Whether it’s called the open market, independent or non-franchised distribution, the channel that buys and sells excess and obsolete electronic component inventory has changed. A growing number of companies in this niche have ratcheted up their procurement and quality-control practices to the extent that component suppliers and many OEM customers acknowledge independents as a vital part of their supply chain.
These businesses have had an uphill climb. During past cycles of component shortages, non-authorized distributors would buy parts from OEMs and other sources and resell -- or broker -- those devices at a high premium. A number of these companies have been prosecuted for selling counterfeit components. But the supply chain’s inability to balance inventory and demand has sustained the open market for decades. Most recently, component suppliers have begun to authorize independent distributors, establishing a hybrid model.
“Many of the lines we are carrying have the option of going to bigger authorized distributors, but those line cards are long and contain a lot of competing products,” said Damon Pouya, COO of hybrid distributor Chip 1 Exchange USA Inc. “They get very little attention because there are bigger and easier lines to sell, and these lines want to become a priority to their distributors.”
Chip 1 is franchised by more than 100 lines including Alps Electric. Franchises require distributors to conform to the handling and quality controls set by original component manufacturers (OCMs). It also means OCMs pass their warrantees through the distributor. For many customers, authorization is an assurance that a distributor is not dealing with sources of potentially counterfeit goods.
“When we talk about independents we know that there are good and bad players in the market,” acknowledged Pouya. “From the procurement and financial standpoint, we provide the best possible service to our customers. We have full test facilities in-house in our three logistics hubs and we do visual inspection, acetone verification, x-ray testing; decapsulization, component baking, ESD compliance and we conform to [trade group] IDEA standards. We have built a reputation as a high-quality, ethical company.”
A half-dozen independent and hybrid component distributors have told EPSNews they are thriving in the current market. Lead times on certain component categories are stretching out as far as 30 weeks. OEMs increasingly are reaching out to the open market -- a trend that's been acknowledged by some analysts. "There is ample evidence of 'double ordering,' as large EMS companies and OEMs that typically buy directly from suppliers are now reaching out to distributors and brokers, which we have seen in past cycles," Stifel said in a recent market update.
Chip 1, said Pouya, has an established customer base that has audited the distributor. Many customers require that components be traceable to an OCM factory to prove they are authentic. “We have a structured customer approval process in place for the components we sell,” said Pouya. “Sometimes components are available from franchised distributors or OCM factories. We do what is right and try to get traceable components. If that is not possible we communicate that risk to the customer. If the customer decides to use the part, and if that test pans out we’ll do incoming inspection. If it passes both processes we’ll ship the parts to the customer. If a red flag goes up we let them know immediately.” Chip 1 Exchange is audited by both its suppliers and customers, Pouya added.
Independents have also evolved as ongoing partners to OEM and EMS companies; they're not just used for shortages. Independents provide a channel for customers' excess inventory; search for hard-to-find parts; and manage obsolete inventory. When suppliers declare a part is obsolete, its value in the market diminishes. OEMs with long-lifecycle products still need replacement parts. Independents will often assume the financial risk of buying end-of-life components. "We see investing in inventory as an asset," Pouya said.
Independents' willingness to stock products gives them an advantage during times of short supply. The authorized supply chain has adopted just-in-time and build-to-order stock models to keep inventory levels low. Independent distributors have more flexibility than their authorized counterparts in other regards. Authorized distributors must work within suppliers’ guidelines to increase or decrease average selling prices (ASPs); independents do not. Some suppliers require distributors to create demand for their products, so distributors invest in engineering resources. Compensation for demand creation efforts is not guaranteed.
“With franchised distributors, some of the salespeople are EEs or highly technical and they deal with purchasing departments that have component engineers. Then there is a process to trace components through production [to get compensated],” Pouya explained. "That process is difficult. When we speak to a customer we never know if a design will materialize. We focus on customizing our products and services to meet our customers’ needs. That includes analyzing upcoming projects; providing in-house technical support for designs; and managing every other aspect of their supply chain."
The hybrid model has proven attractive to private equity firm Wynnchurch Capital. America II Electronics was recently acquired by Wynnchurch, which plans to expand America II's differentiated value proposition.
Chip 1 Exchange generates roughly $40 million in revenue and was established in 2001. It opened in the U.S. in 2007.