Unexpected shifts in demand, pricing, and production capacity are nothing new for Glyndwr Smith and Allan Cole, who each have about 35 years of experience in the passives business. Yet, turning points in market conditions haven't gotten easier for the industry veterans to predict.
"I feel there's a possibility that things could improve, but this is the third year in a row that the industry has expected a second-half recovery," said Smith, assistant to the chief executive and senior vice president of market intelligence at Vishay Intertechnology Inc. in San Diego.
Cole, chief executive of Yageo America in Dallas, seconded Smith's cautious optimism: "We're still trying to figure out what this year will look like, but I expect we'll see a gradual turnaround in demand."
iSuppli Corp. forecasts that worldwide capacitor and resistor revenue will grow 5% in 2003, but average selling prices (ASPs) will continue to fall during most of the year because of low capacity utilization. However, the El Segundo, Calif., research firm said possible disruptions to the global economy, such as the SARS virus, could alter the revenue outlook.
The prognosis for revenue growth could also change if prices fall even more than expected, although passives suppliers are reporting that price erosion, at least for the moment, has eased.
Although last year's unit demand for capacitors was up nearly 20%--with most of that growth in China--prices fell about the same amount, wiping out any revenue gain, according to iSuppli.
As companies are forced to bring their costs into line with sluggish market conditions, the possibility grows of product shortages should business strongly pick up. After laying off employees, streamlining or shutting down manufacturing facilities, and taking other expense-control measures, passives manufacturers continue to pare costs but need to do so without jeopardizing product or technology development, services, or the ability to meet demand when business improves.
However, while ASP declines appear to be easing, prices are likely to continue to fall until factory utilization rates recover substantially. Revenue and profit margins will remain under pressure as a result.
Sentiments regarding the short-term picture vary. Among the most optimistic were executives at Vishay, who reported across-the-board increases in bookings for the company in February, March, and April and a passives book-to-bill ratio of 1.07 in the first quarter.
Although posting a positive book-to-bill ratio for the first time in many quarters, AVX Corp. was more guarded, citing limited visibility and expectations for the current quarter of flat revenue or a slight gain.
According to market trackers, inventory of capacitors and resistors continued to drop in the first quarter, but not to the extent expected. iSuppli estimates that passive component suppliers' inventories barely broke below 100 days.
The challenge is demand, not inventory, John Gilbertson, chief executive of AVX, Myrtle Beach, S.C., said in a conference call with analysts late last month.
AVX's 8% decline in revenue from the December to the March quarter resulted primarily from weak demand in consumer electronics and wireless handsets in Asia, according to Patrick Parr, an analyst at UBS Warburg LLC in New York.
While pricing and capacity are major obstacles for passives companies, still sluggish demand is an even bigger drawback, Parr said. "Demand is not anything they have control of. They have some control over capacity and pricing," he said.
Capacity for growth
How full production facilities are varies by company and product. Capacity utilization has been as low as 30% to 40% for tantalum capacitors and in the 70% range for resistors and ceramic capacitors, according to analysts and industry executives.
Market trackers also talk about "people capacity," which some say could be the most crucial resource in the foreseeable future.
"It's not a matter of brick and mortar," Yageo's Cole said. "If you have to train people it will take time. It also depends on the condition of your equipment."
Cole estimates it will take the industry one to three months to bring capacity utilization back up once demand rebounds. Yageo could ramp up to full capacity in about four weeks, because it would be easy to add personnel in Taiwan and China, two countries where the company's manufacturing is concentrated, Cole said.
The industry should be able to ramp up production by adding people, unless growth in unit demand suddenly soared above 10% to 15%, Vishay's Smith said. Companies that need to add floor space, equipment, and personnel could take six to eight months to bring their manufacturing capabilities up to speed, he said.
According to iSuppli, a previously forecast third-quarter shortage is unlikely because the industry continues to add capacity in China even faster than it takes it offline in North America.
Price erosion, though still sapping profit margins and top-line growth, has eased on some components.
Vishay reports that in the current quarter, resistor prices are stabilizing, although tags on commodity multilayer ceramic capacitors and tantalum capacitors continue to decline.
Longer term, passives manufacturers anticipate modest price erosion and factor it into their cost structures. Capacitor prices normally decline about 6% to 8% a year, or 2% a quarter, according to John Warner, director of strategic planning at Kemet Electronics Corp., Greenville, S.C.
Kemet reports that price erosion in ceramic and tantalum capacitors has moderated during the year to about 5% a quarter.
Also citing 5% quarter-to-quarter price declines, AVX noted in a recent conference call with analysts that the company expects prices will be down by less than 5% in the current quarter, depending on demand.
"Asian companies were not as aggressive in the latest quarter as they were a couple of quarters ago," Gilbertson said. "Their own financial pressures caused them to be more aggressive earlier. If you're going to see a low price, you will almost always see it in Asia first."
Many large passives companies in Japan, North America, and Europe are opting not to chase the prices suppliers in China, Taiwan, Singapore, and Korea are offering, iSuppli analyst Shawn Wood said. "Knowing that Asian suppliers can't support business in other regions of the world at the prices being offered in Asia, many suppliers outside Asia are positioning themselves to fill in the gaps that will ultimately be created," he said.
At the same time, U.S. passives vendors are unlikely to levy dumping charges against Asian competitors, according to Wood, who listed three reasons. One, prices in Asia are lower than in the United States, so the domestic vs. foreign price condition for dumping would not apply. Two, there are many Asian suppliers, each with a small market share, so the cost to pursue each would be enormous. Finally, it would be difficult to prove that Asian suppliers are selling below prime costs because they have different accounting practices.
Dangers of price war
On the surface, the prospect of paying less is attractive to the consumer, but price wars could be unhealthy for the market.
"There needs to be adequate profit throughout the supply chain," said Mike Morton, senior vice president of product marketing at passives distributor TTI Inc., Fort Worth, Texas. "That can result in lower prices to the customer, provided costs are reduced throughout the chain. This can be accomplished through efficiencies of operation and manufacturing, increasing volume, and lower transactional costs."
When prices fall below fixed costs, "You can't provide the proper infrastructure for global fulfillment," said Ken Sykes, senior vice president of sales at Rohm Electronics in San Diego. "As a Japanese company, we maintain a reasonable margin and pricing strategy in spite of aggressive moves of other companies throughout Asia."
Rohm, which manufactures in China, Japan, Korea, and the Philippines, is trying to rely on relationships with customers to maintain share, Sykes said. The key is making manufacturing and fulfillment as cost-efficient as possible. Rohm builds much of its own production equipment, Sykes said. "It's transferable from one facility to another, which ensures ongoing quality."
Billions of passive devices ship every year, and they occupy 70% of the printed-circuit board. Because of the sheer volumes that ship as well as their great variety, passives can be complicated from a logistics and supply chain standpoint.
"We've come a long way, but we still have room to improve," Vishay's Smith said. "Logistics, service, and supply chain management will have to evolve with changes in the industry as manufacturing moves. The same with design and engineering."
Logistics is as important as it always was, but as companies move their production to lower-cost regions, they must adjust to unfamiliar cultures and business practices, said Denny Salmang, president and chief executive of Epcos Inc. in Iselin, N.J. With more than 60% of its employees in low-cost countries in Asia and the former Eastern Bloc, the company's German parent trains local workers to ensure uniform global service.
Less manufacturing in North America could mean lengthened time-to-market for customers in that region, TTI's Morton said. Suppliers will have to continue to improve their inventory management and factor "shipment over water" into their planning, he said.
"When it comes to service and logistics, it is best to be close to the end market, but given equal quality, the consumer will sacrifice service for a lower price," iSuppli's Wood said. "From a passive component market perspective, Asia is the primary consumer, since a large majority of the end electronic applications are manufactured there. So, non-Asian passive component suppliers lose on both fronts of service and price."
However, the quality of Chinese passives continues to be a primary concern when placed into applications that end up in North America and Europe, Wood added.
"China's passives industry has many hurdles to overcome to service its growing local market before focusing on supplying products directly to the U.S. or Europe, and quality is one of them," he said. "However, many of the local Chinese passive component companies are dedicated to increasing quality and rapidly adopting the world's highest standards levels from Japan."
That could be a plus for the worldwide market.
"Competition makes us all better," said Phil Gallagher, executive vice president of worldwide supplier marketing and business development at Avnet Inc., Phoenix. "It will force manufacturers worldwide to be more efficient. A lot of North American manufacturers are all over the world and capable of capitalizing on opportunities in all areas."
Long term, the passives market landscape will change. There will be continued consolidation as the industry focuses on opportunities in China and other countries that are attractive from a cost and customer-service standpoint and companies explore options to expand their products and technologies. Companies with limited offerings or limited cash might be ripe for acquisition or alliances.
Smaller or regional companies might need help with logistics or supply chain management, and acquisitions or alliances might be the answer.
Many small suppliers in China are looking to grow through partnerships, Wood said.
North American and European vendors are interested in such deals. TT Electronics, based in the United Kingdom, is investigating either buying a facility or company in China or cementing a partnership there, according to Steve Wade, director of sales and marketing at TT Electronics subsidiary IRC Inc. in Corpus Christi, Texas.
Some acquisition surprises may be looming.
Kemet, which has never made an acquisition, may be exploring that option, Warner said. Kemet would consider buying or forming an alliance with a company addressing an emerging technology, he said.
Large suppliers already have manufacturing capacity in fast-growing regions, global logistics programs, and broad product lines, but there might be some small deals, such as the sale of a product line, said Bill Glass, national sales director at Samsung EM America in San Jose. Samsung recently sold its electrolytic capacitor business to Korea's Samhwa Electric Inc.
Companies like Vishay that have been acquisitive over the years say they are sticking to that strategy. In a recent conference call with analysts, Vishay executives said the company receives acquisition offers every day.
"I wouldn't be surprised to see Vishay make another acquisition, though it would more likely be on the active component side," said Matthew Sheerin, an analyst at Thomas Weisel Partners LLC in New York. "Unless it was immediately accretive or such a good deal, Vishay would be less likely to increase its exposure in passives."
Market share is the key to gaining economic scale, and acquisition is just one way of getting there, said John Denslinger, senior vice president of Murata Electronics North America, Smyrna, Ga. But Murata's strategy is to grow organically.
"The principles for survival with respect to passives companies are no different than for any other business," Denslinger said. "It takes management commitment to quality, R&D investment, continuous improvement, cost control, and great products made with the best technology."