A recent PURCHASING Magazine survey shows 65% of buyers using distributors' value-added services, many of which are big money savers for OEMs and contract manufacturers (CMs) because they don't have to stockpile as many parts, hire workers for cable-assembly operations, or invest in equipment for chip programming.

However, while value-added services have reduced costs for OEMs and CMs, distributors have not always been properly compensated. In some cases, the distributors may have failed to mark up enough to cover the costs of providing value-added services. In other cases, they may have been providing services for free as marketing tools to win new business from buyers.

"In some cases [services] have been given away as part of a core value proposition," says Roy Vallee, CEO of distributor Avnet. "We give away services to become the preferred supply chain provider and to gain a share of a customer's business. Services have been bundled and may not have had clear activity-based costing associated with them."

Robin Gray, executive vice president of the National Electronic Distributors Association, observes that services are now organizing into two distinct categories. "One is value-added manufacturing for which distributors have always collected fees. Examples would be cable assembly, board assembly, and programming chips." The other category includes services involving such things as design and materials management, which, in the past, have had little or no compensation, but now are being offered more frequently on a fee-for-service basis.

"These are services where there is no touching of the product. They deal with expertise, knowledge about the supply chain, and design," Gray observes.

He notes, for example, that design services used to be an adjunct of selling. "Distributors were trying to get orders, get design wins," he says. "They wanted to get involved early in decision-making processed because they viewed this as an entree to component sales. Once they go the design win, they had a good shot at winning production." While this is still true today, Gray says, "[Distributors] are no longer providing their design services for free because they have high costs."

Actually, whether or not distributors charge fees for their services, often depends on the level of service provided, according to Fran Scricco, CEO of Arrow Electronics, who has been outspoken about the need for distributors to be paid for services.

For instance, with design, Arrow has field applications engineers who are available by telephone or will travel to customer locations. "They will tell customers everything they know about a component," says Scricco.

But some customers want more. "Some may want two or three engineers to work full-time on-site, functioning as their components engineers. This is a high level of service for which we charge monthly fees."

And monthly fees now apply to more than just design services. "We have hundreds of people at our customers' factories who are bringing materials to customers' assembly lines," says Scricco. "More often than not we are obtaining complete bills of materials and forecasts that are delivered electronically rather than piece-part purchases received over the telephone. We are expected to anticipate when customers will purchase materials, then move the materials to the right places, in the right quantities, at the right times," he says. For that level of service, Arrow may in the future charge monthly fees.

Scricco says the idea of charging fees for value-added services is similar to the restaurant business. Most restaurants don't charge single set prices because customers don't order the same items. "Some customers may want appetizers. Some may want wine with dinner. Some want both. Some want neither," he says. One set price would be unfair to the restaurant and to its customers. "The customer who doesn't drink wine would be subsidizing the customer who does. But if each item is priced separately, the customer who orders wine, pays more than the customer who does not." Value-added services, he contends, should work the same way.

The unbundling of services from products presents opportunities for both buyers and distributors. A buyer, for example, may now be able to purchase services from distributors without buying the parts.

"In the past, if you bought a programmable logic device (PLD) from us and wanted it programmed, we would do that," says Avnet's Vallee. "We would market programming as a vehicle to get business and the price of programming would be included in the price of the PLD." Now, Vallee says, a major customer that once bought PLDs from Avnet but now purchases direct from a manufacturer can still use Avnet for programming. "If we had not unbundled programming services we would not be participating in that business," notes Vallee, who expects Avnet to do more business with customers who are looking only for services.

Avnet's fee-for-service business will involve "intellectual capital" says Vallee. For example, last year Avnet formed a new division called Promiere to provide information services to buyers. "With Promiere we can scrub a customer's bill of materials to help determine what the complete manufacturers' part numbers are," says Vallee. "We also help them determine what other suppliers are available and what cross references might be available in the event they have a problem with a supplier."

He says Promiere can also tell a buyer whether or not a part being designed into a system "is a fast mover that is used by large numbers of companies or if the buyer's company would be the only one on the planet using the part." Avnet owns this type of information because of its role in the supply chain, Vallee notes.

While Avnet plans to offer more similar fee-for-service programs, Vallee says not all of Avnet's value-added services will carry fees. "We do not intend to go to customers who are currently buying products and services that are bundled and fundamentally changing the way we do business," he says. "But, we are looking to make sure that, as new services are deployed, they are paid for in one of the three ways: by fee, incremental profit margin, or incremental sales volume. We are making efforts internally to make sure we understand the costs of providing services to our customers," he says.

Pioneer Standard's fee-for-service initiative revolves around Web-based programs and intellectual property. "These are informational services that we deliver over the Web," says Tom Pitera, president of Pioneer Standard's Industrial Electronics division. "We are not taking some of the classic value-added services like IC programming and moving them into fee-for-service because, in one form or another, we have always been paid for them."

The services involve design support and supply-chain management and are provided through Aprisa and SupplyStream, two companies owned by Pioneer Standard.

"Aprisa and SupplyStream involve intellectual property that allows us to focus on our area of differentiation, which is technology distribution and engineering design services," says Pitera.

He says the business is in its infancy stage, but is evolving and customer interest is growing.

Aprisa provides the CircuitNet design tool. "Users can go to the online tool, find reference designs in the system, and then modify those reference designs," says Pitera. "They can start from scratch with a clean drawing board and build block diagrams for their applications. They can do product searches. They can compare products. They can conduct interoperability audits among the components that they put into their block diagrams."

SupplyStream provides materials management capabilities. "There are tools for quoting, inventory management, inventory optimization and total cost of acquisition," Pitera says.

"In focus groups, the materials community tells us total acquisition costs are a big concern," says Pitera. "They tell us they want to manage based on total acquisition costs rather than on piece price variance." So Pitera believes that demand for SupplyStream tools will grow and that buyers will be willing to pay for the services.

Most of Pioneer Standard's tools are delivered through an application service provider model (ASP). "Some customers engage in enterprise type solutions where we're not hosting the application, but, rather, installing it behind their firewall, bringing them up, training them and licensing them to run it."

For other value-added services that involve component sales, Pioneer will continue to factor its costs into prices of the parts it is selling.

"If a customer wants prices for the value-added work and the parts broken out, we will typically do that for them. However, we generally embed the service cost in the price for the part," says Pitera. "We take the cost of the part, cost of the labor, and our profit, then quote a price. The market has been trained this way and I expect it will be a difficult thing to change."

Gray of NEDA says buyers can expect more distributors to offer more fee-for-service programs. "If the Arrows and the Avnets of the world make it profitable, then you will see the rest of the industry follow suit," he says.