Supply Chain Risks Worry OEMs Most: Here are the Top 20

by

Electronics OEMs count supply chain risks as the most troubling set of challenges their businesses face, ahead of global economic malaise and geo-political issues. Problems such as inaccurate forecasts, sourcing constraints, supplier consolidation, pricing fluctuations, inventory management problems and the negative effects of natural disasters on shipping, procurement and logistics top the list of operating risks identified by top OEMs in regulatory filings and annual returns.

Of the legion of “Risks and Uncertainties” identified in annual reports and U.S. Securities and Exchange Commission (SEC) reports reviewed by EPSNews, companies stressed obstacles related to their supply chains as most likely to result in “significant adverse effects on financial conditions and operating results.” A typical example comes from HP Inc., which highlighted pricing uncertainty, supply shortages and overages, obsolescent parts and changes at suppliers and contractors among the company’s biggest worries. Paradoxically, efforts to optimize the supply chain sometimes add to the associate complexity and risks, it said.

“Our ongoing efforts to optimize the efficiency of our supply chain could cause supply disruptions and be more expensive, time-consuming and resource intensive than expected,” HP said in its latest annual report. “Furthermore, certain of our suppliers may decide to discontinue conducting business with us. Other problems that we could face include component shortages, excess supply, risks related to the terms of our contracts with suppliers, risks associated with contingent workers and risks related to our relationships with single source suppliers.”

Electronics manufacturers have long stressed the importance of an efficient and flexible supply chain to their operation. However, the details of the associated risks spelled out in mandatory regulatory filings offer a deeper insight into the likely effects of supply chain glitches on their operation. They also confirm why many of the world’s biggest OEMs are reducing supply chain partners to a handful of component distributors, suppliers and EMS providers that work closely with them to reduce complexity and establish a more flexible and proactive manufacturing and procurement environment.

To better serve OEM customers, supply chain partners would need to understand the specifics risks each of these companies face individually and tailor products and service offerings that can help reduce complexities and uncertainties in their operations, according to industry observers. The EPSNews research indicates many of the companies reviewed not only share these concerns but are also working to develop long-term and more dependable relationships with suppliers. The Top 20 supply chain risks mentioned by the OEMs follow:

1. Inventory Management Errors
2. Pricing Uncertainty
3. Sole-sourcing Risks
4. Transportation and Logistics Issues
5. IP Theft
6. Excess Facilities/Manufacturing Overcapacity/Undercapacity
7. Excess and Obsolete Inventory
8. Inaccurate Forecasts
9. Unexpected Deterioration in the Financial Health of Suppliers and Contractors
10. Inefficient Outsourced and Internal Production Systems
11. Quality Issues
12. Supplier Consolidation Resulting in the Elimination of Product Lines
13. Cost and Challenges of Renewing Intellectual Property
14. Environmental Compliance and other International Regulations
15. Over-exposure to and Dependence on a Contract Manufacturer
16. Unfavorable Contractual Obligations
17. Competition with Supplier(s)
18. Natural Disaster-Related Disruptions
19. Labor Issues, Violations, etc., at Suppliers and Contractors
20. Inaccurate Asset Valuations

The above-mentioned “Risks and Uncertainties” were gleaned from the SEC filings and annual reports of 20 of the world’s biggest electronic OEMs in North America, Europe and Asia. These were matched with similar comments at industry financial conferences, in press releases and other public statements by senior executives at these enterprises. The companies reviewed include top consumer electronics and communications equipment vendors like Apple, Dell, Ericsson, Google, Huawei, Lenovo, Microsoft, Samsung and Sony as well as enterprise equipment vendors such as Cisco, IBM, Philips and Siemens.

The main refrain of all these companies is the challenge posed by the industry’s apparent inability to achieve demand-supply equilibrium. This typically results from inaccurate market forecasts and the direct effects these have on procurement, inventory, facility and production planning. Even efforts to reduce supply whiplash by engaging early with suppliers through prepayment for parts and manufacturing capacity can fail, leading to extreme volatility and losses, according to Apple. Sole-sourcing of parts and manufacturing can also add to the challenges facing the company, Apple said.

“Substantially all the company’s hardware products are currently manufactured by outsourcing partners that are located primarily in Asia [and] a significant concentration of this manufacturing is currently performed by a small number of outsourcing partners, often in single locations,” Apple said in its 2016 annual report. “Certain of these outsourcing partners are the sole-sourced suppliers of components and manufacturers for many of the company’s products. Although the company works closely with its outsourcing partners on manufacturing schedules, the company’s operating results could be adversely affected if its outsourcing partners were unable to meet their production commitments.”

All the companies reviewed emphasized the unpredictability of the system and noted they could not assure investors steps taken to mitigate demand-supply uncertainties would work. In fact, additional complications can result from these actions. Unanticipated changes in suppliers’ financial conditions, executive turnover, M&A activities, bigger and more assertive rivals and natural disasters can all result in severe, negative impacts on operations, the OEMs warned. Cisco Systems summed up the prevailing sentiment for most OEMs as follows:

A reduction or interruption in supply; a significant increase in the price of one or more components; a failure to adequately authorize procurement of inventory by our contract manufacturers; a failure to appropriately cancel, reschedule, or adjust our requirements based on our business needs; or a decrease in demand for our products could materially adversely affect our business, operating results, and financial condition and could materially damage customer relationships.

We have experienced components shortages in the past, including shortages caused by manufacturing process issues, that have affected our operations. We may in the future experience a shortage of certain components parts as a result of our own manufacturing issues, manufacturing issues at our suppliers or contract manufacturers, including capacity or cost problems resulting from industry consolidation, or strong demand in the industry for those parts.

In effect, a tighter relationship between OEMs, suppliers and other members of the supply chain, including component distributors, contract manufacturers, logistics services providers and other third-party service providers, has become critical in today’s ultra-competitive environment, according to industry observers.

Take the issue of production capacity, utilization rate and facility additions in the semiconductor industry. Vendors achieved a fragile level of demand-supply balance over the course of the last several years by tightening inventory management and adding manufacturing capacity only as needed. The result today – in the middle of an ongoing industry expansion – is a tight supply environment and an uptick in pricing for certain components, including DRAM.

It has since dawned on the industry that the stretched production capacity status quo cannot continue as the semiconductor market continues to grow in total sales and unit shipments, according to Malcolm Penn, principal analyst at U.K.-based market researcher Future Horizons.

“We used to build to forecast but now everyone is building to orders,” Penn said. “If you are a supplier, the last thing you want to do is add manufacturing capacity because the business incentive is very low. We hadn’t seen a capacity squeeze in years but we are now beginning to see some. Meanwhile, you cannot change capacity in less than 12 months so the industry is going to have to learn to manage through tight capacity.”

One of the more pressing supply chain risks identified is regulatory compliance, a factor that stretches from raw material procurement through end-of-life. Regulations governing the sourcing of certain raw materials from war-torn parts of Africa, other labor laws and environmental compliance requirements have forced companies to institute systems to ensure compliance internally and throughout the supply chain – even at suppliers to their own suppliers. Like many of its competitors, Huawei is focused on developing such a system, according to company executives.

Sun Yafang, Chairwoman, Huawei

“We proactively engage and collaborate with government institutions and business partners, and our compliance systems have won the recognition and support of our suppliers, customers, and business partners,” said Sun Yafang, chair of the board of directors at Huawei in the company’s annual report to shareholders. “Building a constantly evolving, complete compliance system that covers all aspects of operations is one of our key development strategies. We actively communicate with all stakeholders on compliance-related concepts and practices in an open and transparent manner to increase mutual understanding and trust.”