Who's going to pay the bill? Inventory woes strain relations across electronics industry - OEM' and electronic manufacturing service providers

Electronic News, June 3, 2002 by Rob Spiegel

To the OEM, outsourced manufacturing seemed like a wonderful idea. In addition to lowering costs, the relationship with electronic manufacturing service (EMS) providers let the manufacturer off the hook for managing inventory. Who cared if it still held the liability? The EMS provider ordered the parts, stocked them and paid the suppliers.

To the OEM, the components were out of sight 4% and out of mind. And it all worked just fine, until one day demand for products dropped like a hot knife 4 through butter.

The EMS provider turned to the OEM--nicely, of course, because this is a coveted customer--and asked if the OEM wanted the parts back. The OEM gently asked the EMS provider to hold onto those parts a tad longer because demand surely would pick up later in the quarter. And the supplier turned to the EMS provider and asked if it would pay its bill.

The EMS provider responded that it didn't own the parts, and the supplier retorted that its signature was on the purchase order.

That scenario is essentially the setting for the struggle over who owns the excess inventory and why it has become such a delicate issue among the various trading partners. This issue is less a question of who owns the inventory and more a question of how and when to resolve the ownership question.

"The struggle about who owns the inventory is a little distorted. Contractually, the OEM owns the excess in almost all cases," said Jeff Bloch, VP of electronic manufacturer services at iSuppli Corp., the El Segundo, Calif.-based research firm. "The exception is if there is not an agreement in place or if the EMS customer does not have the documentation that the excess was a direct result of a forecast."

In most cases, the EMS provider is easily able to produce documentation proving who really owns the parts. But if the ownership is clear, resolving the liability is not. For one thing, the OEM would prefer the EMS provider to hold the inventory until demand returns. And EMS vendors are wedged in the middle of two issues, namely excess inventory and keeping the customer happy.

To further complicate matters, the EMS provider is getting pressure from suppliers to pay for the inventory. "The supplier gets put on the spot, too," Bloch said. "Even though the inventory is sitting on the books of the EMS provider, the contract manufacturers will stretch out payments or put a hold on payments." The EMS providers try to stall until the OEM ponies up to take responsibility for the excess components. In spite of the rumors about infighting along the supply chain, Bloch noted that OEMs are taking their fair share of responsibility. "Most of the reputable OEMs end up resolving it," he said.

Even so, there remains confusion along the supply chain about how to make sure the resolution of conflicts doesn't remain an expensive problem. That's especially the case because OEMs believed the EMS relationship had taken care of inventory question. Analysts say the inventory liability problem actually came as a surprise to many OEMs, and it only showed up when demand fell. Whereas most of them believed they didn't have to worry about inventory, now they're faced with big write-downs.

Some believe the problem is intrinsic to the extended supply chain. "People have to look at managing an extended marketplace," said Rob Rodin, CEO of eConnections in Pasadena, Calif. "It's not like managing internally," he said.

Rodin noted that the global nature of the extended supply chain has brought further complexity, causing problems that are not easily cured. "The power of global markets is that you can manufacture anywhere, outsource anywhere. You need to build an infrastructure to support that," he said.

Vinay Asgekar, analyst at Boston-based AMR Research, said he believes the problem of what to do with the excess is ongoing. "There is still a tussle going on. I don't think the OEMs, EMS providers and suppliers have figured out how to deal with each other," Askegar said, adding there is a difference in the way custom parts are handled versus commodity parts. "For critical components, the OEM will continue to control them themselves. As for noncritical components, they have no reason to handle them."

Bloch noted that even with commodity parts, the OEM is ultimately responsible. Yet the OEM has allowed the EMS provider to manage commodity parts. According to Bloch, this responsibility shift became a problem when tantalum capacitors went scarce.

"When the crunch came, the EMS providers didn't perform to the level the OEM expected, so now they're looking at what to do about those scenarios in the future. The long-term trend is to have commodity parts allocated to the EMS provider," Bloch said.

As for solution to the ongoing inventory mess, Bloch believes it will be resolved by OEMs becoming more interested in what parts are going where.

Distribution of Chip Inventory, Q1 2002

Excess = $2.6 Billion

Since the 2001 downturn, who owns the inventory has become more of an
issue.

EMS             29%
Distribution     3%
Semiconductors  48%
Retail/Resale   11%
Network          4%
Other            5%

Note: Table made from pie chart
Excess Semiconductor Inventory Forecast

$ Billions of excess at quarters end

Q101   13
Q201    8
Q301  5.9
Q401  3.9
Q102  2.6
Q202    1

[ ] Actual

[ ] Forecast

SOURCE: ISUPPLI

Note: Table made from bar graph