The Development of Internet-Based Supply Chain Tools and their Effect on the Semiconductor Industry

by Scott Mack, Virtual Chip Exchange

The last time this happened, the Internet was so young it had barely learned to crawl. The next time it happens... well, if the Internet fulfills its most ambitious promises, it should not happen again.

What has happened? In a word, cyclicality. It is the semiconductor industry's chronic string of supply and demand imbalances that result in a painful contraction for chip manufacturers and an expensive build-up of unneeded components in their customers' warehouses. In the middle, are franchised distributors who come under pressure from both sides and end up spending more time than they would like fending off returns from end customers and less time growing their sales. And now that it has happened again, what can the Internet, in its current state of development, do to remedy the current situation and prevent it from happening again?

For one thing, the Internet and its new supply-chain tools (to the extent they have been employed) provided OEMs with a very quick read on the softening demand for their products. So rather than building component and finished-goods inventory for months while demand for those goods slackened, they saw the unmistakable trend and quickly ramped down production, cancelled orders from their suppliers and began restructuring their human resources. The speed with which the manufacturing economy slowed is unprecedented, and is surely the result of greater visibility provided by web-based supply chain and forecasting tools. This also means that the manufacturing contraction may prove to be more short-lived than in the past.

To the extent that the pullback is related to an inventory buildup, the speed with which component purchasing and finished-goods production halted will hasten the economic recovery as there is much less excess to deplete.

Within the electronic components field, what options does an OEM or EMS provider have as they seek ways to alleviate excess components with the best possible return? Doing nothing is dangerous — not only does an electronics manufacturer bear the carrying costs of unneeded inventory, but they run the risk of further hurting their profits if the cost of those components falls before they have a chance to be made into finished-goods. When this happens, the manufacturer finds itself in a non-competitive position vis à vis a competitor who was able to use the price deadline to their advantage (not an unusual situation when electronic components comprise such a high percentage of the overall product cost.)

Another option is to establish a complete Internet-based supply chain. This technology holds great promise, but installing and implementing all of its parts, from analyzing customer demand to purchasing supplies, scheduling factories and tracking orders, is a long term project, costing tens of millions of dollars. While these tools hold great promise for the future, in that companies will be able to react even faster to market changes and make fewer mistakes along the way, they are of minimal help to companies with inventory problems today.

The traditional solution has been to contact an independent distributor, who — without contractual ties to electronic component manufacturers — adds value by working with companies to sell off excess inventory and to help manufacturers source components that might be obsolete or are on allocation.

But independent distributors who purchase excess inventory are often stocking the parts, perhaps for a long time before they are sold. In order to be profitable, they typically have to acquire components at around five percent or 10 percent of their original cost. While this may be a swift solution and it solves much of the electronic manufacturers' inventory problem, it fails to provide a fair return on their original investment in the components.

Here is where Internet solutions have made strong inroads. The concept of a business-to-business Internet exchange is being employed in many industries, and leading researchers such as AMR Research expect these e-marketplaces to achieve sales of $2.8 trillion in 2004. Within the electronic components arena there are numerous companies inhabiting this space, thus creating a new form of independent distributor — one that uses the Internet and its new technology to add value for electronics OEMs and EMS providers.

By its nature, a business-to-business exchange should be an ideal solution for excess inventory problems. After all, the basic idea is that companies can directly trade with each other, and one company's excess is likely to be another company's requirement. Expand this idea to include every company in the world that has the ability to log onto the Internet and there is clearly a strong advantage compared to traditional means of reducing inventory. In fact, instead of returns on investment of just five percent or 10 percent, returns via business-to-business exchanges can range from 60 percent to greater than 100 percent. These stronger returns are evidence of a more efficient market for electronic components than has ever existed before, and this online market is gaining strength every day as more inventory becomes available for sale and liquidity grows.

The greater visibility that companies now have simply by logging onto one of these B2B web sites is leading to strong benefits for both sellers and buyers of electronic parts.

As an example of how this new technology is creating strong returns, an electronics B2B exchange, Virtual Chip Exchange, Inc. ( www.virtualchip.com ), enables its members to copy and paste a spreadsheet of excess parts and upload it to a web site that is searched by thousands of companies looking for electronic components of all types. Via this method, sales of excess inventory result in greater returns for the "selling company" because no one is speculating on their components by offering a low-price in the hopes of selling the parts later at a high-price. Through the exchange, the parts are being bought directly by another manufacturer who needs those components, usually for current production. In short, when a true OEM-to-OEM parts exchange occurs, everybody wins. So that this beneficial result occurs more often than not, Virtual Chip Exchange only allows electronics manufacturers, chip manufacturers and selected franchise distributors to be members of their site; independent distributors may seek to buy parts for resale, but are not granted membership.

Other new technology features are also contributing to produce these beneficial results. For example, software has been developed to enable a member of Virtual Chip Exchange to list parts they are seeking (known as a Part Watch on the web site), so that when another member lists those components as excess, an e-mail is immediately sent and a transaction is facilitated.

In addition, the member seeking the parts can enter the "Part Watch" with target prices, and only if those prices provide the selling member with an adequate return will Virtual Chip Exchange automatically advise both parties. Thus, the buyers have located their components at or below the target price and sellers have sold their excess inventory and received a good return on their investment. Replicate this process thousands of times a day and it is clear that this valuable tool would not have been feasible without the powerful and efficient communication provided by the Internet and new advances in software.

In today's economic situation, business-to-business exchanges like Virtual Chip Exchange are providing solutions for OEMs and EMS providers who are looking to sell excess components and employ lower cost sourcing solutions. The technology has evolved so that concrete benefits are being delivered to thousands of companies every day. In the future, Internet-based supply chains may change the role of today's exchanges, and private exchanges are expected to continue their recent growth trend. But today, the electronics B-to-B exchanges are where component buyers and sellers are both solving inventory and sourcing problems with technology that is fast, easy and virtually free to implement.