Suppliers & Distributors, Uneasy Partners, Part 2

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 examined how certain distribution industry compensation practices evolved; Part 2 looks at how globalization and outsourcing impacted channel relationships.

The problem of outsourcing

The pace of the U.S. electronics industry’s overseas expansion hit overdrive in the 1990s. U.S. distributors were buying up foreign competitors and suppliers were granting global franchise rights. Now a distributor that assisted an OEM designing in the U.S. could fulfill component orders anywhere in the world.

For component makers and distributors, global franchises solved a compensation problem. But the OEM customer base was in a state of upheaval. Vertically-integrated OEMs, which designed and built everything from chips to servers, were investing in technology rather than manufacturing. OEMs were selling or spinning off their manufacturing capabilities. These contract manufacturing operations, which now could build products for any brand owner, began acquiring, expanding and improving their production prowess. They became standalone electronics manufacturing services providers, or EMS.

OEMs saved a bundle by shedding their factory operations and outsourcing their production to EMS. But EMS companies were never really able to charge top dollar for their services. To make a profit, EMS had to produce huge volumes of boards and related products. EMS providers began to look for other ways to boost their margins.

EMS companies figured they could negotiate volume discounts on the components they used. There were a couple of problems with this idea. First, OEMs – not EMS companies – negotiated contract agreements with component suppliers. When an EMS bought a part, it was buying on the OEM’s behalf. Therefore, any price advantage went to the OEM.

The second problem was EMS companies serviced fierce brand competitors. It was not unusual that Dell, HP and IBM boards were being manufactured by the same EMS. To keep HP from leveraging Dell’s component prices -- or vice versa -- sourcing agreements were kept private within EMS organizations. This often meant unique part numbers were assigned to components that passed through an EMS.

This lack of transparency impacted demand-creation programs. Suppliers and distributors were unable to track devices from design through fulfillment. Distributors, whose compensation was based on fulfillment, cried foul.

EMS companies also knew certain types of components -- such as DRAM -- were used by all their customers. They began sourcing large quantities of DRAM at volume discounts. If those DRAM were used in designs “won” by a distributor, the distributor's compensation was based on the discounted price.

EMS companies were running into problems as well. If an OEM specified a component that was not immediately available, the EMS had a choice: shut its production line down until the component was available or substitute a comparable part. Most EMS opted for substitution.

This hit suppliers -- as well as distributors -- in the pocketbook. Suppliers found out after-the-fact that their components were no longer in an OEM design. The partners began lobbying OEMs to hold EMS accountable for part substitutions.

One part, many prices

Although the electronics industry considered itself global by the millennium, suppliers found that they could not charge the same price for a component in Asia as they did in the U.S. There were plenty of low-cost offshore competitors that OEMs could source from. Although the double whammy of outsourcing and offshoring was exerting considerable downward pressure on prices and profit margins, the industry was on the brink of a growth spurt fueled by the internet and the developing electronics market in China. What could go wrong?

In the next article, we'll take a look at how the internet fueled an historic inventory glut, created a new kind of gray market, and changed supply chain practices forever.