Working towards true market demand

Working towards true market demand

The supply chain has absorbed significant disruptions over the past few years. The pandemic, natural disasters, and freight issues, to name a few, have captured headlines but cannot be assigned all the blame for a global semiconductor and component shortage. Instead, supply chain professionals need to be more introspective and closely examine how long-held processes are contributing to the current situation.

One of the most glaring issues the electronic supply chain needs to reconcile is forecasting demand horizontally and vertically. Mixed signals in the semiconductor and component market create confusion and a lack of transparency concerning the demand for products, wreak havoc for organizations in the supply chains that rely on these products. Inaccurate demand signals and data reverberate throughout the entire supply chain ecosystem and make it difficult for companies to forecast growth and predict what type of associated support investments they need to make.

The consequences include not only the shortages and price increases that mark today's market. More ominously, they could result in a strong downturn in demand as companies stop ordering in order to work off their excess inventories.

A multi-faceted problem

Current supply chains in the market were built around low costs and efficiencies, with OEMs operating with significant flexibility by all parties in the ecosystem. Components and semiconductor manufacturers not only offer competitive pricing and aggressive lead times, they also extend considerable flexibility to the OEMs, such as a 30-day cancellation window. This system works well in stable, near-ideal scenarios. Unfortunately, over the past few years, we've learned that such business processes and agreements drastically reduce resiliency during significant supply disruptions. With less-than-ideal conditions, the modern supply chain quickly breaks down.

Many companies that consume electronics have limited visibility on their end-market needs. As a result, most industries have made it possible to forecast 12 months at the component level. Meanwhile, the semiconductor manufacturers and partners need to invest on a much longer cycle-three to four years for most new factories because of fixed costs and inflexible capacity adjustments. Semiconductor factories need to secure high utilization of their capacity because stop and go simply isn't an option, especially in front-end activities. While much of the discussion today centers on semiconductor shortages, the effort to enhance forecasting should cover all types of components.

Finally, a scarcity mindset incited surplus ordering among OEMs as businesses acquire "safety stock" in a business version of hoarding toilet paper. For over a year, media, analyst, and industry reports touting component and semiconductor shortages have inundated supply chain professionals. CEOs and boards of directors were also pressuring their procurement and supply chain professionals to ensure availability by over-ordering in order to protect their organizations from suppliers who can provide only part of each order. The result is padding of demand forecasts and over-ordering. Such behavior has been common in previous supply chain disruptions, and that bad habit is rearing its ugly head right now.

These challenges eventually lead to the so-called bullwhip effect which is a phenomenon known to all supply chain professionals: excess inventory that impacts all organizations in the ecosystem, inventory write-offs, reduced revenue, and a workforce reduction.

Here's a hypothetical scenario that demonstrates the consequences of inaccurate demand forecasts. Let's say that an analyst firm for the major industries and markets that drive economies worldwide says demand for a specific industry will grow 20% over the next year. Five industry leaders within that sector see this report and alter their forecasts to accommodate 40% growth individually to accommodate the growth with the expectation that they will gain market share and increase sales. They all use similar technology, and those increased growth targets are sent to their manufacturing partners, who then send the targets to their distributors and suppliers.

This market movement alone would significantly increase the demand for a similar set of semiconductors and components that would not be rationalized in the current supply chain environment. Multiply this event by dozens of markets and hundreds of OEMs, and it's possible to see how these false demand signals could double or even triple component and semiconductor orders beyond what is needed.

A single source of the truth

While there are some examples of bad actors in the market, the root cause of many of the problems is a flawed system: there is no incentive for companies within the global supply chain to collaborate or be transparent. In order to avoid the problem evident today during future market disruptions, supply chain professionals must work together towards a solution that improves the overall system without diminishing their organization's competitiveness.

One possible solution Flex is exploring with some leading OEMs, suppliers and distributors, is to establish an independent third-party (ITP) organization that can receive and analyze data from various stakeholders and then make recommendations about future demand. The data set submitted by all the participants would be at an OEM part number level. The expectation is that all parties would follow a code of honor in determining their forecast, without exaggerating their inventory requirements, to the best of their ability. Any recommendations by the ITP would be based on the industry growth targets provided by reputable market intelligence companies.

OEMs, EMS, distributors, and suppliers are all interested in receiving accurate demand information, based on which they can plan, and success requires the leading players in the ecosystem to participate. To be valuable, this approach would require a high level of representation in critical segments, perhaps a higher percentage of the market makers and a lower percentage of the industry followers.

Collaboration does not diminish the competitive advantage

A critical question that arose during early conversations is the following: "Does true demand information diminish the competitive advantage?" The answer is no. Each partner in the true market demand model would only gain access to a view of their data and global trends the ITP deemed appropriate to share among competitors.

Collaboration around true market demand among global supply chain organizations can be incentivized. While the ITP would analyze demand focusing on specific markets, the information can be consolidated and benefit the collective participating group.

True market demand is not the only problem to solve

Working towards true market demand isn't a silver bullet for all the industry's woes. Another major problem is the current contract model. Suppliers cannot always enforce the demand forecasts from OEMs because traditional supply contract terms allow brands to cancel orders quickly. Organizations should be required to commit resources to support suppliers' capacity-building and front-end delivery processes to create partnerships built on trust and accountability.

The journey of 1,000 miles begins with a single step

As professionals navigating unprecedented supply chain and logistics constraints today, we are responsible for developing new protocols to increase collaboration and visibility to prevent this from happening in the future. It's time to examine traditional supply chain best practices and determine which should stay and which can be cast aside to move the industry forward. As mentioned previously, Flex has already begun having conversations with industry leaders on these issues and will have more to communicate in the coming months.

Solving major supply chain problems requires an upfront investment in time and resources but has long-lasting benefits. OEMs can focus on innovation, new product introduction, job growth, and sales and marketing. Suppliers, distributors, and EMSs can operate efficiently without the fear of getting stuck with excess inventory. Supply chain professionals can slowly regain their focus on lowering costs and improving efficiencies which will benefit the global supply chain and the economy at large.

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Written by

Lynn Torrel

Chief Procurement and Supply Chain Officer