Distributors face a global challenge

Most electronics distributors posted strong growth in 2004, but growth will be slower this year as more manufacturing moves offshore.

By James Carbone -- Purchasing, 4/21/2005 6:00:00 AM

The Top 75 distributors enjoyed double-digit growth in North American sales in 2004 as component demand was strong across most customer segments. Distributors also reported an increase in demand for value added, supply chain management (SCM), and design services which helped drive revenue growth.

In total, the Top 75 distributors grew sales from $19 billion in 2003 to $22.2 billion in 2004. It is the first time since 2000 that revenue increased for the Top 75. In 2000, Top 75 revenue was $34.6 billion. Also for the first time since 2001, Arrow is the top North American distributor with sales of $6.1 billion.

"Arrow had good growth in all regions in 2004," says Bill Mitchell, CEO. "Our North American components business is very broad based. We showed strength in all segments from communications, medical, automotive and military, and aerospace. Everything was strongly up. The demise of the U.S. electronics industry is premature. High-volume stuff has left for Asia but there is still a lot of medium and low volume business across many segments," says Mitchell.

Avnet, which had been number one, had sales growth of about 10% and finished calendar year 2004 with $5.6 billion in revenue. Despite falling to the second spot, 2004 was a good year for Avnet.

"We set multiyear records in many financial categories," says Roy Vallee, CEO of Avnet. "In the second half of the year components business slowed, but our computer business finished with a record-breaking quarter in December. Overall in fiscal 2004 we had 13% revenue growth. We resumed growth for the first time in three years."

Vallee attributes growth to a broad based recovery of the components business and an increase in capital spending by businesses.

"The increase in capital spending by businesses helped us with our IT business and also contributed to the growth in our component business," he says.

Arrow and Avnet weren't the only distributors who had strong years. Of the 75 distributors, 38 had revenue increases of at least 10%. Among the distributors with the strongest growth was passives and interconnect specialist TTI, in Fort Worth, Texas. The company grew its North American sales by 24.7% to $555 billion despite falling prices for commodity products. Higher performance and higher priced passives based on newer technologies had better margins and made up for the price erosion of commodity products, says Craig Conrad, senior vice president, chief marketing and strategic planning officer at TTI.

"It includes polymer technology, niobium technology, high-voltage ceramic technology. Prices are better for those products and they have better margins," he says.

Catalog distributors also had very strong years. Digi-Key grew sales 28.2%, Mouser, 45.7%; Allied, 19.8% and Newark InOne about 10%.

"Because we are small order, we grow less in the peaks compared to Arrow and Avnet and decline less in the troughs," says Paul Tallentire, president of Newark InOne, Chicago. A typical catalog order is about $300.

"It was a very good year for us," he says. "We grew in the segments we wanted to grow across the business. We exceeded our sales and profitability goals."

Digi-Key also posted strong revenue growth in 2004.

"We have put continuing emphasis on our volume business," says Mark Larson, president of Digi-Key, located in Thief River Falls, Minn. "That is where we are really targeting larger orders from customers who had been using us for smaller engineering orders. That is showing reasonable success. We added some new passives and semiconductor lines that have rounded out our line card nicely," he says.

Distributors reported that most of the growth occurred in the first half of 2004.

"In 2004, the first two quarters were better than the third," says Robin Gray, executive vice president of the National Electronics Distributors Association (NEDA). "The fourth quarter was mixed depending on who you were. The top 20 distributors had a strong fourth quarter."

While distributors enjoyed a robust 2004, they are concerned about 2005. Component demand in the first quarter of 2005 appears to be weaker than in 2004 and modest price declines are likely. That will likely put a damper on distributor sales growth in 2005. Many distributors see flat to 5% growth in 2005.

Distributors are forecasting sluggish growth because component demand is expected to be weaker than in 2004. Semiconductor revenue growth is forecast to be flat to 5% and similar growth rates are forecast for passives and connectors. If forecasters are accurate, the only way for a distributor to post double-digit growth in 2005 will be to take market share away from other distributors.

"No one believes 2005 will be better than 2004," says Mitchell of Arrow. "What most people would say is it would be an OK year and not a great year. Supply chain is in balance. It's a pretty rational, disciplined market. I can get product readily. Leadtimes are low and there are no shortages. It is almost a boring market," he says.

However, while the industry as a whole won't post double-digit growth, some individual distributors expect strong growth in 2005. Case in point: TTI

"We are confident that the North American distribution market will be good although it won't grow the same as Asia," says Conrad. He says TTI can grow by improving its connector business. "We have market share opportunity in connectors. We are recognized as a big player if not the biggest in passives but we have not yet differentiated ourselves in connectors and there is opportunity for us to do that," he says.

Driving sales

Some distributors say the key to growing revenue in North America in 2005 will be serving customer segments that have been historically underserved by distributors.

Vallee of Avnet says that the auto industry is a great opportunity for distribution because of the growth of electronics in vehicles. He says in the past there would be a small number of components in engine control units and braking systems.

"You had a small number of stock keeping units (SKUs) with high volume procurement, long leadtimes in terms of production planning. The value add for distribution was quite limited. But now the auto industry is moving toward programmable solutions that require value add and we are good at that," says Vallee.

Such solutions require programming which is a core value-added service for distributors.

"Vehicles are becoming more complex in terms of electronics content," he says. "There are options that are not automatically ordered on every vehicle. That means lower volume parts will be needed with short leadtimes, which demand services that distributors can provide."

Mitchell says Arrow will not service auto OEMs such as Ford and General Motors, but rather tier three and four suppliers in the automotive supply chain.

"Automotive is one segment that we think is under penetrated by distribution," says Mitchell. He says about 10% of electronics sold to the auto industry goes through distribution while in other industries it is 25-30%.

"The need for a company like ours to service lower tier three and four providers to the auto industry gets greater and greater in North America and Europe and ultimately that will be true in Asia, too," says Mitchell.

Besides automotive, distributors will focus efforts on industries that are likely to say in North America such as medical, military, aerospace and industrial automation.

P.J. Murphy, vice president of sales for Sager Electronics in Weymouth, Mass., says he expects to see strong growth from industrial controls and machinery manufacturers as well as contract manufacturers involved in industrial equipment, medical equipment and transportation.

"Our strategy is to get into that midtier market that is being served marginally by the big guys. That is where our focus will be," Murphy says.

However, the large distributors will also focus on the midtier market in North America because so much high volume business has moved to Asia.

More services

Large distributors say they will service the midtier with parts and a host of services that are designed to help reduce total cost or boost revenues. "The way we gain share with customers is to help them grow revenues or reduce their expenses," says Vallee. "We are going to do that with solutions that leverage supply chain and design chain services."

Design services can help reduce overhead costs from OEMs because the OEMs can use the distributor's engineers to help design products. Supply chain management services also help reduce overhead, increase inventory turns and reduce inventory levels.

"Because of competitive pressure, it's more about providing solutions than just selling parts," says Vallee.

Mitchell says design and SCM services will help fuel distributor growth over the next several years.

"Customers ask 'what can you do for me to help me design my products and get to market faster? What can you do to help me reduce cost,'" says Mitchell. "We have to roll out better services to provide capabilities to a broad range of customers in North America."

He says there is no question customers want more supply chain management services. "We track the percentage of customers with whom we have supply chain engagements with and it is close to 70%. Mitchell says such services are profitable and help drive component sales.

Buyers can expect distributors to be more willing to provide services even to smaller customers. Distributors are looking to grow market share in North America. Services are one way distributors hope to maintain or grow business with small and medium-sized businesses.

An example of this is Newark InOne. The distributor has announced it is offering free tape and reeling services.

"We introduced services where we offer passives on tape and reel and same day, free of charge," says Tallentire. "We will re-reel any surface-mount passive that we have in our offering free of charge. It saves the customer time and money. The feedback from customers has been positive," he says.

For some distributors, supplying parts for equipment repair operations will become an important revenue stream in North America, says Gray of NEDA.

"There are smart appliances like refrigerators, security systems and they are all loaded with electronics," he says. The equipment is heavy and when it needs to be serviced it cannot easily be shipped so a repair technician has to make the repair in the home. Often they need a new board rather than mechanical part and a distributor can supply the board. It's a small volume business and catalog houses are well positioned for that," says Gray.

Look to the East

While large distributors will try to gain market share in the North American market, they will also focus on the growing Asian market especially China.

"It isn't rocket science. Forty-five percent of the supply chain is in Asia. It's not hard to see where you have to continue to invest and grow," says Mitchell

Arrow increased its Asian sales by 40% in 2004 and that location will continue to be a growth engine for distributors. Arrow services many of the transplant companies manufacturing in Asia as well indigenous companies.

"What intrigues us in Asia is we are beginning to see the growth of a local domestic market that is similar to the more mature economies of the world," says Mitchell.

Avnet has also had strong growth in Asia. "We had two years in a row of 50% organic growth in Asia. We don't see that in 2005. We see half of that," says Vallee. "It is good growth but it is cooling off."

He adds that the "outsourcing phenomenon is not going away," and there will be good growth in Asia for years. As more manufacturing heads to Asia, there will be a greater need for the SCM service and design services.

While there is no question that high volume manufacturing has moved to Asia over the last several years, there is no clear agreement on the impact that it has had on North America distribution. Some say it has resulted in less business for distributors. They point out that distribution total available market (DTAM) which peaked in 2000 has stayed flat or dropped a few percentage points. DTAM is the percent of total component sales handled by distributors. NEDA says in 2000, DTAM was estimated to be 28-31%.

Don't be paranoid

However, not all distributors believe the migration of high volume manufacturers has hurt distribution. "I see a lot of people paranoid about business transferring offshore, but I don't know if I'm concerned about the impact on our North American business," says Bruce Goldberg, president and CEO of All American Semiconductor in Miami, Fla.

"The business that is transferring is stuff we wouldn't participate in anyway. The vast majority of what has transferred has been high-volume consumer products," he says.

Goldberg notes that most distribution business involves small and medium-sized OEMs and electronics manufacturing services providers. Most of that is still in North America.

The demise of the North American electronics market has been greatly exaggerated, according to Goldberg.

"Electronics consumption in North America is actually higher than it was before," he says. "Asia may be growing at 30% per year and North America is growing at 10% per year so the market share in North America is going to drop. However, people forget the fact that America is still up 10%. Since 2001, DTAM is up although it is not higher than 2000, except in unit shipments," says Goldberg.

Goldberg says most people think manufacturing moves to Asia just because of cheap labor. While labor is cheaper in Asia, some business has been transferred because parts can be purchased for less as well.

"We see many suppliers quoting the same product 20-30% lower in Asia than they do in North America even if it costs them more to ship it to Asia," he says.

However, that may change in the future. "There is a huge effort with suppliers to get their arms around globalizing their pricing and making sure they are not quoting the same end customer two different prices: one for North America and one for Asia," says Goldberg.

If suppliers move to so-called "one world one price" it will make Asia less advantageous as a low-cost area.

However, even if that happens Asia will continue to grow as a force in electronics manufacturing and buyers can expect more distributors to expand their Asian operations. However, that does not mean North America will be neglected by distributors. In fact, the opposite may be true.

Even if the North America electronics market stays flat or falls a few percentage points, it is still a huge market filled with many of the OEM and EMS customers that distributors want to reach. Buyers can expect distributors to compete fiercely for their business and provide a higher level of service.

Top 10 global distributors

Rank 2004	Company	2004 calendar year ($millions)	Percent change from previous year
(1) Purchasing magazine estimate *Includes Premier Farnell estimate Source: Purchasing
1	Avnet, Inc.	$10,766.0	13.4%
2	Arrow Electronics, Inc.	10,646.1	22.7%
3	Future Electronics (1)	3,472.0	24.0%
4	Bell Microproducts, Inc.	2,830.0	26.9%
5	The Memec Group (1)	2,232.0	24.0%
6	Newark InOne*	1,400.0	10.3%
7	TTI, Inc.	775.0	33.6%
8	Digi-Key Corp.	530.5	32.6%
9	Richardson Electronics, Ltd.	520.1	12.0%
10	Nu Horizons Electronics Corp.	458.0	39.6%