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Front End I Electronic Components Supply Network

Improving control of the grey market

To halt what appears to be a ‘race to the lowest price’ semiconductor manufacturers need to re-think their sales and marketing strategy or risk industry casualties. Adam Fletcher questions if key industry players actually have a defined business strategy in place, or are simply reacting ‘on-the-hoof’ to short term events


roduction efficiencies and greater integration of functions has enabled the widespread availability of new semiconductor technologies at competitive prices. The semiconductor industry has always been global and highly competitive but the pace of change in the last decade has been significant in many ways.

On the supply side a growing number of semiconductor manufacturers now subcontract some or all of their product manufacturing to multiple third party organisations. For many of these companies becoming “fab light”, was a financial imperative, as the escalating cost of their own semiconductor manufacturing operation would never have produced an adequate return on investment. Fab light companies have seen a short-term improvement in operating costs and a lower unit price thanks to the yield improvement that comes from sharing resources and utilising the latest technology but there is a downside. The organisation cannot use its assets in manufacturing operations to create a competitive advantage and is reliant on changing the dynamic with multiple supply network partners, which its competitors are also seeking to do. The outsourced foundry model also

effectively reduced the barriers to entry, which has encouraged both innovation and competition. New entrants are constrained by the rapidly increasing cost of semiconductor design and the limited availability of venture capital funding, whilst many promising start-ups rapidly get acquired by more established semiconductor companies for their proprietary IP. The shift from west to east in volume equipment manufacturing to tier one contract electronic manufacturers (CEM) in China has enabled the aggregation of the demand of multiple original equipment makers (OEMs) and the consolidation of their purchasing power, enabling these CEMs to virtually dictate the price they are prepared to pay. Unfortunately the ability of the CEM or

8 December 2013/January 2014

their OEM customers to accurately forecast their needs generally results in the CEM over ordering components in order to meet an overly optimistic high side forecast. Fortunately for them CEMs often have multiple manufacturing operations and regularly move inventory between locations in an attempt to use it. Unused or deliberately over-ordered inventory is often sold at a higher price on

the vast majority of their customers in the global market.

One of the primary roles of an authorised distributor is to promote the semiconductor companies products in the trade media and via E-commerce and where appropriate, support the technical design process using a combination of technically competent internal and external staff. The results of this activity are monitored by the semiconductor manufacturer (particularly if production is likely to move out of the design territory). Some form of a design registration process is used to provide authorised distributors with a financial incentive for this activity, often by improving the profit margin on that specific customer sale for a defined period of time. There is a legitimate concern in the authorised distribution industry that semiconductor companies are abusing the design

exclusive) products to address. This situation is exacerbated in commodity markets served by multiple suppliers, especially in the current market where demand is suppressed and product lead- time availability remains very low. This will not always be the case however: the market will turn and even the largest CEM purchasers of semiconductors will come to realise that there are many important aspects to total acquisition cost of which the unit price is but one. Semiconductor manufacturers need to focus more resource into promoting within their marketing mix aspects such as availability, capability, new product development, integration, higher reliability, patents, etc. By developing a better awareness of the entire value proposition that they have to offer their customers may enable them to achieve a very small price premium or competitive advantage that results in more sales. Products released on the grey market

represent a profit opportunity for the CEMs but they undermine all of the semiconductor industries global pricing policies and represent a missed profit opportunity for the semiconductor company. Just as semiconductor companies have tightened their contractual terms with their authorised distributors they need to apply a similar action to their direct customers, particularly with regard to releasing products onto the grey market. Don’t believe it can be done? Car giant BMW has just taken some major steps to stop arbitrage in its US dealer network, preventing new BMW cars purchased via its US dealers being exported into China where they attract an eye-watering price premium.

the ‘Grey Market’ in a practice referred to as ‘arbitrage’. The practice of exploiting a price difference between multiple markets is not new and has always been a major industry problem but the activity is now becoming more focused as it comes under the control of a much smaller number of players, principally in China, who are very well placed to leverage global availability in order to disrupt pricing policies. As a matter of policy most

semiconductor companies will only directly support the relatively small number of OEM and possibly CEM customers that generate @60% of their sales revenue. They are therefore heavily reliant on their authorised distributor channel to support

Components in Electronics

registration process without fully understanding the range or depth of value added services provided to a specific customer or more generally as a method of covert margin reduction. Many authorised distributors are

concerned that whilst semiconductor companies may have too high a level of control over their activities and pricing via design registration, they have almost no control over the activities of directly supported OEM customers, particularly when the purchasing is sub-contracted to larger Chinese CEMs. In today’s markets this remains a very

difficult problem for semiconductor companies who have proprietary (near

If a legal contract solution is not possible there may be other strategies to consider i.e. re-stocking unused products from CEMs directly back to the semiconductor company; making the OEM customer contractually responsible for the actions of their sub-contractors; and providing financial incentives for improved forecast accuracy. These industry problems are becoming painful because of the current lack of global demand or growth but they do need to be addressed in the longer term, but it is the very nature of the electronic components supply network to successfully adapt to these sort of challenges.

ECSN | Adam Fletcher is Chairman of Afdec/ECSN

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