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Quest for dominance China's fragmented electronic components distribution market is ripe for consolidation. Who's going to lead the charge?
One of the biggest factors at play in China's electronic component distribution market is that it is a major market where the globally dominant players don't have double-digit share. Eventually, the market will consolidate, with the main players achieving dominance, but cultural habits aren't broken overnight. Certainly, as China's legal system improves and the R-factor--relationships--declines in importance, change will come. But it will take a while to rationalize China's component distribution market. In an earlier ESM article ("China distribution: wide open," April 2006), I listed five factors that I believe will drive consolidation. They all have relatively short fuses--measured in years, not decades. It's hard to say, however, which of them will be the catalyst for consolidation. Perhaps the bigger issue is how much longer the large distributors from North America can wait before ramping their investment in the world's largest component market. I believe the lack of investment (or even entry) into China by most of the top 50 North American franchise distributors is one of the worst management blunders in the history of the industry. Unless this changes rapidly, a decade from now the list of the top 50 global franchise distributors will differ markedly from today's roster. In the August 2006 issue of ESM, Nicole Lewis wrote in "New Roles, New Demands" that Xilinx has "shifted away from a traditional third-party fulfillment program, where all its parts were bought or sold via distribution. Now, the semiconductor company directly sells to its customers, fills the orders and conducts technical support. In making the change, Xilinx chose to forgo 3PLs [third-party logistics providers] and picked Avnet Logistics, a business unit of the top-tier components distributor . . . "Xilinx, a programmable-logic vendor, established Virtual Direct three years ago. Servicing 15 of its largest customers, the program streamlines the flow of parts to contract manufacturers assigned to build products for the OEMs. "By using Avnet Logistics to electronically connect with the manufacturing sites, and by creating forecast intelligence from multiple EMS providers, Xilinx says the supply chain was streamlined, tangibly reducing inventory that Xilinx, the contract manufacturer or the OEM would maintain."
Beyond traditional services It might seem like they're eating their own young. But there has always been a lot of direct purchasing by big OEMs and EMS providers--transactions in which Avnet and Arrow, as distributors, had no part. Now they can get a piece of this business through their captive logistics companies. Further, consider the information available to Avnet and Arrow via these operations about who's buying what and at what price--and the impact of that on their distribution business. In that context, the logistics move looks to be a brilliant stroke that has increased the two giants' market power. The Avnet Logistics Web site claims its services offer "an attractive alternative to general-purpose logistics service providers, tailored to your technology supply chain." That is certainly true, and it is a very powerful sales argument. Who would you rather have handling your sensitive electronic components: Avnet, with its many years of experience, or a generalized forwarder that might ship your sensitive goods alongside something containing a large magnet? But Avnet and Arrow have no such capability in China. Taiwan-based distributor World Peace Group (WPG) is trying to set up a logistics network in China to fill the void, but it has nowhere near the leverage with large vendors that Avnet and Arrow enjoy. Moreover, WPG cannot pressure other distributors to use its logistics in China, because it is not a big enough market force. Indeed, other distributors don't want to use WPG's logistics, because they don't want to give WPG any information about what they are selling to whom and at what price. The problem extends to vendor-managed inventory (VMI) in China. OEMs and EMS providers are clamoring for this service, but at present there is no supplier-neutral company that is willing to work with them to set up the VMI hubs they need.
Realignment needed Our research tells us that most top distributors selling into China would jump at the chance to have a supplier-neutral services company handle their logistics, and they would likewise recommend that their OEM and EMS customers use the same company to handle procurement fulfillment and VMI. So why hasn't that happened? First, only a handful of supply chain management services companies are qualified to operate in China. Second, almost all of these companies, in true Chinese fashion, are involved in all sorts of peripheral businesses that drain management resources and limit the ability to focus on an opportunity of this magnitude. Finally, financing for such an opportunity is very difficult to obtain in China. One possibility is that a consortium of suppliers that is broad enough to ensure supplier neutrality will jointly fund a company to take on this role. Another wild card is that China's share of global electronic component manufacture is likely to soar in the years to come. Capital inflows into China are huge today. Unfortunately, most of it goes to keeping inefficient state-owned enterprises (SOEs) afloat. But China's entry into the World Trade Organization is driving big changes. The government cannot keep its SOEs afloat forever, because those enterprises won't be able to compete with their foreign counterparts. As this problem gets resolved, massive amounts of capital will be available for projects such as building semiconductor fabrication plants. The number of fabless design houses has grown by leaps and bounds in China (that's one business for which there is funding). Certainly, those companies would rather put their ideas into silicon around the corner than around the world. I predict that if the infrastructure is put in place, these companies will sell their products directly to OEMs and EMS providers, as Xilinx is doing. Again, from the point of view of a big distributor selling into China, it would be better to get some piece of this through an investment in a nonaligned supply chain management services company than to get nothing. Big changes are coming to component distribution and delivery in China. There has been no slowdown in the movement of electronics manufacturing to China. Therefore, the growth in the consumption of electronic components will continue at its blistering pace. The days in China of big margins for distributors based on the R-factor and of all components going through distributors will certainly end. It is my belief that in 20 years, several nonaligned electronic component supply chain management services companies will be operating in China, handling logistics, procurement fulfillment and VMI for virtually all of the parts consumed in that country. By contrast, the number of distributors will decline radically through consolidation and attrition.
Henry T. Cochran is CEO of SinoHub Technology Co. Ltd., a Shenzhen, China-based electronics supply chain services provider. He can be reached at hcochran @sinohub.com.
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