Electronics companies brace for a long, hard recession

With revenues falling by as much as 50% in some electronics sectors and with entire markets undergoing fundamental changes, the old ways of doing business are not enough to thwart this downturn.

By Tam Harbert, Contributing Editor -- Electronic Business, 3/10/2009

Collateral damage.

That term keeps coming up when electronics executives talk about today’s economic mess. Unlike the downturn of 2000-2001, which resulted from an Internet and telecommunications bubble that burst and caused a freefall in the high-tech sector, this crisis hit when the bubbles of real estate and credit imploded, causing a ripple effect that’s being felt by every sector of the economy, including innocent bystanders like electronics.

That ripple reached the electronics industry last fall, when customer orders took a steep dive. “October and November were the worst months I’ve ever had in business,” said Rajeev Madhavan, chairman and CEO of Magma Design Automation Inc and a serial entrepreneur in high tech since the early 1990s. 

Even so, many companies last fall didn’t quite realize the gravity of the situation, said John Ciacchella, a principle and the technology lead at Deloitte Consulting LLP. Drawing on their experience from 2000-2001, CEOs took out the same playbooks and immediately started cutting costs and reducing inventory, he said.

This time is different While it’s obvious to compare this downturn to the one eight years ago, this is not a rerun of 2000-2001. “This downturn has a very different dynamic than anything that the electronics industry has seen before,” said Derek Lidow, CEO of iSuppli. Previous downturns were caused by too much capacity. This one, he said, is caused by a steep and sudden drop in demand. “We’ve never had a demand-less downturn in electronics,” he said, noting that there wasn’t much of an electronics market during the Great Depression. To a large extent, the electronics market depends on the disposable income of consumers, he said. Consumers represent 60% of the electronics spend, but even the other 40% – which comes from enterprises – depends on consumers buying the products and services of corporations, Lidow noted. When consumers eliminate discretionary spending and stop buying, businesses have to cut back on their IT and electronics spending, too.  The sudden drop in demand has rippled back through the supply chain. And as it travels, that ripple grows bigger and bigger as each link in the chain not only adjusts to lower demand but also reduces inventory. Roy Vallee, Avnet’s CEO, calls that “the bullwhip effect.” For example, a consumer electronics company sees a 12% drop in sales. It has a finished goods inventory and wants to sell those items first, so it reduces its order to its manufacturing company by maybe 18%. The manufacturer also wants to reduce its inventory so it reduces its orders to components suppliers and distributors by some 25%. In turn, the components makers reduce orders to the foundries by 40%. When will things turn around? According to Lidow, the recession will last as long as consumers either do not have disposable income or are too afraid to spend it. If discretionary spending remains low for long, “it will require a major rethinking of the electronics industry, including which types of products it should be developing for the consumer,” he said.

But by the first of the year, it was clear that this was no ordinary recession. (See sidebar, “This time it’s different”)

“The psychology changed,” said Derek Lidow, president and CEO of iSuppli Corp. “[Executives realized] they needed to make sure they could last this thing out, however long it lasts.”

With revenues falling by as much as 50% in some electronics sectors and with entire markets undergoing fundamental changes, the old playbook is not enough, said Ciacchella.

So what’s the new playbook? Electronic Business interviewed CEOs and industry experts to gather advice on how to survive the economic storm. Here are their top tips:

1. Hone your focus

Hard times call for hard decisions. After a certain amount of across-the-board cost cuts, step back and reassess your entire company. “The new playbook is about making surgical strikes,” said Ciacchella. “Rather than spreading the pain across the company, it’s about picking and choosing.” Rethink what your core markets should be. For some, you’ll need to dramatically scale back your expectations. “In automotive, for example, we are not going to get back to [previous] revenue levels for at least three to five years,” said Ciacchella. You may want to exit some markets entirely. Invest those savings in your most important products, markets and customers.

But Jerry Fishman, CEO of Analog Devices Inc, warns that now isn’t the best time to change strategies, that in fact it could be the worst possible time to make important decisions about the future of your company. He prides his management on thinking in that vein all the time, especially during the boom times.

“You have to think about the fundamentals driving the industry quite apart from what’s happening economically in the next two quarters,” he said. In late 2007 when times were still good, he noted, ADI sold two businesses because it decided they were no longer core to the company’s mission. He also said that the company had already begun or planned many of its permanent cost-cutting actions, such as consolidating fabs in Ireland and the United States, before the downturn. Such actions put the company in a much better position when the crisis hit, he said.

2. Watch the finances of both customers and suppliers

With the credit markets shut down and revenues plummeting, companies can quickly find themselves in desperate straights. Scrutinize the financial health of your customers and suppliers. Roy Vallee, chairman and CEO of Avnet Inc, noted that two of Avnet’s suppliers – Qimonda and Spansion – have filed for bankruptcy, and he’s worried that more may follow. As for customers, watch your accounts receivable very closely.

But if your balance sheet is strong, you may be able to draw the business of the most stable suppliers and customers from your competitors. Vallee has noticed a flight to quality among both his customers and his suppliers. Some customers are having service problems with their other distributors and so are switching more of their business to Avnet, he said. Similarly, suppliers concerned about the viability of their distributors are coming to Avnet as a “safe haven.”

ADI’s Fishman agreed. “We’ve seen that customers want to stick with suppliers that are financially solid,” he said. “They are wary of those that may go out of business or have to cut back so drastically that they can’t support their customers very well.”

3. Take advantage of the situation to acquire new businesses

If your company has the financial reserves, now is the time to go shopping. “We’ll see a lot of acquisition activity coming out of this cycle,” said Ciacchella. “Companies with strong cash positions already have deals in the hopper ready to go, they are just waiting for the right time.”

Avnet has already used the opportunity to scoop up three businesses in the last few months. It acquired Nippon Denso Industry Co Ltd of Japan in late November, acquired Abacus Group PLC of the UK in January, and finalized a joint venture with Sanko Holding Group in Turkey in February.

But in today’s environment, due diligence is more important than ever, said Aart de Geus, chairman and CEO of Synopsys Inc, which acquired the CHIPit business unit of ProDesign in December. “We are in this interesting twilight," he said. "There are and there will be many businesses for sale because they can’t survive on their own."

De Geus said he’s been approached by several businesses in the last few months, often with seemingly innocuous comments about pursuing stronger strategic alignment. “I know what they are talking about,” he said. “It’s called meeting payroll in a month and a half.”

4. Increase customer TLC
 
In desperate times it’s easy to become so wrapped up in your own problems that you don’t attend to your customers as conscientiously as in the past. But now is the time to give extra tender loving care. ADI is staying close to its customers, making sure they understand how the company is well prepared to survive the downturn and making sure the company understands how it can help its customers become more competitive, said Fishman.

Avnet’s Vallee seconded that. It’s easy and tempting for employees to stand around and commiserate, especially if the company has had layoffs. Management needs to emphasize that the staff can help the company out of the bad times by gaining market share and by taking care of customers and suppliers that are depending on them.

5. Flush out bad habits and improve company culture

There’s nothing like a severe downturn to shine a light on bad practices. Magma Design had gotten off track in the last few years, distracted by a lawsuit and its struggle to make its first major technology transition, admitted Madhavan. But those problems are now past, and the economic crisis has forced the company to return to its original start-up culture, which focused on a “grass-roots value proposition.”

Similarly, de Geus said the crisis is accelerating an existing trend in EDA toward lowering costs. “We see this as an opportunity to, together with key customers, do a full-front assault on the total cost of design.” And he’s taking advantage of the hard times to force changes within the company that were more difficult to achieve during calmer times. “Crises are opportunities to let go of behaviors of the past.”