Undoubtedly, electronic component distributors have contributed to the tremendous development of the electronic manufacturing industry for a long time. Being the middleman between electronic component manufacturers and buyers of components, distributors provide value to both parties, allowing them to maintain and grow their business.
The diagram below demonstrates the role of component distributors in a simplified supply chain.
Distributors offer major value to buyers by addressing 3 key procurement needs:
- They provide purchasing channels for small manufacturing companies who cannot purchase direct from the manufacturers.
- They shorten purchasing lead times by maintaining a certain level of inventory to meet both unexpected demand surge and demand seasonality.
- They assist with reasonable pricing. Distributors have strong negotiating power with manufacturers because they have agglomerated orders from hundreds of customers. They purchase components in bulk at a lower price and sometimes share a portion of this price variance with customers.
Simultaneously, they also provide valuable benefits to electronic component manufacturers:
- Distributors are able to reach more customers than manufacturers do because of extensive distribution networks and a strong sales force that helps to boost manufacturers’ sales.
- Distributors stock inventories in their warehouse so that manufacturers can reduce inventory cost.
- Manufacturers can allocate more resources to serve strategically important customers as distributors assist in dealing with thousands of small ones.
Some distributors also provide additional services such as programming on programmable devices, re-packaging and kitting.
Services provided by component distributors have been valuable and their business model is viable because of three conditions:
- They provide fast access to material. By carrying finished components in warehouses close to end customers, distributors can offer shorter lead times (normally less than 2 weeks).
- They manage many relationships, keeping the cost low for manufacturers. For a manufacturer, the cost of doing direct business with smaller customers is not any less than that of large ones however the revenue from smaller customers is significantly lower.
- Distribution margin is not transparent to buyers and information asymmetry exists between these two groups. Buyers don’t know the typical purchasing price in the market so their price is determined by how much they are willing to pay, a value that differs from company to company. In short, same component/service, different price.
Given this, how are distributors doing? From the chart below, we can see that distribution businesses experienced fast growth from 2004 to 2010. Conversely, over the past five years, their tepid growth in revenue has coupled with deteriorated operating income. If this trend continues, distributors will soon start to lose money.
We can also see that 5 top distributors take 80% of the market share while most others are losing share. World Peace Group came from nowhere in 2004 to become the #3 position in 2016 (14% CAGR) although doing it at the expense of margin (2%) which is likely not sustainable.
None of above-mentioned distributors’ Altman Z-scores sit in the safe zone. Many distributors have started to diversify their business away from traditional component distribution operations. For example, Avnet has acquired 25 companies in the past five years and only 8 of those acquisitions relate to its distribution business; the balance are associated with IT solutions, data analytics and component recycling.
Using this overview of the current state of distribution, my next blog will examine if the distribution model is sustainable.
Han Di is a contributor at the operational and strategic levels in supply chain development and is a Supply Chain Specialist at Silecta Inc., a supply chain services company.
