A strain on the chain of supply - Brief Article

Electronics Times, May 15, 2000

Arrow's little letter upset quite a few people, says Paul Dempsey

Earlier this year, Electronics Times published details of a controversial standard letter sent to a number of its smaller contract manufacturing (CEM) companies by Arrow CMS, the UK CEM arm of distributor Arrow Electronics.

The gist of the letter was that credit terms were to be cut and the distributor appeared to be signalling that it only wanted to deal with these companies by fax. A hefty minimum order size - #100 per line item - would henceforth apply.

As Arrow's new business approach became public, it was no surprise that many of the letter's recipients were soon in touch by phone, e-mail or print to express their, shall we say, irritation. But perhaps even less surprising was the flood of distributors of all shapes and sizes, broadline and specialist, that also contacted Electronics Times to say how they would welcome the business that Arrow appeared to be discouraging - and on much more favourable terms.

Let's not be precious here - kicking a man when you think he is down is all part and parcel of the business of selling.

A more important point, though, is that most of the rivals' homilies continued to skirt around and simply avoid one of the great dilemmas in dealing with CEMs facing today's distribution market - one which, whatever else you thought of it, Arrow's letter did at least confront head-on.

That issue was set out by Arrow like this: "Arrow CMS value your business and take it as our responsibility to ensure the whole supply chain is a profitable value-adding and rewarding process. Unfortunately, analysis of our trading shows that this has not been the case during 1999. As such, the conditions upon which Arrow CMS and [name of recipient] trade need to be adapted to ensure a profitable and manageable process is experienced by us all going forward."

There are plenty of reasons why any supplier will continue to trade with a client and invest heavily in the relationship when the supplier is not making any money, even losing it hand-over-fist. The most common instance involves the `little acorns' theory, where the supplier stays on-board in anticipation that today's small market player could be tomorrow's giant. But in the CEM sector, the conception is now that the market has become so polarised that making such decisions has become almost impossible.

Distributors with global reach - such as Arrow, Avnet, Future Electronics and others - have taken on such forms largely to mark the equally global make-up of their main clients. CEMs such as Solectron, SCI and Celestica are important here because they are already, or are close to being, part of the biggest single customer group for distribution's top-end companies.

These distributor-CEM relationships are full of tensions. To encourage outsourcing, CEMs operate to tight, often lower, single-figure margins linked to very high turnovers. Domino-like, distributors' margins are falling in turn from the industry's traditional target of 17 to 21%. At the same time, distributors and CEMs have set out a battleground over value-added design work, with both sectors seeking increasing participation at the OEM level.

The upshot has been that almost all the leading distributors have set up dedicated CEM divisions - just like Arrow CMS - whose structure and economics is specifically designed to balance these pressures and deal with customers who want a global Martini (`anyplace, anytime, anywhere') marketing service. Such divisions not only provide design, but, most probably, sophisticated supply chain management systems. They take on the inventory risk of stocking shelves at the CEM's factory, but retain the components on their own books until the CEM draws them down.

And even these types of structure are not delivering what the distributors want and need. Last year, Stephen Kaufman, Arrow's chairman and CEO, made it clear at a National Electronics Distributors Association meeting in Chicago that his sector was still not extracting high enough charges from clients for the increasing range of services it supplies.

At this point enter another form of CEM. This is a moderately sized, single-country company, be it one stuffing boards or producing highly specialised products on small runs. The economics for dealing with this market are completely different, yet the smaller CEM's owner would still see his or her company as part of the contract market.

One UK rival to Arrow set out just how bleak the comparison is between this type of localised CEM and a Solectron. Within the same sales structure, the cost-to-serve the smaller company could be anything from three to an astonishing 10 times higher. Bear that in mind, and it is not difficult to see where Arrow's letter was actually coming from.

And the company is not alone. Some larger distributors are talking about a trend towards not just `vendor reduction' - the process by which component suppliers have slimmed down their outlets - but also `client reduction'.

As a result, the real criticism from these quarters of Arrow's action comes not of the action but of its execution. People understand what was being said, it is just that - with an eye on the marketing side - the feeling is that it could have been done more `tactfully'.