Suppliers and Distributors Realign as Market Pressures Shift

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Seismic shifts don’t happen all at once. Year by year there’s a little movement, a little resistance, sudden realignment, then aftershocks. It’s an apt metaphor for the electronics distribution industry, where there’s continual movement amongst customers, suppliers and competitors. Key events during 2016 are beginning to change the landscape for the Top 50 Distributors of 2017.

The semiconductor market last year executed some of the biggest mergers and acquisitions -- Qualcomm and NXP; SoftBank Group and ARM; Analog Devices Inc. and Linear Technology --  in its history. M&A in the supply base inevitably impacts distribution, and 2016 was no different.

“What a lot of this M&A has done is they’ve increased the relevance of certain lines on our line cards,” said Karim Yasmine, corporate vice-president, Future Electronics.

At the same time, M&A could mean some lost revenue and lost technology for distributors. “It’s a major uncontrollable on the M&A side,” said Yasmine. “We don’t know who is going to buy who today or tomorrow. If it’s a company that we carry then it’s simple but if we don’t carry the line it could be a distraction to validate why you should get access to the new technology. But so far from a Future perspective it’s been mainly an upside for us and we’ve seen it as a great benefit.”

E-commerce has opened up the distribution markets in ways it might not have expected. Online b2c giant Amazon spent 2016 finetuning its entrée into the b2b market, creating price-related headaches for the electronics supply chain. The channel’s inability to raise prices on its customers, coupled with several years of lackluster demand, increased friction between suppliers and distributors in 2016.

Demand signals in 2017 could well reverse a few of these trends. By May, distributors and suppliers were reporting longer lead times, price increases and even allocation. But distribution isn’t just about order-fulfillment, and that’s been a cause of some of the friction.

Suppliers merge; policies change

The supply chain’s inability to raise prices for a number of years has had a detrimental impact on profit margins. Suppliers determine the margins they will allow distributors for services such as order fulfillment or assisting an OEM with a design. As fulfillment margins have waned, distributors have allocated more resources toward design assistance – also known as demand creation –which carries a higher profit.

In 2016 Texas Instruments – long known for its distributor-friendliness—officially discontinued its demand-creation program. TI, like many suppliers, wanted to retain the margin points allotted to distribution. TI is now calling directly on customers; distributors will fulfill orders.

TI’s decision has removed millions of dollars’ worth of sales opportunity from the distribution market.  Although distributors rarely discuss supplier matters publicly, many are quietly shifting their demand-creation assets toward products that compete with TI’s.

The possibility that other suppliers may follow TI’s lead is a big concern for the channel. “We’ll see how it plays out,” Phil Gallagher, recently named president of Avnet’s Core Distribution Business, told EPSNews in March. “It’s a big move by TI. That said, we’ve seen this before – TI and other suppliers have emphasized demand creation or order fulfillment at one time or another. For a distributor, I think it’s all about your ability to adapt in a shifting environment, the industry is transitioning all the time.”

Distributors are confident that other suppliers will avail themselves of demand-creation programs. “Many semiconductor suppliers don’t have a large salesforce so they rely on us to reach a wide base of customers,” said Arrow Electronics CEO Mike Long in November 2016. “TI is one company that has a lot of salespeople so their strategy is to do [design wins] themselves. We will build a supply chain around that business but with the engineers we have hired every one of them has been put to use and have moved to new suppliers. Some of our suppliers have asked us to increase or double down on them and design registrations are up 3 percent in spite of the TI activity.”

One of those suppliers is Analog Devices, which in February announced Arrow would be its sole global high-volume distributor. ADI had been a longtime supplier to Arrow and its nearest global competitor Avnet Inc. In July 2016 ADI announced it would acquire Linear Technology. Since Avnet did not carry Linear Technology, ADI consolidated its sales efforts under Arrow.

Distributor-supplier relationships appear to be more tenuous than they have been in a long time. Future’s Yasmine disagrees:  “My perspective is that our relationships are deeper than they’ve ever been with our manufacturers because the manufacturers we do business with see value. From an industry perspective, it’s a 50-50 mix.”

Yasmine cites TI as an example where distributors haven’t shown value to the manufacturer which has naturally weakened the relationship. The company’s decision not to “warrant” demand creation in the channel has eroded margins and “essentially makes the channel somewhat obsolete other than a fulfillment arm for them. But from my perspective that is an eroded relationship because the distributors didn’t show them value.”

He believes that other suppliers now have the opportunity to get closer with their distributors that show differentiated value and get more value out of them because they aren’t distracted by a big line like TI on their line cards.

E-commerce and more competition

Digital services may be one of the areas in which distributors can continue to add value. After a shaky start, electronics distributors have embraced e-commerce as an essential sales tool. Distributors that specialize in low-volume high-mix orders have been especially diligent about the buying experience users have on their sites.

Because much of the commerce in electronics parts is based on negotiated contracts and pricing, distributors have developed dashboards and other tools that reflect customer pricing. Many distributors have also formed tight alliances with carriers such as UPS and FedEx so customers can get components as early as the next day.

Amazon has always been the gold standard for b2c e-commerce. In 2015 Amazon launched b2b site Amazon Business, which includes electronic components among its product offerings. By 2016 Amazon had expanded its business services to reflect customer-negotiated prices on its platform; processing requests for quantity pricing; and providing and processing large — pallet-sized — orders through its Amazon fulfillment centers. To assure product quality and authenticity, Amazon is now participating in electronics industry standards efforts.

The electronics industry’s biggest concern regarding Amazon is the risk of counterfeits. “Amazon is distributing a lot of products but people are very concerned about compliance, warranty of product, and counterfeiting,” said Future’s Yasmine. “Distributors offer many ISO standards and certifications and trade and compliance documents to make sure that customers are getting warranted product. Conflict minerals and all those things specific to our industry is something distributors are expert at because that is what we do and we want to protect our customers.”

Any Amazon seller suspected of dealing in counterfeit products is immediately suspended from the Amazon platform. To further discourage counterfeiting, Amazon is pursuing accreditation from quality control and standards-setting bodies — such as the ISO -- across all its product marketplaces.

Amazon does not appear to be siphoning component sales away from electronics distributors. “Today Amazon has not made an impact but they will absolutely,” said Future’s Yasmine. “They will continue to invest in this industry. It would be naïve to think that they won’t be able to penetrate.”

In the meantime, Amazon is causing problems, particularly in pricing. At a recent industry forum, a component supplier said he found his devices on Amazon priced below manufacturers’ cost. Armed with this information, buyers can call on suppliers and distributors to leverage better prices for their orders.

Still, electronics distributors remain confident in their ability to differentiate themselves from online mega-stores. “The electronics supply chain is more complicated than it probably appears from the outside looking in,” said Michael Knight, senior vice president, Americas, for TTI Inc. “I can understand why a company with the scope and ambitions of Amazon would want to get involved, but given the nature and complexity of the industry, and the supply chain that supports it, it seems unlikely that Amazon will be able to apply an existing business or industry model they have to electronic components.”

Constraints emerge for 2017

The remainder of 2017 could help the channel stabilize pricing and demonstrate its competitive advantages over sites such as Amazon.  Distribution’s core business has always been inventory management. In May, Arrow Electronics’ Long said the distributor has strategically been adding to its inventory in anticipation of increasing demand. The portion of Arrow customers reporting low levels of inventory is higher than it has been in a decade, Long added.

A recent Morgan Stanley survey found growing constraint in the electronics supply chain. Respondents who cited seeing supply constraints in FPGA and analog (57% in Q1 vs 36% in Q4) called out product categories such as memory, FPGAs, analog, connectors, and discretes, which is impacting companies such as Murata, Xilinx, Maxim and ON. Overall lead times are still manageable but 68% of respondents saw lead times extend (up from 49% in Q4) in areas such as memory, FPGAs, analog, and passive components, and mentioned a slight impact to a number of companies including Murata, Xilinx, Avago, ADI, TI, Cypress, Maxim, NXP, ON and Samsung.

Morgan Stanley said 63% of respondents (up significantly from 37% in December quarter) saw expedite activity in memory, FPGAs, connectors, analog, discretes, and sensors. Of note, respondents this quarter also saw a slight pick up in double ordering (10% vs 0% last quarter) and push outs (12% vs 8% last quarter). “We have not seen these cyclical effects in multiple years, and it is something we plan to monitor in the coming quarters, though lead time extension is likely to continue to drive increased short term business confidence,” Morgan Stanley said.

This year could be a boon for distributors, particularly those that specialize in hard-to-find parts. Some, such as Advanced MP Technology, have adopted a hybrid model by selling franchised and non-franchised lines. “The distribution market is evolving faster than ever,” said Kamran Malek, global vice president of marketing /Asia Director for Advanced MP Technology.

To increase their reach to customers, suppliers are seeking franchise agreements with companies such as Advanced MP that have traditionally been non-franchised. “We believe in taking different approaches to the market because our customer base is changing so rapidly,” Malek said.

If, as Morgan Stanley suggests, supply constraints and double-ordering continue throughout the year there may be another seismic shift in distribution’s favor. Veterans of the electronics industry recall the last time severe shortages hit the supply chain. It was 1999—right before the bottom dropped out of the market and billions of dollars’ worth of components suddenly became excess inventory. Today’s younger supply chain professionals have not experienced an allocation market or faced the consequences of practices such as double-ordering.

Businesses holding inventory – meaning distributors – have a significant advantage in this type of market. “Right now, we are seeing lead times that were six to eight weeks stretching to 18 to 26 weeks and price increases,” said John McKay, president of sales for independent distributor Freedom. “Even if you can get the part, some of the prices have gone up by 20 percent. TI, Diodes Inc. and Altera parts with leadtimes of four to six weeks are now quoting 12 to 20 weeks. It’s a perfect storm, and I think we’ll see much more of this in the next few quarters.”

To read the complete Top 50 Distributors report, download here.