Understand the importance of electronic component supply chain

To grasp the challenge, it is important to understand the supply chain for electronic components. Typically, a contract manufacturer orders most passive components through distributors rather than directly from the component manufacturer. A demand forecast is set up, and a bond representing the number of parts the distributor guarantees will be available for the project is agreed upon.

Just as the automotive industry has moved to electronic data interchange and online portal processes to tighten communication, contract manufacturers have adopted similar methods to streamline the supply chain process. A pull signal is sent when a production work order is scheduled, the parts are shipped to the contract manufacturer, and the distributor replenishes its inventory. Properly done, there is very little need for human interaction. Inventory liability is minimized, and material arrives as scheduled.

But the longer lead times could mean trouble. Over the last year, these lead times have become unusually long because demand for these parts has grown faster than component manufacturer capacity.

Additionally, more parts are going on "allocation" — when a component supplier tells a customer it can only have a certain percentage of its order. When demand outstrips supply for a component, the component manufacturer determines what percentage of an order it will supply to each customer.

However, there are additional dynamics that make risk of supply chain disruption higher than in previous cycles. First, there has been a generational changing of the guard in supply chain management. Older supply chain managers and engineers who had built face-to-face relationships with their suppliers have retired. The new generation at both electronics suppliers and automotive companies works at a distance — electronically. When demand exceeds supply, suppliers and customers aren't talking. Instead, customers double- and triple-book orders to increase their allocation. Suppliers then try to guess at how much of an order is really needed. Worse, this lack of visibility into actual demand discourages manufacturers from increasing their capacity.

Industry consolidation has also exacerbated the problem. When component suppliers merge, a bill of materials that had multiple sources for each part may suddenly have one source for many of the parts. Fewer suppliers also drives slower capacity increases since there is less competitive pressure to increase capacity.