You can’t really blame financial analysts for their skepticism on current component demand. The last time the electronics supply chain took orders at face value the industry was left with $13 billion in semiconductor excess alone. Everyone from component manufacturers through OEMs had to write down or write off millions of dollars’ worth of inventory.
At least two Wall Street research firms have flagged signs of double-ordering in the electronics supply chain. When component supply gets tight, OEMs or EMS providers may place the same order with two different vendors, such as a component manufacturer and a distributor. If demand for those components doesn’t materialize, someone will be left with unutilized inventory.
One analyst found that several component suppliers cancelled some backlog at distributors and OEMs based on double-booking concerns. Here’s the quandary for the electronics supply chain: how “real” is demand?
That's tough to answer. The electronics industry has become accustomed to short lead times: components have been readily available and manufacturers rarely had to wait for shipments. Now that some component lead times have stretched in to the middle of next year, manufacturers are placing orders 6 to 9 months out. Although those orders represent components that haven’t been manufactured yet, they are interpreted as demand signals. Component demand looks strong for the next 6 to 9 months.
Since the historic inventory glut of 2001, the supply chain has built in safeguards against double ordering. Suppliers and distributors check current orders against a customer’s historic demand. If an order looks too high, suppliers will allocate volumes in-line with customers’ past purchases. Problem solved.
Except it’s not. Component makers and authorized distributors routinely share forecast data. If a customer places duplicate orders with both Arrow and Avnet, the component maker may flag the double-ordering. If a second order goes outside the authorized channel to an independent distributor, that information isn't shared. Component makers may be producing to orders that are being fulfilled by independents. That, too, may cause excess.
It’s in everybody’s interest that excess is avoided. Oversupply causes prices to drop and profit margins to shrink. Also, since 2001, contractual agreements between suppliers and customers spell out inventory liability. Non-cancellable, non-returnable (NCNR) clauses mean customers are “stuck” with inventory even if they don’t use it.
Despite these practices and today’s sophisticated ERP/MRP systems, supply chain veterans still expect there will be excess once this cycle ends. I’m not convinced it will, at least in the semiconductor industry. Since the late 1990s, chip makers have begun to use independent fabs. When chip makers owned production facilities, idle lines meant lost revenue. Chip makers were incentivized to keep those lines humming. Today’s fabs and foundries allocate capacity to many semiconductor designers. If one customer’s demand drops off, another customer is there to take their place. Factory utilization remains high.
Even for relatively low-priced products, such as resistors and capacitors, suppliers are cautious about ramping up production. Although multiple passive and discrete suppliers have upped capacity by as much as 15 percent, lead times are still stretched out to mid-2018. Electronics distributors have not seen lead times come in or IP&E orders cancelled.
It will really be up to customers to avoid inventory excess. In spite of all the technology now used in the supply chain, component makers and distributors say customer forecasts are wildly inaccurate. It’s possible that customers' forecast skills have atrophied thanks to ample supply. Bad forecasting is considered standard operating procedure.
Avnet, the first global distributor to report quarterly results so far, sees demand signals as real. Distributors interface with hundreds of suppliers and thousands of customers so they get a broad view of the industry. Avnet's book to bill is 1:04 to 1.00; order cancellations are in-line with normal activity; and lead times aren't shrinking. Executives are bullish through the first half of next year. Still, Wall Street remains cautious.
"Our research suggests C3Q is likely to be at the high‐end or above revenues expectations and that C4Q growth guidance should be better than expected as book‐to‐bill ratios remain elevated and demand reads remain positive," one firm reported. "Our biggest concerns are keyed by bookings stronger through the channel than through end customers; bookings at least partially driven by stretched lead times; and capacity additions planned due to stretched lead times."
Suppliers appear to be trying to take action to combat double ordering including encouraging distributors to match their orders with true end demand and cancelling order backlogs that extend well beyond normal levels, the firm noted. Maybe this time, things will be different.