As head of TTI’s North American procurement operations the number one question I get from our customers these days is “when will component prices decline, and why haven’t they come down already?”
The often cited reasoning behind this question is that the prices of most raw materials used in passive electronics components (copper, nickel, aluminum, the oil used in thermoplastics) have retreated from their 2008 peaks. In addition, it is natural to expect that component suppliers will have excess capacity in a down market, which they will then be willing to sell at a discount.
These ideas are reinforced for all of us personally every time we fill our cars with gas that now sells well below the +$3.00 per gallon that we were paying less than six months ago. And every time we walk into a department store and find everything in the place is marked down. So why shouldn’t this be true for passive components as well?
As a world-leading distributor TTI carries most of the premier passive component lines. We are one of the largest buyers in the world for these products. This gives the procurement team at TTI a lot of visibility into the pricing, and price drivers, for these suppliers. To date, the signs of expected price decreases have been spotty at best. So far we have not seen anything like the dramatic price decreases that we experienced in our industry’s last recession, which was in 2001. Why is that?
Well, the first thing we are up against is the fact that while quite a few raw materials have declined in price there are also a few that have held steady, and some that have even gone up. For example, gold continues to trade near its peak price. Some of the unique raw materials in capacitors are in scarce supply and have also gone up in price. Examples are the coltan ore used in tantalum capacitors and neodymium used in ceramic capacitors.
Despite the big run up in raw material commodity prices in 2006 – 2008, in a highly competitive market few passive suppliers were able to pass much of their cost increases on via price increases to the customer base. The notable exception to this being the connector manufacturers who, because of high copper, petrochemical and gold content, were systematically instituting price increases during this period. But even in these cases, the component price increases were well below the +100% raw material price increases that were occurring. The net result is that despite the recent fall in commodity metal prices, the ability of a component manufacturing company to correspondingly cut prices varies greatly company to company, and in most cases the “give back” amount is minor at best.
The other thing we are coping with, which I think will be a factor for some time to come, is the quick reduction in capacity our suppliers have made in response to this down market. The nature of the current economic crisis and the deep fear from all the bad news has caused every one of our suppliers to aggressively scale back their operations. This is different from the last recession that hit the tech industry hard but did not affect the overall global economy with anywhere near the same impact. As a result, companies were very slow to take capacity off-line which further exacerbated the inventory build up that caused the crash in the first place.
Learning from that, the component manufacturers have been very slow to add back capacity as the tech market recovered, and we have all become much more vigilant of our inventory levels. So in this downturn quick steps have been taken to prevent any kind of inventory build up. Tens of thousands of production workers have been terminated, and the production lines that they ran have been mothballed. Capacity has been right sized to fit current and projected demand. There isn’t anything close to the kind of inventory overhang we saw in the 2001 recession and as a result, we have seen very little “fire sale” activity.
Our suppliers are still stinging from the effects of the last downturn and have learned many painful lessons. We see them being much more conservative and much less willing to chase unprofitable market share. They have cut capacity and people very quickly and will be very cautious and deliberate when adding them back. We actually are somewhat fearful that when things stabilize there will be some shortages and extended lead-times appearing. When the market does recover, expect lengthening lead times and even further pricing stabilization to occur until workers can be hired and trained and incremental capacity brought back on-line.
In the absence of a crystal ball it is our belief that distributor inventory is an important way for the customers of passive components to mitigate the effects of the current economy on pricing and delivery. During this period of uncertainty the opportunities for well funded, franchised distributors are tremendous. As we’ve seen in past industry recessions, distribution remains one of the most efficient ways for both customers and suppliers to manage inventories, credit and service levels during these uncertain times.