Supply Chain
4 Suggestions for Overcoming the IC Inventory Crisis
As lead times recall the Y2K fiasco, EMS firms and OEMs must share the risks. by Joe Fama

The ongoing IC lead-time crisis is pushing the margins of EMS companies and leaving their OEM customers scrambling. As of this writing, production scheduling under the conditions of withering lead times calls for unprecedented measures riddled with hunches and diminishing hope for acceptable recoveries. For now, production planning is all over the map, with EMS companies working closely with their customers to get through this period without major damage to OEMs’ brands and customer loyalty.

Today, lead times for ICs are snowballing up to 25 weeks on average, with some of the harder-to-source components such as tantalum capacitors hitting the 40-week mark (FIGURE 1). TSMC, one of the largest IC manufacturers in the industry, forecasts the global shortages of semiconductors could linger into next year.1 The ringing note stamped on all lead-time quotes is “subject to change,” and in many cases lead times are downgraded to “TBD,” leaving manufacturers spinning for short-term solutions.

Lead times are not the only parameter exceeding normalcy. Today, unit pricing increases are the trailing edge of lead-time impacts. We see unit prices quoted in three phases: 1. Quote based on RFQ; 2. New unit price at issue of purchase order; 3. Updated unit price before shipment.

Yes, the practice of IC quotes is subject to a three-step function, with the law of supply-and-demand compounding each step. Unit pricing increases are as much as four or five times the average price established only 12 month ago.

With lead times and unit pricing ballooning, industry experts are seeking to identify the cause of the market disruption, as well as the need to determine a timely path to regain control of material acquisition.

When lead-time disruptions were first noted, industry watchdogs generally settled on a set of logical causes, with supply-and-demand principles hovering over the adjustments to unit pricing:

  • During the Covid-19 period, IC manufacturing output was drastically reduced. The return to normal rates has taken months to recover.
  • Projections of the oncoming Covid-19 vaccination approval around the third quarter 2020 and the subsequent rollout provided good news, priming the economic outlook and releasing pent-up product demand, causing production orders to spike.
  • Demand for ICs increased as retailers also jumped on reordering to fulfill pipeline inventory.
  • China’s middle class is flexing its financial muscle, and its size – 300 million people – is almost the same as the total population of the US.
  • The annual pre-holiday order spike was unaffected by the pandemic, adding to the surge.
  • Before the Christmas bump ends, OEMs prepare for the Chinese New Year shutdown, adding production orders to cover up to four weeks of manufacturing stoppage in the February/March timeframe.

These explanations have come from seasonal trends, along with recent reports tied to the Covid-19 period. Although the historical cyclicality says industry should be back to normal, on the ground companies are experiencing a chaotic market with no indications the worst of the IC shortages is over.

Figure 1: Component distributor TTI’s list of various capacitors shows how lead-times are growing. (Source: TTI)
Figure 1. Component distributor TTI’s list of various capacitors shows how lead-times are growing. (Source: TTI)
Why Lead Times Continue to Inflate

As market conditions go from bad to worse, divining the supply picture gets trickier. New causes for slowdowns are being reported, including:

  • Short supplies of raw materials required for IC manufacturing due to extensive consumption, as well as lingering impacts of conflict minerals.
  • China’s OEMs are building inventories as the relationship between China and the US deteriorates. Chinese foundries may be siphoning off ICs to prioritize China’s own internal IC usage.
  • Worldwide Covid isolation lifestyles created unanticipated (high) demand for new PCs, laptops and home office equipment, not to mention gaming and gaming peripherals, causing huge demand for ICs and other electronic devices.
  • As lead times grew, panic buying hit the market. Purchasing now engages in bidding wars as distributors hold inventory for the highest offer.

We can conclude the continued increase of lead-time problems has a multitude of causes, with some influencing the market more than others. One of my sources on market conditions is CCT, a display foundry and modular assembly manufacturer based in Kuala Lumpur. Eric Chan, COO, has taken on the day-to-day hunt for ICs. He states, “There are many causes for lead time increases, and the feedback depends on who you ask and where they are located.”

Chan believes the lead-time crisis will continue to worsen due to investment speculation and greed. “In Asia, there is much talk of a few well-funded individuals who are buying and holding product in mass quantities, creating heightened street pricing for popular IC part numbers. For the right price, any IC is available to desperate buyers, and many buyers are searching the supply chain for immediate inventory.” Chan is one of perhaps thousands of senior executives now being utilized as IC hunters seeking short-term solutions to the lead-time problem.

Impact on OEMs

OEMs that have seasonal products with annual production schedules to hit retailers’ shelves are finding themselves in dire situations. Missed shipments to retailers means lost sales revenue, and this can damage the brand. Late deliveries might not just hit OEMs’ topline revenues but could also cost them their investment in premium shelf space positioning at national and international retailers. Today, many OEMs are weighing the choice of paying higher unit prices for ICs or turning to gray market venues where counterfeit components are openly sold as authentic.

Regarding the size of the EMS or OEM, meeting production scheduling is no longer a given. Thus, the collision of desperate IC hunters has created a heterodyne of a bidding war among the contestants, a perfect world for resellers who take advantage of such market conditions. Panic buying has pushed out lead times of some hard-to-find parts well into nine to 12 months. Even with this advance purchasing strategy, no IC SKU is likely to maintain its normal market unit price.

Minimizing Supply-Chain Disruptions

The value relationship between an EMS and OEM must be levered to new heights to create acceptable outcomes for the OEM. Throw out any procedures in place for forecasts, material acquisition and JIT requirements. To start, managing IC procurement and scheduling, with its expectations that EMSs procure components and take liability for long lead-time items, must change. Following this, increased costs of ICs must be handled separately and not in unison with customary “cost plus” pricing models. In essence, the EMS’s acquisition role, as well as unit price derivations, must be openly addressed. Here are some suggestions to coordinate a best outcome:

  1. The strategy of managing lead times must be a cooperative endeavor between the EMS and OEM. The EMS is to execute normal advanced purchases of ICs covering the usual forecast range of three to four months. For extended lead times, the OEM must share the financial burden of advanced purchasing, along with any risks associated with program cancellation, slowdown of production scheduling, design changes and/or unfavorable financial conditions of the OEM. Thus, the EMS is to be absolved from material risks, while the OEM bears liability of any extended lead-time advance purchases from five to 12 months, or more as we see today. This is a good balance of risk/reward with the OEM taking liability for extended advance purchases.
  2. Beyond the lead-time issues, IC unit pricing and other bill-of-materials components are on a steady rise. To avoid a “runaway” EMS assembly unit price, EMSs are advised to put their “partnership” mantra in super high gear. To do so, EMSs are advised to separate added price hikes from normal unit prices that existed pre-lead-time crisis. To do this, the newfound IC, along with any BoM price-adders, is tacked on to the normal assembly unit price with no added overhead or profit margin burden to the bottom line. Here the EMS is conceding extra profit because the overall IC and BoM costs are not subject to internal burden and profit margins.
  3. For OEMs that desire to remain in full control of the IC progression, a consignment model is suggested whereby the OEM directly purchases ICs, permitting more visibility and flexibility of IC delegation if a second-source EMS is employed or will be employed in due time.
  4. In general practice, an OEM should trail its EMS’s suppliers to fully understand the greater supply chain. In this case, the IC suppliers need close monitoring. Working closely with their EMS, OEMs may create solutions with the knowledge of IC situations where lead times and pricing are unpredictable and reaching untenable conditions.
How Long Will the Lead-Time Crisis Last?

No one knows when the IC market will return to normal. Some are turning to history to shed light on what may be in store for the electronics industry. Tom Sharpe, founder and vice president of SMT Corp., an expert and global evangelist in counterfeit mitigation, compares cause-and-effects of past eras to help understand where disruption in today’s market is likely headed.

“The IC lead-time crisis of today has some parallels to what happened during the Y2K fiasco – specifically a strong economy and vibrant stock market. At that time, there was an overly hyped panic based on ICs in fielded products suspect of not having Y2K compatibility. Many OEMs attempted to replace fielded motherboards or full turnkey products having to do with high-rel applications in the medical, aviation, financial, transportation and aerospace industries, to name a few. Previously programmed ICs in WiP or OEM inventories were scrutinized for possible reprogramming or replacement to ensure proper operation at the Y2K turn. Manufacturing and sales of PCs and cellphones were at a historic high. The dot-com boom was nearing its apex, and technology-based stocks were on fire.

“Like we see today, EMS suppliers were severely backlogged, leading to extreme price increases for ICs and other materials.”

With that in mind, Sharpe shared his view of when the inventory crunch may return to normalcy. “The Y2K movement started roughly in mid-1999 and ended shortly after Q1 2001.” That said, while it took two years to cycle through the Y2K lead-time crisis, he feels that timeline isn’t necessarily a proxy for today’s situation.

“We cannot use the contributing factors of the Y2K shortage to predict how long today’s lead-time crisis will exist, since the dynamics causing the current shortages are very different in nature. And now, China is a significant player in the supply of ICs, which includes the emergence and proliferation of counterfeit ICs invading the global supply chain.”2

The Counterfeit Industry’s Dream
While discussing the subject of the IC market with Sharpe, I took the opportunity to gather updates on the status of counterfeits. The feedback is depressing, albeit unsurprising. “Unfortunately, these market conditions are exactly what the clone manufacturers pray for,” Sharpe asserted. “It is logical to see the spike of counterfeit demand when OEMs have little choice other than to turn to the open market to complete their BoMs within reasonable timeframes.”

The US government is increasingly worried about its dependency on China, as well as other Southeast Asian nations, Sharpe also noted. Roll Call, a periodical newsletter covering Defense Department subject matters, reports China now supplies over 13% of the US Defense Department’s semiconductor needs.3

“With China’s counterfeit network growing in size and capability, our national security is truly in jeopardy, since some of the newly minted counterfeit clones are capable of high performance,” Sharpe notes, adding that clones remain untested at extreme temperatures for long periods of time. “The clone-produced ICs remain a question mark insofar as long-term reliability.” He reiterated a fear of the clone’s ability to conceal embedded spyware, a nefarious threat to national security.

The electronics industry is hanging upside down. Capacity cannot keep up with demand, and IC unit pricing is increasing steadily. The complexity of the global market obscures the eventual end to this lead-time crisis. And on top of this matrix of uncertainty is the human emotion, whereby global panic buying amplifies IC demand beyond any realm of predictability. It is too early to determine when the electronics market will settle down. Until such time when the market resets itself to some form of normality, the EMS and OEM must synchronize, creating unprecedented cooperation to combat the unfolding catastrophe.

References
  1. Debby Wu, “TSMC Lifts Targets After Warning Chip Crunch May Hit 2022,” Bloomberg, April 15, 2021; bloomberg.com/news/articles/2021-04-15/tsmc-profit-beats-as-chip-shortage-shows-no-sign-of-abating.
  2. Mike Buetow, “Attack of the Clones: Do Counterfeits Still Pose a Problem in Electronics Manufacturing?” PCD&F/CIRCUITS ASSEMBLY, November 2020; circuitsassembly.com/ca/editorial/menu-features/34424-attack-of-the-clones-3.html.
  3. John M. Donnelly, “Microchip Security Continues to Confound Pentagon,” Roll Call, Apr. 6, 2021; rollcall.com/2021/04/06/special-report-microchip-security-continues-to-confound-pentagon/.
Joe Fama is an EMS consultant with extensive experience in the global EMS marketplace, including 35 years with Singaporean, Malaysian, Filipino, Vietnamese and American EMSs addressing global marketing agendas and business development; joefama@gmail.com.