The results of the annual EPSNews Top 50 distributors survey finds that the North American (NA) franchised distribution industry grew revenues by only 1.3 percent in 2015, after posting a five percent increase in 2014. Distributors faced several challenges last year, including slow growth, currency issues, price pressure, and margin erosion.
Sales for the top 50 North American-based franchised distributors reached $32.1 billion in 2015, up from $31.7 billion in 2014. The number one challenge for electronic components distributors last year was slow growth. They also faced severe price pressure and margins on passive components, primarily hurting distributors that specialize in interconnect, passive and electromechanical (IP&E) devices.
“The biggest challenge for the channel in 2015 was continued slow growth, and in fact some contraction in the second half,” said Michael Knight, senior vice president, TTI Americas. “This was a challenge for all, including the electronic component manufacturers. This has been the fundamental challenge now since the post-recession surge petered out in 2011, and will continue to be something the industry grapples with in 2016.”
Falling oil prices also had a big impact on the oil and gas industry, hurting distributors that garner significant business from the segment. “The collapse of the oil and gas industry, and the domino effect in green energy development, had a big impact on TTI’s North America business in particular, and to a lesser extent, our business in other regions,” said Knight. “Being a Texas headquartered distributor, the oil and gas sector has long been an important one for us and we are closely feeling our customers’ pain.”
Russel Dorwart, president and COO, PEI-Genesis, agreed. “We were doing significant business in oil and gas and growing, and now it has gone the other way. We were quite stunned by how dramatic a drop in gasoline prices was for the manufacturing industry in general.”
PEI-Genesis was also hurt by a slow military market and supply issues with two of its largest interconnect vendors – Amphenol and ITT Cannon. Cannon moved its factory from Santa Ana, Calif. to Nogales, Mexico and the move did not go well, severely damaging the distributor’s ability to keep product flowing to customers.
In addition, the Defense Logistics Agency (DLA) Land and Maritime issued stop shipment orders to Amphenol Aerospace and ITT Cannon in March and February 2016, respectively, for several types of mil-spec connectors due to sourcing components from non-approved facilities, resulting in shipment delays to customers and millions of dollars of inventory sitting on distributors’ shelves.
PEI-Genesis also sold its power value-added business to Arrow Electronics for $10 million. When the interconnect specialist created the power business it was looking for other ways to take advantage of its customization assembly skills.
“While we were very good at selling interconnect solutions, we weren’t really good at selling power supplies. We got off to a good start and then got stuck and we weren’t growing,” said Dorwart. “We decided to hire sales engineers that focus on power but it was too little, too late, and had to ask ourselves if we wanted to throw a whole bunch of money on a separate sales force.”
However, the sale of the power business gave PEI-Genesis a war chest to invest in China. The distributor opened a new 84,000 sq.-ft. connector assembly factory in Zhuhai, supporting its strategy “to buy there, build there, and sell there.” The company also plans to add new capabilities to its design processes that will speed up the delivery of drawings and custom prototypes.
China presents several challenges for distribution in general.
Other key challenges included the slowdown in China and counterfeiting, said Mark Burr-Lonnon, senior vice president of EMEA and APAC business, Mouser Electronics. “We all complain that China is slowing down when it only grows by eight percent last year and six and one-half percent planned for this year but that is still more than any other region.”
“It’s only a problem because it’s not growing at the speed it was. But still the slowdown in China has caused a lot of people a problem,” added Burr-Lonnon.
Another challenge in China is continued counterfeiting. “When you look at Asia and talk about counterfeiting they don’t care,” said Burr-Lonnon. “You try to sell them on franchised distribution, but they say if they can buy it cheaper they will, and if something goes wrong, they’ll just buy more, which is a very strange attitude. It’s certainly alien to the U.S. and to Europe whereby if something goes wrong you have quality inspectors all over it.”
Burr-Lonnon thinks the mindset is due to the way China buys parts. “A huge amount goes through dealers and traders, and because of that they almost expect to receive counterfeit parts. There is still not a huge desire in China to go direct to manufacturers or direct to franchise distributors.”
Price Pressure, Margin Erosion
A major headache for distribution last year was continued price and margin pressure on passive components.
“Another source of pain in 2015 was the continued pressure in passive component selling prices and margins,” said Knight. “Capacitors in particular were squeezed very hard last year, and as the leading distributor for the premier capacitor manufacturers, we felt every ounce of the squeeze.”
“We always face the reducing margin issue but that is something that we all have to live with,” said Burr-Lonnon. “One of the biggest issues last year was currency. The strength of the dollar is good but not so good for some companies when everything is based in U.S. dollars. Currency probably caused some of the biggest headaches financially last year.”
“Macroeconomics overall presented challenges,” said Alan Bird, president of Arrow Electronics Inc.'s Americas components business. “As an industry, currency fluctuations had an impact specifically around the large multi-national industrials. We saw them struggling because of the decline in exports. Asia had a good year overall and started to see some headwinds in the second half, which were more attributable to the macroeconomics of China.”
“In the Americas, we bucked the trend and delivered growth in a challenging year. It speaks to our execution of our strategy and how we’re building the business to address the needs of our evolving customers as we head forward,” added Bird.
Part of Arrow’s strategy is a focus on vertical markets. The global distributor’s lighting business in the Americas had double-digit growth, and the transportation and the Internet of Things (IoT) businesses also saw significant growth.
The military segment had low single-digit growth in a market that isn’t growing, said Bird. “It proves to us that having a vertical focus matters to customers and suppliers.”
The other key part of Arrow’s strategy is solutions selling, which continues to evolve. This entails providing customers with everything from design and manufacturing to shipping and value recovery. This includes new product introduction (NPI) solutions, full turnkey assemblies, box builds, global supply chain management, direct shipments to customers, and ultimately repairs and hardware decommissioning.
“Demand for this part of our business continues to grow,” said Bird. “It has a lot to do with easy capital that is available now through Kickstarter and GoFundMe, and even the number of incubators that we’re involved in. Customers can go from a great idea to $1 million in capital in months. They are looking to us to get them to market fast. I believe it will help us fuel our growth.”
What also helped fuel Arrow’s growth in the Americas last year was the addition of account development managers, hired between the second half of 2014 and first half of 2015. Their job is to find new customers in new areas.
“It’s not without risks,” said Bird. “Not every customer that comes up with a great idea makes it to market but if you’re calling on a significant number of these customers with a dedicated team with technical resources supporting them you’re going to capture two out of 20 or 40 who do make it. You see these customers growing from zero revenue to significant revenue in a relatively short time of 18 to 24 months.”
Distributors expect 2016 to nearly mirror market conditions in 2015 with single-digit growth. However, a few distributors, such as TTI, expect higher growth thanks to signs of growth in several end market segments including transportation, automation, and medical.
“We are expecting the industry in all regions to feel in 2016 a lot like it did in 2015, which means an overall growth rate in the low single-digit area. Our own growth rates are forecasted to be a bit better as we have good momentum in market segments like transportation, the automation part of industrial, and medtech,” said Knight.
“The electronic content in these sectors continues to grow ahead of the overall market, and in particular as the end product becomes ever more connected, these segments become an ever larger part of the IoT story,” he continued.
Despite the projected low-digit growth rate for 2016, distributors continue to make investments in preparation for stronger growth in the future. For example, TTI is adding additional distribution center capacity in all regions including the construction of a new state-of-the-art facility in Texas. The distributor also is expanding local sales teams and adding to its management team in all regions.
“Being able to invest in our business out of phase with near term market conditions is an advantage afforded us by our parent, Berkshire Hathaway, that isn’t as available to many in the channel, especially those who are publicly traded,” Knight said.
TTI also continues to invest in inventory to support customers. “TTI’s own investment in inventory historically runs 2 ½ times that of the channel and through thick and thin we keep our inventory levels above 100 days-sales-in-inventory (DSI). Our goal has always been to provide the best inventory safety net in the industry, which in cold markets really helps our suppliers, and in hot markets really helps our customers,” said Knight.
Knight said overall industry inventory levels remain very stable, and he does not expect it to change in the near term due to relatively short lead times from manufacturers. “Over the long haul, they have quickly adjusted to market conditions to remain in the 40 DSI range, plus or minus a day or two.”
Similarly, Mouser Electronics’ focus is on inventory and breadth of product. “We put a huge amount of inventory in place and added an additional 250,000 square feet of warehouse in Texas, which will increase our inventory. The drive for us is having the widest breadth of inventory,” said Burr-Lonnon.
Mouser’s growth is “more of a function of how successful we are in getting into new customers; how successful we are in getting new subscribers, and how successful we are in getting good content to the market which helps drive buying decisions. That is a big drive for us,” he added.
“We don’t engage in the volume side of the business so we don’t see those huge upsides or downturns. Our focus is on new technology and NPI,” Burr-Lonnon said.
Burr-Lonnon expects growth in all three regions in 2016 with Europe leading the way with 15 to 20 percent growth, Asia close to 15 percent, and the Americas at four to five percent.
Overall, the top NA electronics distributors experienced nearly flat growth last year. Twenty-nine distributors posted a revenue increase last year with only three reporting double-digit increases. In 2014, 39 posted a sales increase with 13 reporting double-digit increases. Eighteen distributors reported negative sales in 2015, up from eight distributors in 2014.
The top 50 North American distributors also slightly grew their global revenues, reaching $66.3 billion in 2015, up from $66.2 billion in 2014, increasing revenues by less than one percent.
The top distributors still derive the majority of their global sales from North America at 50 percent, up slightly from 49 percent in 2014. They also derive 26 percent of their sales from EMEA (Europe, Middle East, and Africa), and 23 percent of their sales from Asia. Revenues derived from sales in South America hold at less than one percent.
In terms of customer base, 56 percent of the top distributors' business comes from OEMs, and 33 percent of their sales is from electronics manufacturing service (EMS) providers and original design manufacturers (ODMs). The remaining 11 percent is derived from "other" customers including MRO, retail, R&D, design service companies, brokers, cable assembly houses, and other distributors.
The customer base percentages are based on responses from 38 of the top 50 distributors, and six of the top 10 distributors did not respond to this question. The revenue market share of the top 10 distributors is 94 percent.
Based on 36 responses, the survey finds that the top distributors derived most of their sales from industrial customers (29%), followed by military/aerospace (23%), automotive (11%), telecommunications (8%), medical (8%), computers (6%), energy (5%) and mobile communications (2%). The top distributors also derived eight percent of their business from "other" markets. Eight of the top 10 distributors did not respond to the question.
Industrial and transportation sectors are two of the biggest segments expected to drive component growth this year. The industrial semiconductor market is expected to grow at a compound annual growth rate of eight percent, reaching $59.5 billion in 2019, up from $43.5 billion in 2014, according to IHS Inc. The United States accounted for 30 percent of all semiconductors used in industrial applications in 2015, followed by China, which gobbled up about 16 percent of all industrial semiconductors last year.
IHS analysts expect market growth to be driven by increased capital spending and continued economic growth, particularly in the United States, led by commercial aircraft, LED lighting, digital video surveillance, climate control, traction and medical devices.
Transportation also continues to drive good growth in the distribution channel. Even if the number of vehicles is flat, transportation will show growth because of the proliferation of electronics for safety, entertainment, and connectivity, said Bird.
Distributors also have no doubts that the IoT will grow their businesses particularly around sensors, microcontrollers, and power management.
“IoT is making a big difference,” said Burr-Lonnon. “There is still no killer app but it’s a nice upside.”
Specialization Fuels Growth
Two of the smallest top distributors – Air Electro (#33) and Sherburn Electronics (#43T) - as well as Electro Enterprises (#17) were the only distributors to post growth in the double digits in 2015 for North America. Sherburn Electronics led the top 50 in growth rate, increasing revenues by 14.8 percent to reach $14.0 million in sales. The distributor attributes its growth to a niche market focus.
“We are a specialized distributor 100-percent focused on the aerospace and defense markets since the third quarter of 2012, said Jim Burke, president, Sherburn Electronics Inc.
The company also increased its head count in customer service to support sales and started offering a broader product base to its customers because “we got to really understand their needs. We meet with them in person. It’s not driven by Internet sales,” said Burke.
“We didn’t increase inventory last year but it got smarter. We don’t do as much commodity product selling and offer more specialty items,” Burke continued.
“I can’t compete with Arrow, Avnet, Digi-Key, TTI and Mouser with volumes of inventory. I had to find our niche,” he added. “We were lucky last year, and in the first quarter of 2016, we already are eight percent ahead of last year.”
Similarly, Electro Enterprises attributes some of its growth success to additional product lines particularly for value-added military connectors, an additional 36,000 square feet for a new value-added facility, head count expansion, and a focus on military/aerospace. The distributor increased its revenue by 12.3 percent, reaching $80.6 million in 2015.
“We believe that the key drivers to our growth were the growth in our European Operations, and that we added key product lines in our value-added and pick-and-ship product areas, and inventory to be able to service the market better than some of our competitors,” said Andy Enright, director of operations, Electro Enterprises Inc. “The addition of key sales associates also helped drive demand from our inventory growth.”
“Our inventory grew by design last year from $26.5 million to $32.1 million,” Enright added. “When others were lowering their inventory position we took the opposite approach and it obviously helped drive our sales number up.”
“Our key challenges last year were the market itself as it was really soft,” said Enright. “The defense cuts were still in play topped with the oil and gas industry dropping significantly. You could feel the softness in other markets like the business jet and the helicopter side because of the lack of spending in the oil industry.”
But 2016 is looking good, Enright continued. “We are looking at high single-digit to double-digit growth again. The challenges we face this year are the same ones that we faced last year but it is our belief that we are still doing the right things to combat the lackluster results of the market as a whole.”