Fork In The Road

The distribution field is rapidly diverging between companies that can offer global economies of scale and those that can offer specialization and distributors that do not fit into either category are getting shunted aside.

The move by Arrow Electronics Inc. to acquire the troubled component

division of Pioneer-Standard for $285 million is only the latest case in point. Of the big former industrial distributors -- Avnet, Wyle, Pioneer and Arrow -- only two are left standing in the electronics business. And they’re getting bigger, and creating an ever-widening gulf between themselves and their competitors.

For Arrow, the latest deal will instantly add 20 cents per share in increased earnings, according to Arrow executive VP Rob Klatell. Arrow will not take on Pioneer’s warehouses, IT infrastructure, sales facilities and corporate support functions -- about $60 million worth of overhead that cut into Pioneer’s bottom line while not allowing it to compete on a global scale with Arrow or Avnet Inc. Arrow doesn’t need it. It has its own infrastructure, with far greater reach and economies of scale that Pioneer couldn’t match.

“This is going to simplify the supply chain,” Klatell said. “Large distributors do have an advantage to offer to their customers and suppliers. Because of their global operations they can do the same job in the United States, Europe or Asia.”

While that may help Avnet and Arrow sell add-on services, it is unlikely to have an immediate effect on product pricing. Pricing is almost entirely dictated by supply and demand, and for the past 18 months supply has far exceeded demand. As a result, distributors sold as much as they did prior to the downturn but received only about half as much for the same products.

Big distributors with cash in the bank have been able to eke out a living in this environment, but smaller distributors living on razor-thin margins have found themselves without the cash reserves to remain competitive. In Pioneer-Standard’s case, the issue is whether to continue in two businesses or try to emerge as a major player in the midrange computer business, which has remained profitable and which will only improve as the market picks up again.

Once the market does pick up and shortages return, distributors’ profits will subsequently rise. That, in turn, will go a long way toward boosting their credit ratings, allowing them to borrow more cheaply and thereby increase their profits even further.

In addition, while Avnet and Arrow had sworn off acquisitions in North America, it’s clear that nothing is forever in this industry. Arrow had said the same thing before it acquired Wyle.

Ironically, it now appears the biggest battle among distributors will be fought not in the electronics industry, where they all got their start, but in the midrange computing market where they have built practices over the last decade. Arrow, Avnet and Pioneer all have midrange units. What still is unclear is whether having a component business will help or hinder those businesses.