The electronics distribution industry is at an inflection point. Not since the 1990s has there been so much change within both the channel and its supplier base. During that decade, globalization, the internet and M&A changed the face of the supply chain. The same forces are at play now, but the results have been very different. In a series of admittedly subjective articles, I’m going to take a look at how distribution relationships have changed over the years and why it matters in 2017 and beyond.
Part 1: The genesis of demand-creation
Although suppliers and distributors profess to be symbiotic partners, few things test those partnerships like demand-creation. The channel was dealt a major blow in 2016 when a leading semiconductor supplier scrapped its demand-creation program. To understand the significance of this move, you have to go back a few years to when distribution’s main function was fulfilling — rather than creating — demand.
In the early days of the channel, distributors bought inventory from suppliers, stored it, and then sold it to customers that suppliers didn’t serve directly. In general, suppliers priced their components — for example, $1 per unit — and added a profit margin – say, 25 percent. Distributors bought devices from suppliers at cost and sold them for $1.25. However, suppliers carried, or franchised, more than one distributor. To undercut a competitor, a distributor would sell parts for $1.20. Although that ate into the distributor’s profit margin, securing an order had its benefits.
Suppliers quickly found out component prices were eroding. They required distributors to seek approval for price cuts or risk losing the franchise. If a customer was strategic enough, price cuts were approved.
Eventually, this practice wreaked havoc in inventory management and accounting. Distributors could wait as long as 16 weeks to receive parts from suppliers. In the meantime, they could fill orders from stock. If those parts sold for less than the distributor paid, the supplier provided a credit (or debit) toward a future purchase. But a volatile market and shifting prices and leadtimes created “phantom” inventory on the books and an unwieldy term — “ship-from-stock-and-debit.”
At this time, distribution’s main function was to manage inventory and fill orders. The orders could be generated by the distributor itself, a supplier, or a manufacturer’s rep.
Design and demand
As the semiconductor industry became more competitive, component suppliers tried to gain an advantage over one another. Suppliers began to incentivize distributors to push their products over a competitors’. As a reward for creating demand, suppliers would grant distributors a couple of extra margin points on the fulfillment sale.
Those extra points reduced supplier profit margins. In effect, suppliers — rather than customers — were paying for the distributor’s service. But suppliers and distributors were hesitant to increase component prices because they were facing competition from overseas.
The global expansion of the electronics industry added a new level of complexity to distributor-supplier relationships. Distribution franchises were awarded on a national basis. If a customer designed and built a product in the U.S. and Germany, a U.S. distributor couldn’t sell to the German factory. Instead of working with one distributor the OEM now had two; and the U.S. distributor was shut out of the German business.
Distributors cried “foul.” They tried to manage this by tracking components from the point of design (the U.S.) to the point of consumption (the U.S. and Germany). If the distributor could prove the German business was related to a U.S. design effort, the distributor would “register” the design with the supplier. In such cases, the supplier could arrange for the U.S. distributor to sell components to a German distributor and both distributors would get compensated.
This process added costs to transactions and split compensation between two distributors. Ultimately no one was happy. Customers, who typically negotiated volume discounts with a single partner, didn’t want to deal with two distributors. Suppliers worried that distributors would no longer push their products if they weren’t paid. The solution: customers were encouraged to buy from the distributor with the design registration; if they didn’t, suppliers paid a bonus to the registered distributor. But this limited customers’ ability to choose which distributor they bought from, and bonuses ate into supplier profits.
Fast forward to the year 2000 and the electronics industry is global. Suppliers were granting global franchises so customers could buy parts from the same distributor anywhere in the world. Design registration programs now “protected” distributors no matter where components were consumed. What could go wrong?
In the next article, we’ll look at how outsourcing further complicated supply chain relationships and why there was no such thing as global pricing.