Representor Summer 2024 - Executive Commentary


Our prices come with parts

Walter Tobin, ERA CEO

by Walter E. Tobin, ERA CEO

At EDS, there were a lot of questions around the state of the union of our industry. When are things going to turn around? When is business going to get better? When is the excess inventory in the channel going to get burned off so we can get back to booking new orders? When will things get back to “normal’?

Defining words like “things,” “getting better,” “excess inventory” and “normal” depends on the lens that you are looking through: a manufacturer, a rep and a distributor may define these words very differently. What about our customer? How would they define them? I think very differently.

And what about Wall Street and the financial investment community? What do they think about the times we are in today? Do they even understand the challenges of our industry? Do they even care about anything other than the stock price of the publicly traded companies? Do they look at anything other than return on working capital, gross profit margins, net gross profit margins, total days of inventory, inventory levels and turns and days sales outstanding and days of collections? Inventory is a dirty word on Wall Street — yet, somewhere along any supply chain there has to be inventory. But everyone wants someone else to carry the inventory on their P&L and “not on mine!”

Our industry has grown up over the years by relying on manufacturers to continue to develop and manufacture highly complex electronic components and make them available to a broad range of customers who have varied levels of sophistication in their ability to forecast demand and then manage their supply chain. On what do they base their demand forecasts? Certainly, the inputs of their manufacturing teams who have to plan out their build cycles based on what? The forecasts that they are receiving from their own customers and sales force. How accurate are these forecasts? How often are they changed? How do they manage the forecasts that come in from their manufacturing teams, who need product inside of a manufacturer’s lead time?

Their first call may be to their manufacturer partners: “Can you manage this unforecasted demand for us? We need the product in four weeks versus the manufacturing lead time of 12 weeks!” This “unforecasted demand inside of manufacturer’s lead time” is placed at the feet of the distribution community. After all, isn’t that the role of distribution?

The typical distributor services anywhere from 20,000-40,000 customers, all with supply chains that get set at the beginning of a month or quarter, only to have them blown up by these unforecasted demands right after they are transmitted to their suppliers. Can you imagine the challenge of the distributor who is aggregating the forecasts of thousands of customers whose forecasts are +/-25 percent wrong? How does the distributor accurately forecast its own demand on their manufacturers and even come close to being correct?

When the pandemic hit, many of us panicked — we rushed out to get product and we double- and triple-ordered parts. You could not get masks or ventilators; remember those days? However, throughout the first 18 months of the pandemic, with product on allocation and in a shortage mode, when you asked any company, “How’s business?” the answer usually was, “I am having a record year.” How could this have been true? Someone was ordering, shipping and billing something to someone.

Many of us were experiencing book-to-bill ratios of over 10:1. Then, as things eased up a bit, we were waiting for “the golden screw” — that final part on the bill of materials (BOM) that we were waiting for to release the BOM to the manufacturing floor. Once the golden screw came in, we rushed to cancel the overages that we bought on the other devices and begged our suppliers (distribution or the manufacturer direct) to let us both cancel or backlog and/or return the overages that we bought.

We were then faced with both the manufacturers and distributors enforcing NCNR orders that we willingly agreed to a year prior simply to get parts: after all, no one had ever enforced these NCNR orders! Well guess what? They did.

Now here we are in 2024, finally almost recovered from the excess inventory up-anddown of the supply chain. We went from a sellers’ market to a buyers’ market in 18 months. What do you think the next cycle will be — a sellers’ market again? The only thing we do not know is when.

So, here we are, trying to manage a very complicated supply chain that consists of sophisticated state-of-the-art electronic components, selling to manufacturers who will incorporate these parts into their own products. They have outsourced manufacturing to the world of EMS which usually relies on the distributors to their supply chain – often due to their supply chain expertise and/or discounted/extended payment terms.

In most cases, the demand from the OEM customer, either direct or via EMS, is inaccurate. The demand forecast is based on manufacturers’ lead times which are often inaccurate or not in line with lead times.

So, in many cases, with all of our supply chain automation, adoption of APIs, etc., we are simply transmitting bad information faster! Yet, Wall Street thinks we are managing commodity items, parts that are easy to set lead times for and easy to forecast demand. Not so! So, what is a customer to do? How can any OEM or EMS company reward great performance and punish bad performance? Simple! Change the archaic ways of measuring the supply chain teams on purchase price variance (PPV) and go back to looking at the total cost of ownership (TCOO) that was introduced by economist W. Edwards Deming years ago. What good is a low price when the quality is not there? When the product is not there?

Any supply chain executive will usually lose their job when they do one of two things: 1) Buy too much – They buy extra quantities to get a lower price to satisfy their PPV goal and they end up with excess inventory that may take the company another 12-18 months to burn off. Yet, the buyer hits his/her PPV goal and gets additional incentives. The CFO has the buyer terminated. 2) Buy too little – The buyer may reward an order to a supplier that gives them a low price but then cannot meet the expected lead time to the manufacturing floor — the manufacturing line stops. The buyer may be asked, “Where are the parts?” They may respond that they bought from the lowest price solution to hit their PPV goal. The line gets shut down; the buyer is terminated.

Buyers generally do not get terminated for paying a few pennies more. After all, the cost of an individual part represents .000001 percent of the total COGS in any BOM and the line hums and there is no excess inventory on the company’s P&L. Suppliers need to be measured on their total cost of ownership. Do customers even look at this today? When was the last time you told your customer about your on-time delivery and quality ratings? Have them ask the competition what their ratings are. Start this today at your own customer base.

It is up to us to change the game here — to take away the price discussion and take it back to TCOO.

Any good supplier should be able to say, “Our prices come with parts.” Nothing else matters.