core to the entire supply chain have now been distributed throughout the system. Many OEMs no longer touch components or finished goods and have become purely marketing outfits. Some even employ outside design houses to support internal teams, where they exist. As a result, power within the electronics market has become diffused throughout the industry and every player in the supply chain today can claim ownership of a segment of the system. Winning, therefore, requires collaboration with other players.
Price Determines Winners: Whether the negotiation is about the end product, manufacturing and supply chain services, or components costs, pricing is always a critical issue in any electronics industry contract decision. However, some people have taken this to mean they must squeeze out the most advantageous pricing concessions from a partner if they want to be successful. It’s a weapon that cuts both ways. A company that yields to unfavorable sales terms today will hold a grudge against that customer and exact revenge eventually. In an industry characterized by stomach churning up and down cycles, prices negotiated at the bottom of market growth won’t necessarily be available at its crest. Best-in-practice companies elevate long-term relationships above immediate pricing gains.
Production in China or other Low-cost Locations will make your Products Competitive: The total cost of ownership (TCO) is a better metric for determining competitiveness, according to experts. Production in lower labor cost China has its advantages but shipment delays alone can substantially increase total costs or even result in huge losses if products miss sales seasons.
The West is not Competitive: This is related to No. 3 above but it is worth restating. Western economies continue to garner the greater profits from the electronics industry because companies in North America, Europe and Japan are still dominant in product design, development and marketing. Apple Inc., for instance, sucks up more than half of all profits in the smartphone market despite controlling a smaller market share. Furthermore, concerns about security of communications and intellectual property means many OEMs are compelled to manufacture certain products nearer consumers. Chinese labor costs have also increased recently, drawing nearer costs in places like Mexico and parts of Eastern Europe.
Your Company is Commoditization Proof: Except for certain military grade or security-related products all electronics equipment eventually fall victim to the creeping erosion of commoditization. This applies throughout the supply chain, including at component suppliers where many companies now put a lot of money into developing proprietary parts with the goal of locking in OEMs into long-term supply agreements. Notwithstanding the level of sophistication most products eventually get copied by competitors and this happens even in areas where the manufacturer has initial exclusive agreements with the buyer.
The Design Engineer Rules the Roost: This is one myth that has now taken over the entire electronics design and supply chain. Components suppliers and distributors now devote the larger part of their marketing budgets to attracting design engineers who supposedly are critical to winning an OEM’s volume production contract. Design engineers are indeed key to winning design sockets and play this role to the hilt during the product design phase and in new product introduction (NPI) activities. However, engineers are part of a team and often get overruled by other departments and senior executives.
Distributors are Only Middlemen: The modern distributor does not simply move parts around. They provide a dizzying array of value-added services (see below) and have, in many cases, become the design and supply chain divisions of some smaller customers.
Distributors’ Value-Added Services are Free: They are not. There is no sugarcoating this point. Component distributors as noted in Myth No. 7 above assist OEMs with design information, help with new product introduction activities and offer inventory management and excess inventory liquidation programs. Many of these services were seen as “add ons” by customers but they are provided at a cost to distributors who want to be compensated. Suppliers, OEMs and EMS providers who are loath to pay for these services should not be surprised when distributors take them off the menu.
Vertical Integration is Dead: Maybe vertical integration in its purest form has been abandoned by the biggest OEMs but it lives on in segments of the industry. No single company was ever completely vertically integrated; even companies like IBM Corp. that once had semiconductor and manufacturing facilities also sourced other components externally. Since the wave of non-core product divestment of the last decade a hybrid form of vertical integration has emerged. Championed by companies like Apple, Foxconn and Samsung it involves companies buying key suppliers to gain their technology and, in the case of contract manufacturers, adding certain sourcing facilities to improve margins. Apple in 2012, for example, bought sensor maker Authentec to secure its fingerprint technology that has now been incorporated into the latest iPhones.
The Design Chain is Separate from the Supply Chain: This is another myth that has its roots in the image of the design engineer as the top dog in the electronics food chain. Bellwether electronics makers make employees in their design chain work and collaborate early in the product development cycle with folks in the supply chain. Companies that don’t involve supply chain early in the product development cycle often regret this decision.
Win the Design Socket and you are Set: Suppliers will do anything to win volume component orders from OEMs and EMS providers. One, seemingly guaranteed, way is to grab the design socket early in the product development phase and thereby secure the OEMs long-term supply contract. It often happens exactly like these but OEMs consider other factors before deciding who gets the volume production contract. These include component availability, sourcing contracts, pricing and relationship with other suppliers. The design-socket-win strategy works best when the product is proprietary and the OEM doesn’t want to go through the rigors of seeking and verifying alternatives. But this typically lasts only through the first production cycle.
The Integrated Device Manufacturer (IDM) Model is Dead: Let’s admit this upfront: there are fewer IDMs around today than 20 years ago. That model is definitely under pressure but a few companies are soldering on because they have the financial muscle to take on the pure wafer foundries like Taiwan Semiconductor Manufacturing Co. Ltd., and GlobalFoundries. Companies like Intel Corp. say manufacturing remains a competitive advantage. Samsung, for its part, plays both sides of the field by making chips for rivals and its own OEM units. The IDM model faces significant challenges, though, according to McKinsey & Co., which said in a report that companies who use this manufacturing strategy must, conduct efficient and high-value R&D, identify the most promising pockets of market growth, manufacture at competitive rate, contain manufacturing costs, improve time-to-market of product development, identify the best sales channels and create the best people and resource management strategies.
The PC is Dead: Other platforms, including smartphones and phablets have indeed usurped the PC's role as the dominant consumer of semiconductors in the electronics industry but that doesn’t mean people are still not buying the device or that they will stop in the near future. Juniper Research reported recently that more than 1.2 billion smartphones were sold in 2014, exceeding by far the market size of the PC sector. However, companies continue to battle for PC market share and the erosion of the sector by smartphones and tablets has since slowed, according to analysts.
The Next Big Thing is Around the Corner: The “Next Big Thing” is always around the corner but, in the electronics industry, the reality is that wide selling products take time to gain customer attention. Every technology that has gained wide appeal has been a long time coming and by the time the industry realizes the “next big thing” is around others have cornered the market.
Apple Invented the Smartphone and Tablet PC: Apple, which is so far looking like the biggest innovator of the digital age, introduced products based on existing technologies. There were digital music players, tablet PCs and smartphones before Apple introduced its devices. Ericsson LM is credited with inventing the smartphone, for example, but the company did not infuse it with the ecosystem that could make it a winner in the market. That’s what Apple did.
Smart Innovations Always Win: No, they don’t. Continuing the tread from Myths No. 14 and No. 15 above, the smartest innovations don’t always win in the electronics industry. In order for the industry to turn smart innovations into winning innovations, the products typically requires a believable champion. No company in US history is as innovative as IBM Corp., which reports more patents each year than any other company worldwide. Yet as of the moment of writing, IBM’s market capitalization of $152 billion is less than one-quarter of Apple’s $672 billion in market value. Innovations help companies win but there are other essential ingredients that some innovators lack.
Semiconductors are the most Important Components on the PC Board: No other components on a printed circuit board attracts as much attention as the semiconductor or the processor. That’s always been the case but chips aren’t the most populous components on a PCB, although by value they may be the most expensive. Interconnects, passives and electromechanical parts play a huge role in the supply chain as evidenced by the furious scramble for scarce passives in 2000 at the peak of the industry’s upturn. OEMs that focus their purchasing power on acquiring chips and neglect other components on the board may rue the shortsightedness in the event of a component shortage.
Inventory is an Asset/Inventory is a Liability: The electronics industry knows a lot about the headache of having too much or too little inventory; some companies make a living by stockpiling parts and brokering it for sale at a premium during times of market downturn while others, especially some component distributors, pride themselves on being able to meet customers’ needs at the shortest notice. But where exactly does inventory belong? Should it be considered an asset or a liability? Some folks in the industry hold tightly onto the concept of inventory being an asset. They have allies in the accounting profession where inventory is positioned in the asset column of balance sheets. For others in the financial industry, however, inventory can quickly become a liability especially when a company is saddled with unwanted parts or finished goods that cannot be used or sold at a profit. Declaring inventory an asset or a liability is a fruitless exercise. Its value or liability depends on the leverage an enterprise is able to get from it.
The OEM Owns the Inventory: Today’s OEMs own very little in the supply chain outside of their intellectual properties. Most have outsourced manufacturing and sold off production plants. OEMs don’t even want ownership of components kept for them by distributors as bonded inventory; they have walked away from sourcing contracts, leaving suppliers holding the problem. “Sourcing contracts aren’t worth the paper they are written on,” said a former CEO of a U.S.-based components supplier. OEMs may ask suppliers and distributors to hold inventory for them but in difficult times it’s not unusual for these companies to simply dump the problem of inventory liquidation on partners.
Engineers are not Involved in Procurement: Many are. Period. Many engineers have been seconded to purchasing departments where their technical expertise can be leveraged in procurement contract negotiations. Also, many smaller firms do not split the role of the design engineer and procurement expert because they cannot afford it.