How many Sourcing Professionals remember when the technology sector exploded onto the scene back in the 1990s?  There were countless new products being introduced at a record rate.  The economy was vibrant and full of life as consumer spending was in abundant supply and more than eager to gobble up  the plethora of new products.  Electronic suppliers rushed to add manufacturing capacity and were rewarded with nice organic growth.  Flash forward to the early 2000s.  The technology bubble bursts, stocks tumbled, and inflation ran rampant.   Everyone from the OEM to the resistor supplier pulled back on their expansions and eliminated capacity.  The impact was like a tsunami to those affiliated with the electronics industry as their net income across the world was decimated.  “Focus on your core-competency” and “cut cost” became the battle cry.

Around 2002 to 2003 the electronics industry rebounded.  OEM product that consumed PCBAs started to drastically increase.  This drastic “increase” was the quiet before the 2nd wave of the tsunami.  When tsunami’s hit, the first wave cripples everything in its path then the waters recede allowing more pressure and force to build.  Suddenly without warning it unleashes another devastating blow more lethal than the first.  The increase in electronic product consumption is akin to receding waters of a tsunami.  Those drastic increases were a welcomed site for a struggling economy.   Companies began focusing on churning product to satisfy starving stakeholders.   But, the negative impact of the initial blast from the Tsunami that caused the aforementioned “battle cries” began surfacing  as  “Component shortages.”

During the down turn, everyone focused on their core-competencies and reduced capacity:

· Electronic component providers (i.e. resistors, capacitors, microprocessors, etc) reduced capacity by cutting “less profitable” product offerings.  This meant that older, more mature product was made obsolete forcing OEMs to utilize their next generation offerings.

· Contract manufacturers reduced capacity because of low volumes.  They sold idle equipment in an attempt to create cash.  Additionally, they began focusing on the core of their strategy and reduced spending.  Contract manufacturers also began cosseting key strategic relationships with progressive OEMs with matching short & long term strategies.

· OEMs pulled back on forecasts as their demand was significantly reduced.  Obsolescence charges skyrocketed creating a deadly spiral where organizations focused on short-term performance and peppered suppliers with E-Auctions, reduced employee headcount, as well as other cost reduction measures.

 

When reflecting on those days,  I immediately get a headache.  With the economic pull back (1st wave of the tsunami), the knee jerk reaction of most in the industry was to reduce capacity, worker-force, etc.  The negative impact from this period was that once the economy rebounded, OEMs still couldn’t recover because of component availability issues.  This, ladies and gentlemen, was the 2nd, more lethal wave that sucked profits yet again.   A lack of components meant products could not make it to market.  And, when some were successful in shipping product, expedite charges quickly eroded the profits for those units.

I spent countless hours fighting component shortages.  Distributors and brokers were all on speed-dial.  I would often ask myself how could a $0.30 part now sell for $3.00?  Making matters worse, not only was the cost of my bill of materials significantly inflated, the expedite fees were staggering.  The cost of expediting the finished product was 8X of plan.  My factories were inefficient as they would have down-time one week and then work over-time the next.  My OEM’s customers screamed because they couldn’t get product on time.  Our total acquisition costs (TAC) were more than 50% higher than normal.  Considering the fact that a 1% change in cost of goods sold yields on average a 16% impact in net income, we knew our spiraling TAC’s were being punished even more than the downturn (1st Tsunami wave) in sales.

Once the industry realized the economy had recovered, capacity was slowly increased and OEMs were able to meet demand with normal schedules.  No one suspected the 3rd wave of the Tsunami that pummeled the industry.  This one was even more deadly than the first two waves.   With component providers making their less profitable products obsolete and reducing manufacturing capacity, OEMs utilizing those parts were crippled as they could no longer produce their products.  It then became a mad dash to find any and all supply of those components so that the OEM could bank the parts and allow themselves time to qualify  alternate components.   Many OEMs expedited their quality approval process and took on significant product failure risk by quickly moving to alternate components.  After gaining approval they would find that the new parts they wanted to migrate to were often on “allocation” because the component provider cut capacity and couldn’t satisfy all the demand for those components.  Component migration and obsolescence lead to  the “birth” of the counterfeit component industry!   Counterfeit components combined with relaxed product approval processes created huge quality issues for OEMs as product failure were 2x to 3x normal limits 12 to 18 months after the mad dash.  Even today, fake components account for $230B of a $1.7 trillion electronics assembly industry.  As much as 30% of the components on your PCBA can be fake.   Needless to say, when this 3rd wave hit, our warranty and cost of quality numbers sky-rocketed to all-time highs.  What little cash the first two waves of the Tsunami left behind was now devastated again.

When evaluating  where we are today, I see a strong resemblance to those times back in the early 2000s.  Consumer demand is at record lows due to the economic recession.  Manufacturers have cut back on existing capacity and are now focusing on their core.  Workforce reductions are the norm for the evening news.   This time, the Government is involved as they are bailing out industries and painting rosy pictures.    Right now,  there are a record number of designs being created.  Alternative energy, green applications, and a host of others have joined in making the large electronics industry grow even faster.  This means that even more demand for the component capacity that the mature OEMs will consume is on the rise.  This will force OEMs to reacquaint themselves with the phrase “allocation” as component availability issues will impact the majority of the industry players.

Almost every company in America has seen their net Income negatively impacted by the recession.  The more proactive and innovative companies are planning and investing in new products and redefining their sourcing and development strategies.  However, a rebounding demand balanced against cuts in component manufacturing capacities will lead to a brutal game of leverage as allocation begins to dominate the industry.  For those that do not have the leverage to improve their position, there will be highly undesirable options.  Those options are to be left without supply, acceptance of poor quality parts, late deliveries, and overpriced/ rushed parts.  There is an industry that feeds on these dynamics.  Don’t let your spend will be counted as a portion of the $230B “Counterfeit” component industry!

We are squarely in the recesses of the first wave of this new Tsunami and the second more catastrophic wave is building.  With any catastrophe comes the resulting best practices that can prevent the next Tsunami from devastating your organization.  Not only should you have a warning system, but you also need a plan of attack that prevents your organization from being devastated when the waves hit.  The rebounding of the economy and resurgence of consumer demand should be a good thing.  Take action now and plan properly by seeking higher ground immediately so you can thrive in the wake of the next big approaching wave instead of being an innocent bystander wondering what just happened to you and your profits.

                                 

 

Orlando Malone

The Electronic Component Tsunami:  Are you positioned to survive?

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Orlando Malone

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KISMET Strategic Sourcing Partners, LLC