The Case for Further Distribution Consolidation

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The electronics component distribution market is straining under severe margin pressures that are bound to persist until businesses in the sector come to terms with one harsh reality: there are too many of them. Further consolidation of the sector is necessary if surviving distributors are to reap the full benefits of restructuring actions undertaken in response to changes rippling through the economy.

Alas, a reduction in the number of market players may not be a priority today for the distribution Titans that led previous consolidation efforts. It’s not that they are opposed to acquisitions. Market leaders like Arrow Electronics Inc. are still active buyers but they are less interested in bulking up market shares through acquisitions. The M&A goals are different this time. Arrow wants to be a critical partner and provider of a suite of comprehensive cradle-to-grave services to electronics manufacturers. Similarly, Avnet Inc.’s purchase of U.K.-based Premier Farnell last year was aimed at raising the company’s online presence and offerings to design engineers.

Tier-1 distributors are redefining their roles in the electronics industry and opting for transactions designed to distinguish them from the pack. The strategy is not wrong, however it should be complemented with market consolidation. Distribution is facing an open crisis of margin suppression despite improved financial results and sales projections. The market grew at a solid pace in 2017; sales shot up at a double-digit clip at enterprises like Arrow and at mid-tier companies favored by engineers.

Digi-Key, Electrocomponents, Mouser and Premier Farnell are experiencing bumper harvests. London-based Electrocomponents last year reported revenue rose 17 percent in its fiscal 2018 first half ended Sept. 30 and Premier Farnell notched a 33 percent sales surge for the fourth quarter of 2017. Analysts project Arrow’s December quarter sales will rise 16 percent, pushing the company to a robust 12 percent annual growth spurt. Arrow will announce 2017 results on Tuesday, Feb. 6.

These are heart-warming numbers. But they mask weighty concerns. Distributors are still searching for the elixir that can make them a higher-value and better rewarded group in the electronics design chain and supply chain. Suppliers appreciate the value-added services provided, but distributors have not been rewarded with much higher operating margins.

The downward pressure on margins won’t go away. Neither will the potentials for supplier attrition as suppliers conduct mega-mergers to improve their financial positions, leveraging distributors’ value-added services for design wins at equipment manufacturers. Without further consolidation, suppliers and equipment vendors can continue to play one distributor against the other, creating a buyers’ market for the additional services offered by these companies.

Seeking Efficiencies

EPSNews believes the distribution market can be better served by fewer players. Distributors do not like to hear this, but at its core, this is still a middleman’s business. It involves securing components from suppliers and getting these to engineers and manufacturers whenever needed at the lowest possible price. Top distributors have championed efforts to change this image and have been successful to a large extent in positioning themselves as more crucial partners to design engineers and the purchasing/procurement community with supply chain management services.

Nevertheless, the core functions many small- and medium-size distributors provide revolve around the delivery of components quickly and cost-effectively to design engineers and “Makers.” Most of the other services distributors offer are meant to facilitate the sale of components. Arrow wants to move beyond this by positioning itself as a facilitator of the design chain and supply chain fulfilment processes versus being a component “handler”. Other top distributors are humming somewhat similar tunes.

It’s a worthy goal. Achieving it, though, would be easier if the industry had fewer players still competing on the old process of fast product distribution. The ecosystem strategy is worth pursuing, if proponents avoid fault lines. Engineers may not want to be locked into a single ecosystem, but they will accept a comprehensive one that meets all their information needs. Today, the distribution market is littered with multiple technical websites, each trying to capture information about design engineers and leverage these for design wins.

The system of multiple sites often offering the same information and “communities” is indicative of an inefficient system. It can be confusing to customers and can waste time and other resources. Even here, distributors compete not only against each other but also against their own suppliers. This must change.

EPSNews believes the optimal number of distributors that should be in this market is about 10, globally. It will take years before a shakeout moves the needle in this direction. And it may never happen; regional differences and political concerns are likely hurdles. The current number of tens to more than 100 huge to tiny mom-and-pop distribution outfits is nevertheless unwieldy and a deterrent to market efficiency. It is as confusing as having 40 different smartphone operating systems, web browsers or ERP software providers.

Distributors play a critical role in the electronics industry, but their financial health is being undermined and their value and role cheapened by the large number of enterprises in the sector. A move deeper into the design chain and supply chain will help companies like Arrow stave off margin pressures but if distribution is to fully gain the credibility it deserves, top players must whittle down the competition. Again.

Bolaji Ojo is editor-at-large of EPSNews. The views expressed in this blog are those of the author alone who promises to base his sometimes biased, possibly ignorant, occasionally irrelevant but absolutely stimulating thoughts on the subjective interpretation of verifiable facts alone. Any comments should be sent to the author at bolaji.ojo@epsnewsonline.com.