David meets Goliath

Small and midsize distributors are honing their focus to compete successfully with the industry giants

by Barbara Jorgensen -- Electronic Business, 4/1/2006

Sections: No place like home Stick to your niche Be tops with your suppliers Investing in tech Coddle your customer Endangered still?

It's been a while since small- and midsize distributors have had reason to gloat. For decades these companies have been an endangered species, being gobbled up by larger competitors, losing valuable component franchises and watching the U.S. electronics industry march overseas.

But within the past few years, the tables have begun to turn: Whereas top-tier OEMs and contract manufacturers—customers coveted most by the $10-billion-plus megadistributors—have largely vacated U.S. shores, second-tier manufacturers have stayed put.

"Clearly, offshoring has had some impact on our business, but it hasn't been nearly as severe as people think," says Bruce Goldberg, CEO of $435million All American Semiconductor. "The majority of the business that has moved offshore is not the type of business we typically participate in."

No place like home

The distribution industry has just come off a good year. The National Electronics Distributors Association (NEDA) says its members (which represent a large percentage of the distribution industry) experienced double-digit growth in 2005, after a long stretch in the single digits—and the first half of 2006 is following suit.

However, the market remains dominated by two companies that dwarf even their nearest competitor: $12.6 billion Avnet and $11.2 billion Arrow Electronics. Both derive an increasing proportion of their revenue from the Pacific Rim—the industry's fastest-growing market. And both are responsible for the massive consolidation that has taken place in recent years. So how does the rest of the distribution industry—the other 23 companies on EB's Top 25 list—continue to compete in this increasingly global marketplace?

Some have expanded overseas, albeit on a much smaller scale than Arrow and Avnet. Beyond that, however, is a population of distributors (well beyond our cutoff of 25) that still rely heavily on the Americas marketplace. Their presence overseas is limited, as are their resources. Yet they have survived consolidation by focusing on their niches, investing in technology and offering the same level of service as their larger competitors.

"Do we have technical capability? Do we have an experienced sales force? Do we have value-added services and programs? If the answer is yes, then we are competitive," says Frank Flynn, president of $265 million Sager Electronics.

Flynn and other executives of small to midsize players say they can offer a better level of service than their larger brethren because they are quick, nimble and dedicate the bulk of their resources to their Americas customer base.

Small and midsize distributors say they have weathered the Asian migration well because of the type of customer they serve. Instead of playing in the high-volume "fulfillment" space—where a distributor tries to fulfill a customer's entire bill of materials by offering every possible product line—the smaller companies have focused on a small number of product lines and local customers in local markets.

These customers tend to be small- to midsize OEMs and electronics manufacturing services (EMS) providers that don't manufacture huge volumes of products—it's the high-volume business that has moved overseas. These customers also tend to be more industrial than consumer-oriented. Consumer products—which are usually small, light and churned out in huge volumes—are easy and inexpensive to ship to the United States from the Far East. Heavy industrial and infrastructure equipment has stayed onshore or in the Americas, because it's prohibitively expensive to transport from Asia. These products are also manufactured in lots of 10 or 100 units—not of 1,000 or 1 million.

Small distributors will claim—and big distributors will dispute—that low-volume customers have been largely ignored by the top-tier players. Component distribution is a volume-driven business—the more products you ship, the more money you make. Megadistributors such as Avnet and Arrow have so much overhead that it can cost them more to fulfill a small order than the order itself is worth. Tier 2 and tier 3 EMS companies and OEMs are the sweet spot for smaller distributors.

"The bigger distributors have been driven to the larger customers and therefore have been disproportionately affected if a customer moves overseas," says Steven Fisher, CEO of $91.3 million distributor PEI-Genesis.

Stick to your niche

Many smaller distributors are also niche players, specializing in one type of product or one or two dozen product lines. PEI-Genesis, for example, has focused on military and circular connectors for 60 years. Connectors aren't known for the same kind of technology breakthroughs as semiconductors, and they don't command high price tags, but they are used in virtually every electronics product. Therefore, although most distributors sell connectors as part of their broader product offering, few specialize in them. PEI-Genesis is one of those few.

"The overseas migration hasn't affected us to the same extent it has affected the semiconductor distributors," Fisher says.

For one thing, the connector market is more stable than the ever-changing chip industry. Vast amounts of semiconductors, he points out, are used in OEM products that are churned out by the thousands but don't require a complex mix of electronic components in their design. Most of the manufacturing that has migrated to Asia is of the high-volume/low mix variety. Military and aerospace products are highly complex and not marketed to the masses.