Computer industry buyers deal with tight supplies

By By James Carbone -- Purchasing, 9/21/2000

The strategic alliances that computer industry buyers have forged with their critical suppliers in recent years are about to be put to the test.

Computer OEM purchasers say a variety of semiconductors and passives are in tight supply and supply conditions may worsen later in the year as PC shipments build for the Christmas selling season. Supplies are tight because of rising computer demand-forecast to be about 17% this year-and strong component demand from communication equipment and consumer electronics manufacturers who use many of the same components as PC OEMs

While component demand is rising, there has been a lack of investment in new capacity by component suppliers. All this could spell trouble for computer industry buyers in the fourth quarter when the bulk of PCs are shipped for the year.

"Tight supply conditions are an issue for the industry right now," says Jack Baikie, vice president of corporate procurement for Compaq Computer, Houston. There are memory shortages as well as logic, linear and discrete shortages. Suppliers haven't ramped up capacity to meet the needs of the marketplace."

However, while computer OEM buyers are concerned about supply conditions, they say they have not missed any shipments because of shortages. They say their supplier strategies and alliances forged with key suppliers are helping to get them through the supply crunch. In addition, many are beginning to implement Web-based e-commerce tools with suppliers and contract manufacturing partners in an effort to further strengthen those supply chain alliances.

However, despite those efforts, buyers acknowledge the supply situation is getting dicey. "The purchasing environment is much more challenging now than it has been for several years," says Bob Haycock, vice president of corporate purchasing for MicronPC, Boise, Idaho. "CPUs are difficult to get. Memory is tightening up; the cell phone industry is using up a lot of the capacity for capacitors and resistors. It puts a higher reliance on our forecasting capability. We have to forecast better."

He says he expects supply for tantalum capacitors to remain tight through the year, and dram and optical drives may become sourcing headaches in Q4. However, so far, tight supply conditions have not prevented MicronPC from shipping any product. One reason is that MicronPC has cut back its number of suppliers in all commodities. By doing so, Micron gets more attention-and more parts-from suppliers, because the PC company's spend represents a larger percentage of the supplier's business.

"We are focusing on fewer suppliers and have built good supplier relationships. We took the initiative to reduce our supplier base to two or three key suppliers for each major commodity group.

MicronPC isn't alone in its strategy. Hewlett-Packard has forged partnerships with many key component suppliers, says Jun Kim, materials manager for HP's mobile computing division. "We do better during allocation. Suppliers give us preferential treatment," says Kim. "HP does not deal opportunistically with suppliers, no matter what the market situation is," says Kim. "We share information, update them on our technology roadmap, regardless of whether the market is in shortage or oversupply. If the market is oversupplied, we have suppliers knocking on our door offering a 10% discount, but we don't automatically take it. So when the market is allocated, suppliers give us preferential treatment," he says.

Watch out for MPUs

While forging alliances with key suppliers is crucial, ultimately there are only so many parts to go around, and if demand severely outstrips supply, someone is going to get caught short.

One area of trouble for computer industry buyers could be microprocessors. Intel produces about 90% of the microprocessors used by computer companies, while AMD produces about 5%.

"Both Intel and AMD say they were operating at full capacity in the first half of the year," says Tony Massimini, chief of technology for Semico Research, Scottsdale, Ariz. "The second half is always hotter than the first half. You hear that PC companies can't get enough, and AMD and Intel have the pedal to the medal." As demand picks up there are bound to be shortages.

Big name companies like IBM, Compaq and Dell will get their share of processors. "Intel and AMD have long-term relationships with those companies and have long-term agreements. However, there might be mix issues," says Massimini. The computer companies may see demand increase for faster systems that use processors, such as Pentium III MPUs running higher than one gigahertz. Production is limited, and if demand for faster systems swells faster than expected, it would result in PC companies not being able to ship those faster systems.

The second-tier computer companies are most at risk. "Those companies often don't have long-term relationships with Intel and AMD. "Buyers at those companies will have to go through distribution or the gray market and could have some serious problems," says Massimini.

What about DRAM?

Memory may soon become a sourcing headache for purchasers in the computer industry, says Steve Cullen, an analyst for high-tech market researcher Cahners In-Stat. He says dram demand is rising and prices have gone up, but spot tags have not increased dramatically. "That's a sign that things are not desperate and everybody is getting what they need so far."

However, the dram market is starting to get tight and may pose problems later this year, according to Cullen. "Right now, however, no one is missing shipments because of a lack of dram," he says.

Cullen forecasts that supplies will get tighter later in the year and dram tags will rise. He says this summer 128Mb parts were in the $12-$13 range and may increase a couple dollars, but will not go over $20. Cullen says when "dram prices are not going down, they are going up." dram usually starts at a higher price when the latest density part is released. The price then falls as more parts are shipped as manufacturers realize economies of scale and their manufacturing costs are lower. However, when demand outstrips supply, prices stay flat and manufacturers don't have to reduce prices to compete and realize higher profits.

"The dram market is going to start getting tighter and it's going to run for a couple of years. By 2002, it could start to look like 1994 again." In 1994 and 1995 dram demand surged, prices increased and shortages were common.

Cullen says those computer companies who are experiencing the highest growth in demand for their systems will likely have the hardest time sourcing dram. That's because allocations are based on what a computer company purchased the previous year. So if a PC company bought 5% of a dram supplier's production, it would get 5% of the chip maker's production for the next year. But if demand for the PC company's product surges and dram is on allocation, the company only gets what it purchased the previous year.

The problem can be exacerbated if the amount of memory per system increases, which it usually does every year. "If output is dramatically limited, a PC company may get what dram they can and manage it by cutting the amount of memory in their systems. However, PC companies don't like to do that because memory is a selling point for computers. dram manufacturers aren't crazy about the idea either because it means less business.

To guarantee dram supply, some PC companies have invested in up-and-coming memory manufacturers. Others have cut long-term deals with DRAM manufacturers agreeing to buy a large portion of their dram production. Micron has deals with Compaq and Gateway, says Cullen. "Basically the deals give Micron preferential treatment as a supplier and vice versa. So they will get more parts than under their normal allocations. Companies who don't have those kinds of contracts will get cut off," he says.

As supplies tighten, smart buyers will be going all out to maintain relationships with dram suppliers. "In the next six months, you'll see more buyers getting on planes to Boise, Korea and Japan to keep relationships up with dram suppliers," he says.

Buying on the spot

Some major computer companies have quietly formed partnerships with one or two independent distributors, such as necx.com, Smith and Associates, America II and Classic Components, who sell parts on the spot market.

"PC industry buyers will be going to the spot market," says Cullen. "I don't know anybody today who doesn't go out and work the spot market. Everybody gets their allocation and they always want a little more. If you go back 10 years, there were some major PC companies who wouldn't touch the spot market. They thought it was beneath them. But 1994 cured them of that."

The fact of the matter is buyers at PC companies go to the spot market because during times of shortages, that's where the parts are, albeit at a higher price. One reason there are parts on the spot market is because DRAM makers sell into the spot market.

"dram suppliers like to leak a certain percentage of product out the back door into that broker market because they get a real good price for it," says Cullen. "There is a limit to how far you can go pillaging your major customers, but you can really pillage in the broker market. As much as these guys like to serve their major customer, they also want to make sure they have some percentage of stuff going out the back door that they are really making money on," he says.

While the dram market will tighten later in the year, there is some good news for PC industry buyers. Intel announced it would support PC 133 dram with a chipset for its Pentium 4 process. Intel has also said it is considering supporting double data rate architecture as well. Previously Intel has said it would support only Rambus dram.

Intel's support of PC 133 is good news because there is a limited supply of rdram. Samsung produces about 80% of all rdram. rdram also costs about two to three times more than PC 133 synchronous dram.

With the market getting tighter, PC OEMs don't want to commit to products where there is a limited dram supply. "A PC OEM may say to Intel 'I'd love to use the Pentium 4, but I'm not going to commit a whole product line when there is one guy producing 80% of the dram that can be used with it. If part gets short they are really going to hold me up,'" says Cullen.

Intel doesn't want to tie Pentium 4 introduction to available dram so they are compelled to support PC 133. There's also a competitive reason for Intel to support PC 133. AMD supports it as well.

While microprocessors and dram are concerns of PC OEM buyers, so are low-ticket items such as capacitors, resistors and logic parts. While the parts are inexpensive compared to microprocessors and memory chips, shortages of them can prevent a PC company from shipping product on time.

"When a PC company says it did not meet earnings expectations because of component shortages, it could be due to a lot of things," says Massimini of Semico. "If you open up any machine and look at any motherboard, there is so much standard logic on board. We have seen a huge surge in standard logic demand. If you can't get those jellybean logic parts, you can't ship product. It's like an auto maker not being able to finish a car because he couldn't get enough nuts and bolts," he says.

The problem is those jellybean parts as well and more pricey components such as flash memory and digital signal processors are often used by other industries as well. Cellular phone manufacturers and consumer electronics companies need many of the same components as computer OEMs do.

"We are in competition for parts with the cell phone folks," says Kim, HP's materials manager. They use flash and DSPs and so do we. There is a proliferation of technologies and their usage. Core components are being used across the board. It isn't just PCs anymore. Components are used in many different products and there is more competition for components," he says.

Kim says the problem is little capacity has been added. "Semiconductor capacity has not been added for two years because chip companies have not done well. In the meantime, PC demand has gone up and up and up and demand is greater than supply," he says.

Moving to the Web

While component supply issues are on the front burner, there are other supply chain management issues computer OEM buyers are dealing with. One is e-commerce.

Computer companies are looking to move more of their business to the Web for a variety of reasons. Many are looking to reduce procurement cycle time and lower the overall cost of doing business with suppliers. Some are looking to reduce purchasing headcount.

However, at IBM, the idea of Web-based e-commerce is not to reduce the number of buyers, but to automate purchasing transactions so buyers can work on more strategic purchasing issues, according to John Paterson, chief procurement officer at IBM.

"We are aggressively automating the transactions that take place and diverting those resources and skills to more value-added activities such as working with suppliers or working with internal development teams," he says.

Web-based purchasing is a top priority for MicronPC, according to Haycock. The company is implementing I2 software and then plans to move its suppliers to Web-based purchasing. All purchasing transactions will be done on the Web. The idea of Web-based e-commerce is to better serve customers, says Haycock.

"I want to link our major suppliers with our major customers," he says. Suppliers would see an order for new computers when MicronPC sees the order. "The goal is when a major customer places an order or a forecast through Web communication with MicronPC, suppliers react to it. The goal is to bring our customers and the suppliers closer together. Everything we do Web based has got to have that focus as a goal," says Haycock.

Besides e-commerce, outsourcing continues to be a major trend in the computer industry. Many PC OEMs are using contract manufacturers more not just to build boards, but for entire systems. Often those systems tend to be lower end, but in the future, CMs will build more high-end equipment as well.

As PC companies outsource more, they entrust the purchase of many components to contract manufacturers. Typically the CM is given a bill of materials and is sent forecasts weekly. PC companies often negotiate long-term contracts with crucial components such as microprocessors and dram. However, in a constrained component market a PC company becomes more involved in component buying and will negotiate contracts with suppliers of other components such as capacitors, resistors and logic.

"We hire contract manufacturers to manage materials," says a purchasing executive at a leading computer company. "We don't just hire them to put stuff down on the board. But if they can't get supply, we have to jump in and help them because it can affect our business," he says.

Diversified skills needed

As computer OEMs use contract manufacturers more, it impacts the purchasing function at the OEM and the skills that buyers need, says Paterson of IBM.

"When things are manufactured internally, a company obviously needs a manufacturing function, engineers, logistics and material experts. When you move that to an outsourcing model, those activities have to be performed, but to a lesser degree," says Paterson. "You don't just throw this over the wall and it all works well. You need levels of process integration and collaboration as well. All of that responsibility resides in procurement," he says.

Buyers at companies that outsource need the ability to manage multiple tiers of the supply chain. "When you buy a component-memory, storage, keyboards-there is one set of processing tools that you need. When you manage the component supply to one of these third-party CMs, there are different processes and tools needed," says Paterson. "We have to make sure that people will be retrained and re-educated and deal with strategic sourcing.

He says buyers working under an outsourcing model need manufacturing, engineering, capacity planning and material management skills to manage the outsourced supply chain. "Historically those were in other parts of IBM. There is a skill transformation that needs to occur," says Paterson

As OEMs outsource more, purchasing will become a more integral function at computer companies. "Many times procurement is the only organization in a company that can leverage best practices in one business unit and carry them over into another," says Baikie of Compaq.

For instance, a portable computing business unit may have a process or a design that could be used in the workstation business unit of the company. Often those units work separately and may not be familiar with the designs or processes of each other. However, because procurement works with all of a computer company's business units, a savvy buyer can identify the best practice and suggest that it be used by other groups. "If you see a design that has a commonality from one division to another, the design teams perhaps can collaborate and come up with one set of tooling, says Baikie.

Computer industry buyers say, despite supply problems, the future of the computer industry-and for purchasing-looks rosy.

"We have great products, great demand for those products, and our supply picture looks reasonably good," says Baikie. We are in a position to succeed. The key is to execute."