Distribution boosted by rising OEM design and supply chain services

Distributors are the hands-on experts OEMs are increasingly turning to in their search for supply chain efficiencies and to optimize design engineering activities.

Electronic component distributors have hit the sweet spot of their market. In addition to surging demand for semiconductors, passives, interconnects and electromechanical parts, OEMs are asking distributors to support them with more value-added services, including design engineering, supplier management, inventory management and scarce component procurement functions. 

The largest OEMs typically prefer to handle critical value-added supply chain activities in house but even they have joined the throngs of electronic equipment manufacturers seeking more of such services from their distribution partners. The impetus for this development varies but it is primarily being driven by the ongoing shortages for components and the need to tap all available resources and avenues to secure the parts, according to industry executives.

“OEM demand on our business has always been strong when there are supply chain disruptions,” said Todd Burke, president of the Americas at N.F. Smith & Associates, a leading independent components distributor. “The companies affected by the ongoing shortages are many and some have strategies in place while many don’t. Before the crisis, people knew what to do but many don’t now, so they need help and support.” 

Value-added services have always been controversial in the component distribution business. Many OEMs believe it is an essential part of the functions distributors should provide and have always been reluctant to pay extra for it. Top distributors, on the other hand, consider it a premium offering for which they should be adequately compensated. The controversy deepened in the last decade-plus as more OEMs whittled down their design engineering teams and became more reliant on distributors. Services such as design engineering, inventory management and even the coordination of activities with OEMs approved vendors were shifted onto distributors, increasing their operating costs as they sought to win supply contracts. 

The sometime adversarial discussion about the essence of value-added services eased as the ongoing shortages pinched OEM operations. Unable in many cases to secure components they increased collaboration with distributors, sharing critical production information and teaming up to assess component requirements to assure manufacturing efficiency. In addition to their traditional procurement functions, distributors were heavily involved in design manufacturing services, assisting with the redesign of systems and subsystems to keep production lines humming. They also assist in determining replacements for unavailable parts, a process that may involve minor or major redesigns.

“Our record gross profit and earnings per share for the quarter were driven by strong execution in the face of supply chain demand imbalance,” said Michael Long, former CEO of Arrow Electronics Inc., while presenting the company’s first quarter results to analysts before his retirement at the end of May. “I’m pleased to report that our past investments to enhance our capabilities, especially in the area of supply chain as a service are leading to growth and our profit performance.” 

Like many of its competitors, Arrow is on track to report strong financial results this year, building on solid growth in the prior year. Revenues are seen increasing 8 percent in 2022, jumping to $37.6 billion, from $34.5 billion, in 2021, according to analysts’ consensus estimate. For the current quarter, Arrow itself expects sales to be between $9.04 billion and $9.64 billion, up 12.6 percent at the high end from $8.56 billion in the second quarter of 2021. The components business is expected to contribute about 79 percent, or $7.59 billion, of the revenue, with the global enterprise computing solutions division making up the difference. Arrow executives noted that the company’s supply chain and design engineering services are expected to remain a mainstay of the component business in future. 

“Arrow is helping customers navigate shortages and supply chain challenges so they can maintain production, bring new electronic products to market, and securely manage their applications and data,” said Rick Seidlitz, interim chief financial officer, during the company’s first quarter conference call. “By helping to mitigate production risks and facilitate a continuous stream of products to market, Arrow deepens customer relationships and solidifies its position as a trusted partner.” 

Supply chain services also helped Avnet Inc. in its fiscal 2022 third quarter ended March 31. Having gone through several rounds of restructuring and repositioning of operations, Avnet is experiencing a resurgence and has seen patronage rise from core customers. The company exceeded industry growth average in the March-ended quarter, with sales rising 32 percent, to $6.5 billion, from $4.9 billion in the comparable prior year quarter. Phil Gallagher, CEO of the Phoenix-based company attributed the financial improvements also to an increase in supply chain services, in addition to regular component operations.

“Growing demand for supply chain orchestration is driving strong financial performance across our global business,” Gallagher said, in a statement announcing the results. “Looking ahead to the fourth quarter, amid the backdrop of geopolitical uncertainty, we continue to anticipate a favorable demand environment and expect to sustain strong margins from our recently implemented operating improvements.”

Avnet told investors it expects sales in the June quarter to be between $6 billion and $6.4 billion, up approximately 22 percent from $5.23 billion in the comparable quarter of 2021. Avnet said its recent reorganization activities are beginning to pay off and said it expects further improvements on ongoing market strength. 

“We are competing favorably across the board and are pleased to see continued improvement in our Americas business, where strong demand and expanded supply chain orchestration opportunities helped us grow revenue by over 40 percent year-over-year and achieved our fifth consecutive quarter of operating margin growth,” Gallagher said. “Our continued investments in digital and design tools and field application engineers are paying off, as demonstrated by another solid quarter of design and engineering activity across all regions. These high levels of design registrations and wins in prior quarters resulted in yet another quarter of record, demand creation sales and gross profit.” 

Globally, the component distribution market is benefitting from continued strength in demand for parts from different segments of the economy, including the automotive industry which over the last couple of years witnessed extreme semiconductor supply shortages. The industry is also benefitting from rising average selling prices, a result of the tight supply conditions and the willingness of OEMs to pay a premium for components in order to stave off manufacturing challenges. So far, distributors have been able to pass on the higher component costs to OEM and EMS customers, sources said. 

Will the industry be able to maintain the higher ASPs? For now, a downturn is not in the outlook for semiconductors and IP&E components. With lead times stretching out as much as 52 weeks in cases, the pricing pressures will remain, observers said. At the same time, the electronics companies have good prospects ahead due to the continuing injection of semiconductors into major segments of the economy. The growth in demand for electric vehicles and autonomous vehicles as well as demand from the medical and industrial sectors will keep sales strong for OEMs and in all parts of the supply chain, executives said. OEMs, EMS providers and component distributors must maintain their collaborative activities to avoid further supply chain snafu, executives said. 

This collaboration should include regular updates on production schedule, joint pre-production planning and design engineering work, according to Smith & Associates’ Burke.

“Distributors have legitimized our involvement in the design engineering process and in the supply chain and this should not stop,” Burke said. “OEMS became more active in the supply chain and involved distributors even more. Will they continue to involve us in future? I believe it is important that they do. The supply chain may not be an exciting part of OEM operation, but it should be a high priority.”