Avnet's Roy Vallee: Staying constant in a world of change

By Suzanne Deffree, Managing Editor, News -- Electronic Business, 8/26/2008

Thirty-one years ago, Roy Vallee joined a little company known as Hamilton/Avnet as a field sales representative. After subsequent promotions and decades of growth, Vallee in July celebrated 10 years at the helm of electronics supply chain giant Avnet Inc, one of the world's largest companies with revenue exceeding $17.95 billion. Electronic Business recently spoke with Avnet's CEO and chairman about what the electronics distribution industry was, what it is, and what it will be. What follows are excerpts of that conversation.

Electronic Business: How would you describe Avnet and the distribution landscape 10 years ago?

Vallee: Ten years ago was pre bubble. From our point of view the semiconductor industry was still more cyclical and volatile. We were largely a North American company but had begun expanding in Europe and had just stuck our toe in the water in Asia. Nearly all of our previous CEOs had been founders. I got the CEO promotion and was just hired help. A lot of the acquisitions were not fully integrated, we didn't have a global culture, operations were scattered about. Just domestically, we were in California, Atlanta, New England, and New York. 

Now we [span] 70 countries and just finished under $18 billion. The [North American] operations have been consolidated in Phoenix, Arizona. We have achieved market share in Europe that is comparable to what we have in America. And Europe has become our single most profitable region in the process in EM [Avnet Electronics Marketing]. We built a $3 billion business for EM in Asia and we have a small launching pad in Japan. And our computer business [Avnet Technology Solutions] has expanded dramatically in that 10 year timeframe and it's now a $7 billion operation and is sneaking up on 50% of Avnet's global sales.

Electronic Business: Are you concerned about the economic downturn impacting the computer business?
Vallee: Oh sure. In fact I'm concerned about it impacting the whole business. Our reported growth for the year was around 14% top line. However, if you strip away acquisitions, the growth is substantially lower. Then, if you strip away currency, the growth is even lower. That's especially true if you look at the last couple of quarters where pure organic growth has slid down to the low single digits. The global economic slowdown is having an impact on Avnet's business and results, for sure.

But there's a silver lining in that cloud. We're in very strong financial condition, and a big part of that is based on what we call "value-based management" and the return on capital. The combination of higher return on capital and slower industry growth means lots of cash flow. We're setting records for cash flow and we're using that cash flow to do value-creating acquisitions. Those acquisitions are helping us grow and increase our scale and scope. So while I'd rather have a more robust environment, the reality is this slowdown has created some opportunity for Avnet.

Electronic Business: How has Avnet's merger and acquisition [M&A] strategy changed over the years? If you go back 10 years, the whole distribution industry was very merger- and- acquisition based. That seems to have slowed down.

Vallee: That could be the perspective of an American. … In America, we've been fairly highly consolidated for a while. This decade, the only real blockbuster deal I can remember off the top of my head is Memec and that was three years ago. Following that, the computer business consolidated, and while that was happening the components business began consolidating in Europe. There's been a lot of M&A activity in Europe. In Asia, it's well under way but it's in high gear now. America is almost done from a consolidation point of view; Europe is maybe one step behind that; Asia is still very much active in the consolidation space; and I'll stick my neck out and say that Japan is now the place that needs consolidation the most.

Electronic Business: Can you expand on that?

Vallee: We counted 37 publicly traded component distributors in Japan. This is a market that is roughly the size of the Americas distribution market and it is the most unconsolidated of any market in the world. As the Japanese OEMs [original equipment manufacturers] establish manufacturing sites around the world including in Asia Pac, there is a need for global support for supply-chain services, there is a need for design- here, build-there support. 

Electronic Business: Japan is a tough nut to crack for United States-based companies, based on cultural differences. How are you going about that?

Vallee: The first word that would come out of my mouth is patience. We're not very good at that as Americans. We like instant gratification. Avnet's been a fairly aggressive company, but Japan is going to be there a long time. It's a big market. Change happens slowly. We need to be patient. My second comment is that what we've learned when we've expanded into Europe and Asia is that we run Europe with Europeans and we run Asia with Asians. We can bridge that local cultural part with the global business culture. Culture has two dimensions: there's a local piece that's more social in nature, then there's the global piece that's more business in nature. Successful global companies have figured out how to have both. 

Electronic Business: How does Vietnam look?

Vallee: Vietnam is a highly skilled but low- cost labor market, similar to several of the Asia emerging markets and perhaps Eastern Europe. We don't see a lot of design work going on there, at least not yet, but we are seeing an increasing amount of production as a demand-fulfillment, supply-chain-services type of an operation for our components business.

Electronic Business: And you see design opportunity in Japan?

Vallee: Huge. Japan is a major OEM design center. I believe the US is still No. 1, but Japan may be No. 2. 

Electronic Business: How has the inventory channel changed in the last 10 years?

For more on the distribution market, see: Avnet's Harley Feldberg: Distribution evolution Digi- Key's Mark Larson: Think local, act global

Vallee: There are some structural changes that have caused total days of inventory to fall. First of all, consumer goods have become more than half of the total market for semiconductors, and I think that is also true of IP&E [interconnect, passive, and electromechanical]. Consumer goods have short product lifecycles and relatively low margin when you compare them to traditional markets like IT and communications. If you're an OEM and you've got a product that has short product life cycles and low margins, even though it might have high volumes you have to be conservative on how much inventory you carry. When you are building things on 80% gross profit, the last thing you want to do is be short a component. When you are building things at 20% gross profit, the last thing you want to do is have obsolete inventory. 

There's also this dramatic shift to contract manufacturing, whether it be EMS [electronics manufacturing services] or ODM [original design manufacture], the margin structure is dramatically lower than the margin structure for the OEMs that they are building for. With the EMS community at large now managing, let's say, a third of the world's raw materials, out of necessity they are going to manage that more tightly than the OEMs managed that themselves. … If you drill down, the OEMs are very lean and the distributors are very lean. The EMS companies are very diligent about inventory management, however, they are still subject to the forecast accuracy of their customers. Of course, once they have acquired inventory for a customer, if the forecast changes, they don't have other places to go sell that inventory. As a result, EMS inventories are not as lean as they would like them to be. 

Then the big change is the components makers themselves. You've got a supply chain of distributors, EMS companies, and OEMs who are managing inventory from an MRP planning perspective at least weekly, but semiconductors take 13 weeks to build. So you have component makers who are starting the 13-week process and then every week they are getting changes in the schedules. The result of that is inventory gets accumulated at the component maker. Whether it's wafer banks, die banks, or finished goods, there is substantially more inventory in the hands of the components makers today than there was 10 years ago as a percentage of the total supply chain. 

Electronic Business: How has, if in any way, the Web changed inventory strategies? Unlike 10 years ago, you now have customers able to access information and make purchases 24 hours a day, seven days a week.

Vallee: The Web is used heavily for information exchange and communication, but in our volume business, I wouldn't say that it's affected our inventory strategy. Where we did make a strategy change is we have consciously decided to carry a significantly larger number of SKUs in support of new-product-introduction and R&D activities for our customers and we sell them through the Web. 

Electronic Business: Have you noticed any shift in specific technology demand since the Web has gained traction in electronics supply chain management?

Vallee: The suppliers for the most part are narrowing their focus around specific products around programmable logic or they are picking end markets. … If you go back 10 years ago, the kingpins of the industry were the broad line suppliers—the Motorolas, the National Semis, the TIs, the STMicros. Now these guys are spinning off what they consider to be non-core product lines, they are buying assets from other companies to try and get stronger in specific applications. They are narrowing their focus and they want to be very good at their chosen fields. Now, no one supplier can give you the support you need for a whole design.

The big change is that engineers who want support across the board have got to come to a distributor because the components makers can't give you support across the board. We are the technical solutions provider. What we are seeing is the customers are coming to our site and they want our reference designs, they want to know where our seminars are, they want to get educated, and then they want instant availability of information and prototype materials quantities. 

Electronic Business: Have you seen a significant up tick in design-chain services, or demand creation, since launching your Avnet Express Web site?

Vallee: Yes. 

Electronic Business: How does that demand for design-chain services compare to the demand of the last 10 years? 

Vallee: Demand creation has been important to us since Intel created the microprocessor and the whole concept of registrations and design wins became a part of the semiconductor industry. For us, the acquisition of Memec, which was a worldwide semiconductor company dedicated to semiconductor distribution, substantially increased our talent pool, we picked up some best practices, and under Harley Feldberg's leadership we put a stake in the ground three years ago and said we were going to lead this industry in demand-creation services.
 
Electronic Business: What percentage of your revenue comes from demand creation compared to fulfillment?

Vallee: For EM, it's roughly 35%. 

Electronic Business: Are you happy with that percentage?

Vallee: I'm not sure the right way to think about it is as what percentage comes from either direction. We have a suite of design-chain services that we want to drive as effectively as we can worldwide and make design win as big a percentage of our total as possible. At the same time, we are driving a suite of supply-chain services. If one moves better than the other the ratio can change. What really matters to us is how we are competing in each of those individually. 

Electronic Business: What's challenges are you facing and overcoming, besides the economy?

Vallee: In the classic sense of what keeps you up at night, Avnet is getting to be a big company. I want to make sure that as we get big, that we don't allow ourselves to get slow. I also want to make sure that we continue to be a market- lead company. One of the things we've done in the last couple of years is we launched a global customer loyalty program. It's a permanent part of our landscape now. We collect information continuously from our customers to address any tactical operational problems and to provide strategic input for our planning so we know where to make our investments for the future. 

Electronic Business: What are you most proud of from your last 10 years as CEO?

Vallee: On the tangible hard side, I would say the work we have done around value-based management and how that has changed the way we have run the company. It's affected the way we deal with suppliers, customers, the way we allocate our resources, and it's had a dramatic impact on Avnet's return on capital and cash flow. … On the soft side, I'm really proud of the culture of the company. I think we are a place that employees are proud to work, our customers and suppliers are comfortable, they trust us, and it's the kind of place that people want to come to work. 

Electronic Business: How do you think the distribution industry is going to look 10 years from now?

Vallee: It'll probably not be what we think it's going to be, but based on what I see today here's what I would say: truly global—design anywhere, build anywhere, follow-the-sun kinds of design efforts; highly consolidated because of the scale and scope that will be required to actually be able to operate globally; the Web will be integrated in just about everything we do; and more and more of our profits will come from the services we provide as opposed to the [products] we sell. I think that in all industries, not just in technology, the world is moving toward solutions. It's just a function of time constraints and cost constraints that are driving customers to solutions. In order for us to provide solutions, we are going to have to have more and more services to complement the products that we sell, be they hardware or software. Ten years from now I think that will be a very important part of the distribution industry.