Chip Buyers: Old Habits Die Hard

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Chip supplies could see a surplus as early as the first half of next year, according to Gartner, following more than two years of severe constraint. Demand is plummeting for PCs and smartphones, loosening up inventory for other users of semiconductors. Not all IC categories will be in abundance: microcontrollers, PMICs and analog chips remain under pressure.

Once supplies loosen up, are OEMs going to revert to pre-pandemic buying habits?

Several supply-chain have practices faded in the wake of Covid-19 and the scarcity of chips. The first is lean/just-in-time (JIT) inventory, where there’s just enough product in the pipeline to fill OEM orders right before production. As the global electronics market was bouncing back from a shutdown in 2020, JIT and lean left component inventory levels inadequate to meet demand. Fab capacity takes time to ramp up and ICs take a minimum of 18 weeks to build.

End result? Extended lead times and supply constraints.

Leading business advisors recommended OEMs adopt “just-in-case” inventory for critical components. That didn’t visibly happen in the electronics industry.  Holding inventory is anathema for most electronics businesses – there are costs and risks associated with maintaining stock.

Automakers sounded the alarm bells early in 2020 when they couldn’t get chips. First, let’s acknowledge end-market forecasts from all industry sectors are notoriously bad. Automakers have a long supply chain: many rely on tier-one contractors to forecast chip needs. These companies are only slightly closer to chip suppliers which, in turn, were dealing with pandemic-related upstream challenges  – materials, packaging and substrate shortages – just as demand ticked up. Few OEMs have that depth of visibility into their supply chains and are prepared to seamlessly switch suppliers.

These and a few other dynamics spurred positive developments in the supply chain: More attention is paid to materials and services suppliers and the automotive industry has formed partnerships with chip companies to avoid getting caught short again. They’ve put some skin in the game.

In general, supply chain digitization — which improves end-to-end visibility —  is gaining ground.

Many component orders have become non-cancellable, non-returnable (NCNR). Pre-pandemic, over- and under-ordering was rife. Typically, unused parts are returned to suppliers and distributors to be sold to other customers. Parts are also re-sold into the open market. This can drive market prices downward and increase buyers’ risk of procuring a counterfeit part.

OEMs are not fond of NCNR as their capital is tied up in inventory. But long lead times have prompted customers to place orders well into next year and fabs are still building to those forecasts. The chip industry has to finance its ambitious capacity expansion and government incentives will only go so far.

The customer remains king in the electronics supply chain, and most pre-pandemic purchasing practices were designed to benefit OEMs. Forecasts were fluid. NCNR was rare. Annual cost reductions were built into purchase contracts. Visibility was limited to how much information partners were willing to share.

The pandemic and supply constraints have limited the volumes of components available to customers (call it “just-what-you-need”) and logistics determine delivery. Order levels have been closely monitored in the channel. Chip prices have made annual price reductions next to impossible. Digitization is seen as an enabler for better forecasting and early warning signs of supply disruption.

The supply chain is far from perfect, but there seems to be more equity now between buyers and sellers.

But now that demand is cooling down, customers are scaling back orders placed with fabs. Chances are good that OEMs placed multiple orders in the supply chain — to fabs, distributors or through EMS partners — due to extended lead times.

It will be interesting to see if order cancellations cascade and if customers are held to their forecasts. Demand remains firm, industry sources say, so a level of excess can be absorbed. But it’s unclear to what extent OEMs have been stocking up on inventory they’ll no longer need and if so, how they dispense with the excess.

There’s been a lot of talk about supply chain partnerships over the past few years. Alliances work best if all parties are prepared for some give-and-take. Will purchasing habits shift again as inventory becomes more “normalized”? We’ll see.