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rrow Electronics's Necessary Evolution in a Perilous Market

Source:wridy company limited Date:2018-02-02 14:48:01

Arrow Electronics Inc. is knee-deep in the most consequential evolution in its history, one that has the potential to result in a complete transformation of its business and heavily impact the entire electronics value chain by forcing a reshaping of the design, engineering, new product introduction, procurement and the entire supply chain. Once finished, the process — quietly begun several years ago — may reduce component distribution to a fraction of Arrow’s global sales and push the company deeper into the design chain.

It is a transformation born of necessity and emblematic of a conundrum facing the industry. The old challenges of commoditization and margin pressures remain intractable even as new sales opportunities open for distributors, semiconductor suppliers and high-tech equipment manufacturers. The explosive adoption of wireless connectivity (IoT) by most segments of the economy is creating massive sales opportunities in areas once closed to electronics manufacturers but it is also forcing a re-evaluation of the product creation, development, engineering and manufacturing processes and thus, the role of component distributors.

But while rival top-tier distributors are tinkering hesitatingly with existing business models, Arrow, instead, seeks a more central role in the value chain. The reason for caution on the part of other distributors is simple; the sector is growing, lifted by a resurgent economy and strong demand for electronics and components. Many distributors are, therefore, more focused on protecting current revenue streams and proceeding with reorganization at a slower pace, according to observers.

Arrow is growing, too, well-ahead of industry average (2017 sales are projected to reach $26.6 billion, up 12 percent, from $23.8 billon, in 2016) and it has surged passed rivals to establish a commanding lead of the distribution available market. But executives say the company is also determined to forge ahead with a repositioning of its operations because they believe the old business model is not longer-term viable. So, while the ongoing changes are the latest in a string of industry-leading actions taken by Arrow since it was founded in 1935, they will be the most transformative.

Arrow wants to be at the heart of the industry design chain and supply chain, pumping out critical services – whatever the customer needs – to old and emerging players, Andy King, head of Arrow’s components division, the company’s biggest operating unit, said. The parts required for this transformation have been acquired and are being deployed, he said. The company has amassed a trove of design, engineering, technical information, media, logistics, supply chain management, production, end-of-life management, enterprise resources, software and IP solutions to service whatever the customer needs and at whatever stage of the product development, manufacturing and introduction process. The customers determine what they want but Arrow will be ready to offer those services immediately, according to company executives.

“We’ve assembled many assets to take advantage of the market fragmentation and opportunities opened up by the explosion of IoT into economic segments that we weren’t playing in before,” King said, in an interview. “We are in the midst of a very large-scale digital transformation of the economy, but we’re not scared by this because we’ve got all the elements we need to compete in place. We are adding rocket fuel to the offerings and services we already have.”

Perhaps King should be a tad concerned. This is a bold move in a market even he describes as "highly fragmented," which makes any major business repositioning risky. What Arrow is doing and where it is headed will see it functioning as a core provider of most essential services in the electronics design chain and supply chain, exponentially widening the range of offerings and making it more competitive and critical to customers.

But the company will also be in uncharted waters fraught with risks. What Arrow is doing goes beyond a simple industry consolidation or a reorganization of its operations. The company, in response to a wave of new technology offerings that have collapsed existing sector walls, is heading deeper into the center of the market. It is a bold and, ultimately, highly rewarding move, potentially.

The changes are, therefore, not without risks, the most obvious of which is the uncertainty inherent in re-engineering a successful and still-growing business. Customer response cannot be determined and some of the actions, especially those involving its foray into heavier engineering operations, will position Arrow as a competitor against even some of its own suppliers and current customers. Arrow must also remain nimble to respond flexibly to unexpected developments.

Change or be forgotten
Anyone who thinks Arrow, or any of its peers in the components distribution market, can continue on the current track is mistaken. The component distribution sector has changed much over the last several years, forced to respond to structural changes in the larger electronics industry as the customer base evolved and as new technologies resulted in the dramatic expansion of the addressable market. As a result, the top companies cannot even be accurately described as distributors anymore. They offer design services, technical information, sub-assembly and supply chain management services, in addition to the traditional distribution fulfilment services. Today, component distribution is the most basic of all the services offered by these companies.

To better understand what’s happening at Arrow it would help to first state what the company is not doing. First, it is not reorganizing operations or doing structural alignments to reduce operating costs, increase profitability and “better serve existing customers.” Second, it is not merely engaged in moving up the high-tech food chain by becoming a “higher value-added services provider” as some of its competitors are doing.

Lastly, Arrow — though a voracious buyer involved in multiple consolidation M&As — is not purchasing rivals to gain scale, access existing markets or increase sales in specific regions or industry sectors. Arrow has done all these. It is still making acquisitions and forging new alliances, just of a different kind. The latest tie-up, for example, was with AT&T Inc., with which it is partnering in the telecom service provider’s foundry business to “help customers get their products to market quickly.” This is a move all the way up the food chain and far removed from Arrow’s original charter as a distributor.

What the company is doing is taking actions that have already and will further expand its addressable market, potential customers and economy segments served. The steps taken will deepen Arrow’s relationship with existing customers, but they go well beyond this. In a few years, applying the nomenclature “electronics component distributor” to Arrow will seem quaint and basically erroneous. That is, if it isn’t already outdated. Here’s how chairman, president and CEO Michael Long described Arrow in November while discussing the 2017 third quarter results:

“We enable businesses to globally deploy, manage, monitor, analyze and monetize connected devices through their entire lifecycle,” Long said. “Arrow has an unprecedented opportunity to create a lead that is insurmountable. We will do this by investing in our Sensor to Sunset capabilities, especially our digital platform, our IoT practice and our software and cloud solutions.”

That’s right. Arrow sells software, in addition to, design services; engineering solutions and technical information; connectivity solutions for IoT products; components; supply chain management services, and everything else a customer needs to bring an idea or product to prototype production or full volume manufacturing. Arrow will deliver whatever the customer needs, be it components, design, engineering, sub-assembly, a small part of the product engineering and new product introduction services or the entire set of solutions to get the product to market, according to King.

“We are a technology company able to offer the services customers need to leverage digital technology, irrespective of what we used to do traditionally,” King said. “Arrow has transitioned into a technology company. It is no longer about the individual parts of what we offer. Hardware is no longer the name of the game; it’s about the business process.”

Arrow isn’t just trying to deepen its offerings, however. Executives said it is not layering on services but undergoing a total transformation akin to turning a caterpillar into a butterfly. By the time the process is complete Arrow will have essentially become a new enterprise sporting a remnant of its old services. Essentially, components distribution will become a component of its much-wider range of offerings.

Evolutionary journey
Arrow is on an evolutionary journey and what it will become may not be known even to the current architects of its change. They will have to adjust objectives and goals, adopt new ones, refashion offerings, exclude some and embrace unanticipated but customer-mandated services. Executives must be flexible because the market itself is evolving.

“The market is going to shift, and it will evolve, but it is not going away,” said an Arrow executive providing background information for this report. “There is too much happening to say IoT is a flash in the pan or that it’s not real. I think we’ve passed that point. That’s why we are strengthening supplier relationships and investing in people and training. We want to make sure we are ahead of the curve.”

Previous evolutionary actions undertaken by Arrow since it was founded were aimed at bulking up its size and gaining suppliers across the globe. During this phase the company helped lead the consolidation of the distribution market and, together with rival Avnet Inc., reduced to a handful the number of companies in the sector able to serve the industry as global players.

The current metamorphosis is designed differently from the aggressive consolidation-driven M&As of the past 30 years. Rather than take over rivals, the company is evolving “into an engineering and services business” that offers solutions rather than products; an enterprise that “understands how to engage with a customer to solve problems rather than just take orders,” for components, according to an executive at Arrow who shared confidential information about the company’s objectives.

“The company is evolving,” he said. “When I am talking with a customer it’s no longer just selling a component and value-added services. I am instead offering a technology stack that include sensors, microcontrollers, connectivity solutions, the gateway, the Cloud, applications, servers, storage, networking, security and solutions up and down the stack.”

Acquisitions made by the company in recent years reflect the new focus. Arrow in January acquired engineering firm eInfochips, gaining an enterprise with 1,500 engineers spread across three continents and with expertise in product development. What makes the eInfochips deal special is that it places Arrow squarely in the center of the engineering business and beyond simple FAE services offered by traditional component distributors.

eInfochips has a customer base that includes companies in non-traditional economic segments served by Arrow. The deal opens opportunities for Arrow to widen its reach in sectors like retail, industrial, food, banking, health and medical services, transportation, financial and even insurance; basically, any enterprise seeking a technology solution but not interested in fashioning a product by itself, according to Pratul Shroff, CEO of eInfochips.

“Think of us as a design factory working across the economic value chain,” Shroff said, in an interview. “We create roses in the desert for companies no matter their business sector. Our objective is to offer complete solutions for the customer and Arrow’s involvement will balloon eInfochips’ services by enabling us to offer solutions to even larger companies.”

The eInfochips transaction follows a pattern that Arrow set years ago. As companies began exploring connectivity solutions starting with M2M products, Arrow assembled the assets needed for the predicted waves of IoT products. Its acquisition strategy changed to deals involving companies complementary of its focus on building a network of engineers, technical information and product expertise. Recent acquisitions included media assets that offer market information, research, data and other industry intelligence to deepen engagements with engineers.

“The nature of the market has changed,” said components division head King. “Look at the new set of customers coming from new vertical markets and who need support from the bottom up and down the chain. We have assembled several assets to take advantage of these changes and as we’ve proceeded on this journey these tentacles will allow us to scale up globally.”

The face of Arrow’s customer has certainly changed. While the company continues to service traditional OEMs and contract manufacturers – the components division remains its biggest – Arrow now sees a different future set of customers. The new ones will come from all segments of the economy and be spread out globally, according to King, who noted that “IoT is taking us into economic segments that we weren’t in before in addition to new players springing up and becoming large quickly.”

Arrow’s customers will also vary in size, ranging from individual members of the Maker movement working with a “vague” design idea to small, medium and huge enterprises in all parts of the globe. One challenge the company anticipates is figuring out how to serve the new and expanded customer base in a fragmented IoT ecosystem where rapid technology changes can result in margin pressure.

“The biggest challenge we see is that the rate of technology progression is very fast,” said another Arrow executive who declined to be identified by name. “It is a risk, but we are addressing this with investments, products and strengthening relationships.”

Contrast Arrow’s strategy with that of Avnet, its chief North American competitor. Both are betting on the IoT market and have invested heavily in the sector. They’ve acquired enterprises involved in IoT design and services and added homegrown efforts to strengthen offerings. The similarities end here. Arrow set the pace with early investments that shored up its two biggest business divisions – components and enterprise computing – while Avnet, lost in a restructuring spiral, sold its technology solutions business to Tech Data for $2.6 billion in 2016.

The sale of Avnet TS to Tech Data opened a dramatic difference in the rivals’ operating strategies. Arrow executives said retaining the enterprise computing solutions (ECS) business meant it could offer a more comprehensive set of services, complementing design and engineering offerings. Further, Arrow is moving deeper with cradle-to-grave engineering services, which it named Sensor-to-Sunset.

Avnet executives concede the company had become less competitive in the technology solutions segment because it delayed critical investments in the business. They argue, though, that this move meant they could deploy scarce resources into the components business while partnering with companies like Tech Data and others to offer a comprehensive set of services to customers, according to CEO William Amelio, in an interview last year with EPSNews.

Customer-driven change
From a customer perspective, it would seem to make sense to source these range of computing and design solutions from a single provider than have it offered piecemeal, especially for companies that have limited engineering expertise or that have no interest in becoming a technology firm and simply desire a turnkey solution.

Perhaps Arrow, too, would have preferred to toddle along in its old ways, raking in steady sales and profits and avoiding the turbulence that comes with business re-engineering. Analysts say that scenario is no longer an option for the industry. IoT is barreling through the entire economy, threatening to reshape markets, springing up new players and upending established relationships.

The distribution market is bifurcating into two segments, according to industry observers. The first has tier-1, or large, volume distributors that must evolve operations in the face of dwindling margins. This group needs to evolve or become extinct within years, they said. In the second group are specialized distributors competing on the basis of technical knowledge and the ability to swiftly deliver small and medium-size components packages. This group faces similar margin pressures but survive on lower costs and digitalized operations.

“The outlook for the distribution market is generally tough,” said Malcolm Penn, principal analyst at U.K.-based Future Horizons Inc., a provider of market intelligence and consulting services to the electronics industry. “The business model has to change. Distribution is hurting from the move of high-end design to certain geographies and it will get worse. The industry must figure out how to generate demand and grow profitably on ever increasing margin pressure.”

Arrow executives agree the pressure to change is huge but insist they have found a solution to the problem identified by Future Horizon’s Penn. The company realized the need for change years ago and this explains some of the moves Arrow has made, which have contributed to sales growth, they said. An analyst countered with an explanation that the market has been growing generally in the last year.

“It doesn’t matter how inept you are as a distributor in the current high demand environment,” said the analyst who works for an industry organization and requested anonymity. “You would make money by just showing up. The real challenge comes when the market changes.”

So, is Arrow’s strategy the correct one? Time will tell, but it is being proactive in responding to customers, and putting in place a mechanism for dealing with changes in its market is a necessity. Observers said Arrow is forging ahead with its evolution because standing still could cause it to experience a fate similar to the slow strangulation suffered by cities bypassed by the railroad during its giddy expansion in the Americas.

Rather than wait for such an end, Arrow is pouring more resources into engineering and asking to be the driver of the next wave of industry growth, a company executive said, adding, “we will take instructions from customers, but we have laid the tracks for wherever they want to go, and we have the wagons in place to get them there.”

Will the target customers patronize the new Arrow? Many are doing this already. The real measure of the company’s success will be how many more it can get onboard, according to Future Horizons’ Penn.

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