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Will component distributors take on PCB sales?

Someone recently emailed to me a column written ostensibly on the "demise" of M-Wave (mwave.com). M-Wave, you may recall, was once riding high, with a stock whose price bolted from about $1 to over $15 in under 24 months. The company had dreams of hitting $100 million in sales using a model that combined traditional PCB manufacturing and board-brokering services.

Like so many others, the company did not quite live up to its promise. Sales crashed. The board shop and other assets were sold. Bankruptcy and delisting ensued. Little remained, except for the brokerage business.

All of which prompted the submitted column, which read in part: "[I]t appears that M-Wave's business model, that of a board broker between North American customers and Asian PCB makers, didn't pan out. … [W]ho needs a broker when most of the North American companies are either in Asia manufacturing boards themselves, or well acquainted with the Asian fabricators independent of M-Wave?"

Calling the problems at M-Wave symbolic of the entire board distribution industry requires a huge leap in logic. It is a faulty assumption; indeed, the PCB distribution market is growing by leaps and bounds.

Another flaw in this logic: M-Wave's net sales were $16.6 million by September 2005, an increase of 22.1% year-to-date. Gross profits were up 34% to $3.2 million. That does not sound like a company in a market on life support. In fact, most of M-Wave's problems can be tied to past financial mistakes, not a poorly conceived business model.

How is the board distribution market shaping up these days? And what will it look like in the future? To understand where PCB distribution may be headed, we need to look at the broader components distribution market. That sector today is characterized by two groups: franchises and independents. Franchises are the larger of the two. The top 10 franchised distributors had global sales of $37 billion in 2004, up 20% from $30 billion in 2003.¹ Combined sales of the two largest, Arrow and Avnet, made up 54% of the total.¹

Independents, meanwhile, are smaller but no less successful. Revenue at the top 10 independents was $2.4 billion in 2004, up nearly 15%.¹ The largest, Smith & Associates, grew 60%.

Catalog distributors grew faster than the broader distribution industry in North America in 2004, according to the National Electronic Distributors Association (neda.org).² Catalog distributors, whose ranks include Digi-Key, Mouser, Allied and Newark InOne, cater to engineers who buy low volumes of components, often for prototyping. Broad-line and specialist distributors, on the other hand, focus on large accounts.

Overall, the distribution market is doing just fine. 2004 was the industry's best year since 2000 (Table 1). When the final numbers for 2005 are in, year-on-year growth high in the single digits is expected.

The bulk of component distributors follow one of two models: pure play (passive and active components only), or dual distribution/EMS services. Eight of the top 25 worldwide distributors offer EMS services. For the top tier, the trend since the late 1990s has been away from combining the services; Reptron (reptronmfg.com) is among the notables who have split. Among lower tiers, however, a number serve dual roles; examples include World Micro (worldmicro.com) and Sarco (sarco.org).

What the distributors have not seized upon are PCBs. According to research firm Henderson Ventures, PCBs were a $42 billion worldwide industry in 2005.³ Yet component distributors have stayed away, in large part because the smaller volumes and custom nature of PCBs make a poor fit with the catalog-style line cards offered by distributors.

In the absence of the bigger players, a large (and growing) group of small firms have filled the void. The PCB distribution industry can be segmented into two or three tiers. Tier one distributors, such as M-Wave, are characterized by dozens of clients and multiple PCB suppliers (Table 2). They have sales in excess of $1 million per month.

Tier two is the broadest category. Firms may have a handful of clients and suppliers, or dozens of clients but a single PCB supplier, or no dedicated PCB broker. Electronic Components Marketing Group (theecmg.com), which reps Circatex in the U.K. and Ellington in China, is run by Bob Mills, son of Viasystems founder James Mills. Westwood (westwoodpcb.com) and Nypac (nypac.com) sell for Nanya. Staci (stacilc.com) in Florida and U.S. Tech in Ohio broker more than just PCBs. Same goes for San Jose-based Addison Labs, which is very secretive.

Tier three is PCB fabricators that also offer brokered boards. Just how many fabs in North America do this is widely debated. However, by most accounts the number is large. One source says that when the question was posed to 40 or so company representatives at the IPC PWB Presidents Meeting last year, more than 30 raised their hands. According to an IPC poll (ipc.org), 33% of the revenues from PCBs sold in North America by domestic fabricators in October came from boards produced offshore.⁴

Distribution Trends

For distributors, "[a]dding the service part of their business is helping them take margins higher," says Tucker Anthony Sutro Capital Markets analyst Robert Damron.⁵ Among the offerings:

Design services.
Assembly, other procurement services.
RoHS component guidance.
BoM scrubbing.
Component kitting.
Tracking/IT.

The underlying reason for distributors to move into more value-added services is clear: Slim margins. In the fiscal year ended July 2005, Arrow reported a gross margin of 4% and net margin of 2.1%. During the same period, Avnet reported a gross margin of 2.9% and a net margin of just 1.5%.

For many of these companies, profits are generated from high inventory turns. Still, expect distributors to add services to build margins. Engaging in such programs will put them head-to-head with their EMS customers, who are also moving into supply-chain management territory to remedy horrendous margins.

Moreover, from the flank come so-called third-party logistics providers (3PLs), including DHL, FedEx and UPS. The top 100 3PLs control almost 33% of the estimated $270 billion in outsourced value-added logistics services, says Armstrong Associates, an industry research firm. The top 25 have annual revenues of about $79.5 billion and are growing at a 6 to 8% annual clip.⁶

Large EMS firms such as Celestica, Sanmina-SCI and Solectron are using distributors less than before. Their smaller counterparts - EMS firms below $200 million - tend to use a combination of distributors and direct suppliers. OEMs under $50 million are tending toward distributors, including for circuit boards. Reason: It does not make sense for smaller OEMs to spend time buying boards in Asia.

Typical designs built by North American assemblers today are high-end computers, medical equipment, industrial controls and some automotive systems. Such products have large and complex bills of materials. Volumes tend to be lower, with more component variability, and programs are heavy on new product introduction and engineering. This plays into the hands of catalog distributors.

"I think certain segments of the distribution and EMS industries will converge slowly over the next 20 years," says Carter Shoop, an EMS analyst at Deutsche Bank (db.com). Some have started. In July 2005, RAD Electronics Inc. (rad-tech.net), an EMS firm, purchased the assets of Astrex Inc., an electronics distributor. In a statement, RAD said it expects 2006 sales to exceed $100 million⁷ (up from $3 million in 2001⁸). Nor did it see any inherent conflicts. Asserted CEO Charles W. Mann: "We see substantial cross-selling opportunities to our mix of OEM, contract manufacturer and reseller customers."⁷

The counter argument, consultant Susan Mucha notes, is that the pure EMS model is very service-focused and doesn't lend itself well to the same level of commoditization found in distribution. Companies entering the EMS model from distribution may underestimate the scope of support services required by that tailored service package element or find that their component purchasing requirements extend far beyond the lines they cover. Plus a big challenge is that EMS providers make up a large portion of the total available market for component purchasing.

"Many manufacturers reps won't represent EMS providers because they are afraid of the impact it would have on their sales to EMS providers. Some distributors who dabble in EMS activity to support some key customers keep that very quiet to minimize the fallout from EMS customers. Companies that become visibly successful as both EMS provider and distributor may find distribution sales drying up from EMS customers who start to view them as competitors," says Mucha, founder of Powell-Mucha Consulting Inc. (powell-muchaconsulting.com) and a Circuits Assembly columnist.
And while the distribution business is characterized by low margins, some mid-tier EMS companies still have gross margins of 10% or more. It would be unlikely for companies in such a position to water those down.

With distributors under pressure to grow margins and revenues, and with large hurdles (not to mention a poor track record) to adding EMS services, it would make sense that they would at least look to the as yet untapped $40 billion PCB market as an area in which to expand. One possible scenario has catalog distributors teaming with a small number of PCB shops (or bare-board brokers) to fill out their line cards. This would put them in position to supply complete BoMs to OEMs. We may have caught a glimpse of this synergy last February, when a Swedish components distributor named ELFA (elfa.se) announced a deal with Elprint (elprint.com), a Norwegian PCB supplier, to offer a single source for components and PCBs. ELFA will sell boards for production of prototypes and ramps, enableing buyers to "use one purchase channel for both components and PCBs."⁹

The battleground is coming into focus. Distributors are moving toward more value-added services; EMS firms are doing the same. War - or convergence - is inevitable between the two groups over who wins the OEM's supply-chain management.

Going forward, we can expect EMS firms to remain buyers of PCBs, and some EMS companies will try distribution - and fail. We can expect distributors to retain some in-house EMS work. Meanwhile, distributors - mainly catalog types - looking to improve margins and value-added services are a potential customer for PCBs. Some, like ELFA, will get into PCB sales. No doubt, America's board brokers will be ready.

References
"Top 35 Global Distributors," Electronics Supply & Manufacture, May 2005.

National Electronic Distributors Association, neda.org.

Henderson Ventures, June 2005.

IPC October book-to-bill, November 2005.

Arik Hesseldahl, "Stock Focus: Electronics Distributors," Forbes.com, March 21, 2001.

Thomas A. Foster and Richard Armstrong, "Top 25 Third-Party Logistics Providers Extend Their Global Reach," Supplychainbrain.com, May 2004.

Rad-Tech company press release, April 2005.

Rad-Tech company press release, May 2005.

ELFA company press release, Feb. 7, 2005.

Mike Buetow is editor in chief of Circuits Assembly magazine. This article is adapted from a presentation he gave in September 2004.