How independent distributors regulate prices during component allocation
Brokers or independent distributors play an essential role in the electronic component supply-chain:
- they buy overstock;
- they source hard-to-find components;
- they source better prices (since their prices are not controlled by the manufacturer).
But they have another crucial role during component allocation: they regulate prices. Here’s how.
The regulating role of brokers during allocation — Photo on VisualHunt
In most markets, prices regulate supply and demand. Take the wheat market for example: if harvests are poor (decreased supply), price surges and you buy rice, corn or quinoa instead (so wheat demand drops). This is a market with ‘elastic demand’. Demand is altered, along with the price, due to the availability of substitutes.
For example, you need oil for your car, no matter the price. But still, you could use public transport as an alternative, or change your oil heater for an electric one. As a result, when the US government announces that any country importing Iranian oil will be subject to US sanctions, supply is lowered by 1 million barrels per day (a 1% drop), and prices immediately increase by 2.5%. This decreases the demand for oil. Why? Because there are still alternatives.
The inelastic semiconductor market
You see the comparison here? The electronic component supply-chain is one of the most volatile; a succession of imbalanced supply-demand cycles because there is no direct substitute for an electronic component in the short term. To use an alternative component, you need to redesign your product and this can’t be done overnight. As a result, electronic component demand is not elastic in the short term. Price does not regulate demand. In fact, in this industry, it is actually even worse: if prices increase quickly, demand will also increase because buyers are afraid to be in shortage so they increase their orders!
“The history of price collapse in the semiconductor industry indicates that short-run demand for semiconductors is highly inelastic. The sharp fluctuations in price, over 6-month period, are strong evidence of this. Such inelasticity occurs because price drops are not readily translated into new demand for devices. Many electronics markets are not very price competitive and those that are tend to be at rock bottom prices. So cost reductions are not immediately translated into lower equipment prices. Moreover, it takes time to design semiconductors into new applications, which cold bring about demand for greater volume, The result is that demand for semiconductors does not respond quickly to price changes. This aggravates price fluctuations and makes the market price inelastic in the short run.”
– Handbook of Semiconductor Manufacturing Technology, Second Edition, by Robert Doering and Yoshio Nishi
Another consequence is that it is very difficult for component manufacturers to request price increases. Because customers have no alternatives. If you negotiate a price increase without buyer alternatives, that is not a negotiation but a hold-up; which destroys any further relationship.
That is why this market follows cycles of supply and demand which are imbalanced. But without the intervention of independent brokers , it would actually be much worse…
The regulation role of the independent distributor
No matter how inelastic the market demand, there is always a limit. Multiply oil prices by 2 and the number of flights will decrease. Multiply it by 100… and only a few will remain.
But how can component manufacturers multiply prices in a market where any significant price increase destroys commercial relationships? This is where brokers come in.
Manufacturers are selling their freshly allocated production to independent distributors for a reasonable price increase (+30% for example) that would be refused by buyers, and brokers are reselling them at the supply-demand real price (2017–2018 price multiples reached crazy figures of between 30 to 80 times more).
Do you need proof? Have you ever noticed that allocated components via brokers often have very fresh production date codes. Direct from production!
Can we blame the manufacturers? Not at all. Only brokers can offer the market such very high prices. And those very high prices are the only efficient means to properly allocate production capacity. Without them, allocations would never finish.
So, now the big question, can you avoid such prices in the next purchasing cycle? Yes you can. Just explain to the manufacturer that you understand the situation and proactively request a price increase to get the components.
After all, this is what brokers do, and it works.
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