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Supply chain contrarian

Posted: 04 Aug 2005 ?? ?Print Version ?Bookmark and Share

Keywords:analog? oem?

For the record, Bob Swanson, chairman and founder of analog chip maker Linear Technology Corp., doesn't want to give the impression that he's calling his customers idiots.

He just wants everyone, starting with the big OEMs and down the food chain, to create morally responsible forecasts. And he blames the intense focus on supply chain management for leading everyone astray from good old-fashioned common sense.

Swanson said that people are still making the same mistakes that exacerbate the bullwhip in the electronics industry, even at companies that are considered to have model supply chains. He thinks big investments in management software and newfangled supply chains are a waste of money and energy. Offshoring engineering and outsourcing manufacturing are also wrongheaded, in his view.

This contrarian attitude is rare in an industry that has wholeheartedly embraced supply chain restructuring as a way to deal with the forces of globalization. But the 66-year-old Swanson, who recently gave up the CEO job, likes to speak his mind.

"There were proponents of supply chain management who said there was still a magic bullet to solving supply-and-demand problems," Swanson said in an interview. "I thought they were charlatans. A lot of it was about OEMs figuring out how not to be responsible for their forecasts. This whole culture created part of the bust. This supply chain myth contributed to the boom-and-bust cycle that happened in the dot-com bubble and the more recent correction that we just saw."

It may seem Swanson is taking a quixotic and archaic stance when others are bleeding all inefficiency out of their supply chains, but he has a golden goose. Wall Street analysts consider his 23-year-old company to be one of the best-managed players in the chip industry. The Milpitas, Calif., company has as complex a business as any manufacturer. It makes more than 7,500 products for 15,000 customers and it employs more than 3,100 people. It has a half-dozen manufacturing processes in factories worldwide.

But even with that complexity, Linear has executed with laser precision. Its gross margins of 78 percent are the highest in the chip industry, and its pretax profits have exceeded 50 percent of sales for 39 consecutive quarters. It has had 80 quarters of positive cash flow. It has cash of $1.74 billion and zero long-term debt. Though it competes with big rivals such as Maxim, Analog Devices, Texas Instruments and National Semiconductor, it outshines them all in financial performance. Even when Linear's sales were halved in 2001 during the bust and it had to lay off employees for the first time in its history, the company still didn't lose money.

"I challenge you to find any company anywhere with a better business model," said Tom Thornhill, an analyst at UBS Securities.

The secret sauce
How does Linear execute so well? Consistency breeds virtue in the supply chain and good relations with suppliers and customers, said Lothar Maier, who assumed the CEO job from Swanson in January. Maier is more mild-mannered than Swanson. But Maier shares Swanson's skepticism about schemes for easy fixes.

"We do things differently from other companies," Maier said. "We are a little slower to rush into the latest fad. We tend not to use consultants at all. They come in and pitch us that they can improve our gross profit margins. We show them our numbers and they go away."

Linear does embrace healthy supply chain practices, but Swanson insists that common sense rules. When the music stops, as Swanson said about demand drops, Linear makes sure it doesn't get stuck holding the bag. The secret of how this happens is brilliant in its simplicity.

Linear promises that its lead time for deliveries will be four to six weeks, a factor that it can control because it does almost all of its manufacturing and assembly internally. Although it takes 16 weeks to make chips in the factory, the customer has to assume responsibility-and take ownership of the inventory-four weeks before delivery. That period also happens to be the last stage of manufacturing, when the chips are moved out of Linear's die banks and into packaging, test and assembly.

"That's no coincidence on the timing of the terms," said Dave Bell, president of Linear.

Because Linear is so good at living up to its lead-time promises, customers aren't panicky. They aren't motivated to place double orders with Linear the same way they would with other suppliers. And, because of Linear's strict contracts, they can't cancel an order inside the 30-day window, whether business is slow or busy.

"The OEM has to be morally responsible for the forecast," Swanson said. "Four weeks from delivery, the OEM owns it. They can't renege. In the 1990s, the OEMs tried to break this down with our competitors. They pushed their suppliers to take all the risks. But no customer is good enough for me to assume all of the risk."

Linear can back up its claims. It does business with a wide range of the top global companies. And when those OEMs reduce the number of suppliers on their approved vendor lists, Linear makes the cut.

One such happy customer is Altaf Khan, commodity manager at Sunnyvale, Calif.-based Trimble Navigation Ltd. Trimble buys more than 200 parts from Linear regularly, including regulators, amplifiers and other analog circuits that go into Trimble's navigation equipment.

"Linear has been able to successfully deliver parts on time," he said. "If there is a spike in my demand, they will meet my needs inside the four-week limit."

As for Linear's policy on requiring customers to own their inventory in the last four weeks of production, Khan admits it's "inconvenient." But he weighs that against the value that Linear brings in other ways. For instance, Linear is reliable, its parts are unique, it delivers on time and is competitive on pricing. "A competitor would have to really work hard to displace them," he said.

Linear's leverage
This combination of attributes gives Linear the luxury of holding its own in negotiations with customers. It can afford to say no to unreasonable demands from customers, even if they come from players such as Dell. That's because Linear isn't playing in a commodity business.

"Big customers have a lot of clout, but shame on the suppliers who agree to their terms," said Linear's Bell.

Some experts once thought that analog would be displaced as the world went digital with the personal computer revolution. Far from it. Every new digital gadget requires analog chips, like voltage regulators for cell phones, to deal with real-world signals. The analog market was $34 billion in 2004 and is expected to hit $42.7 billion by 2007, according to the Semiconductor Industry Association.

Intel's average selling prices for microprocessors are well above $100. By contrast, Linear's average prices for its analog chips are only $1.40, but that is twice the industry average-and much of that is profit. That's because it takes highly skilled analog engineers to create the products. Those engineers are often in the field, speaking to customers, so that they can anticipate high-end products to design.

Because so much skill is required, Linear treasures its employees. In an age when desperate CEOs are laying off U.S. employees by the thousands to deal with globalization, the attitude is unique. Linear doesn't have a fancy headquarters. Its walls, cubicles and meeting rooms are notably stark. But for the sake of morale, the company is generous with options and bonuses, Swanson said.

"We use our people to innovate and differentiate," he said.

Linear Technology gives employees lengthy sabbaticals every five years and its bonuses range from 20 percent to 60 percent of their base pay in any six-month period. It hasn't offshored engineering to India or China, in part because foreign universities aren't pumping out analog experts.

While some might view these as unnecessary expenses, Bell said it keeps turnover at a minimum and recognizes the fact that a single experienced analog engineer is worth 10 inexperienced ones. Even Wall Street analysts say that this generosity to employees is part of Linear's success formula.

"Analog [companies'] assets are their people," said Ramesh Misra, an analyst at C.E. Unterberg, Towbin. "And those assets appreciate over time. Most chip makers have factories as their assets, and they depreciate over time."

Linear targets about 95 percent of its products at the high-performance analog market, and it eschews commodity products, no matter how high the volume. Once its products are designed, the deals often last for five years because it's so hard to take a design to another analog vendor, said Misra. But once products become commodities, Linear makes the tough decision to discontinue them, Bell said.

"When it's no longer a good business, we hold the line," he said. "We try not to irritate the customer and offer them the chance to make an end-of-life purchase, or we work with them to obsolete a part over time."

On the manufacturing front, Linear owns all of its factories, in part because its plants aren't capital-intensive. The company spends $100 million a year on capital expenses, a tenth of the capital budgets for digital chip makers that have to use leading-edge equipment, said Doug Freedman, an analyst at American Technology Research. Analog chips, fortunately for Linear, can use older equipment. And this enables the company to avoid contract manufacturers, who might lower costs but who also might strip the company of control of its production.

Learning from Linear

Even with these unique advantages, Swanson said that many other companies could use Linear's common-sense approach to supply chain management. Take, for instance, multimillion-dollar investments in supply chain software. Linear hasn't installed an SAP management system.

"The best software in the world can't solve a stupid forecast," Swanson said.

Instead, Linear relies on relatively antiquated ManMan software for general accounting reports, Promis for tracking inventory in the production process and SD&G for sales order processing, accounts receivable and finished-goods inventory. Linear tailors those tried-and-true programs to its needs so that it gets a real-time picture of the overall manufacturing situation.

"We use these applications to collect and consolidate data," said Maier. "We don't use them to make decisions. A person makes the decision."

Swanson, naturally, is more blunt: "People say that software is going to solve this problem," he said. "Well, I say garbage in, garbage out. No amount of software is going to fix the problem of bad, irresponsible forecasts by the guy at the top of the food chain who wants to place an outrageous order."

Bell notes that automated orders come in one day and are cancelled the next. Linear's sales and customer support staffs are trained to question every order, as if they were checking their expense reports to make sure the columns and rows match, Maier said. By scrutinizing every order and checking it against the customer's history, the company minimizes its exposure to write-offs. It all has to add up, said Maier.

"We use human intelligence to control both sides of the business: what goes into the factory and what comes out," Maier said. "It all has to match. We don't blithely put an order into the backlog. We have to know the customer's business."

Linear makes sure that it sources its materials from multiple suppliers and multiple locations. For about 20 percent of its packaging, it uses subcontractors and looks to them as a second source to gain flexibility. But 100 percent of final assembly is internal.

This doesn't mean everything always works perfectly. Some customers are more demanding than others and Linear may have to expedite an order. With customers like Apple Computer Inc., whose iPod has seen dramatic success, there is no sales history that can foretell explosive demand for a product. In some cases, Linear has had to catch up with a hot-selling product. With Apple in particular, Bell notes that Linear did not hold up iPod production.

Sometimes, new players come into the picture, sending shock waves through Linear's orderly systems. For instance, a few years ago during the outsource-everything craze, Linear had to learn how to deal with big contract manufacturers. These companies didn't always have the best handle on inventories, since their stock on hand might serve 25 customers, each with its own flawed forecasts.

Similarly, when Chinese cell phone makers entered the market a few years ago, they ordered huge volumes, couldn't sell them and got stuck with excess inventory, triggering the latest down cycle in the chip industry.

Swanson grants that there are unsolvable problems even for companies like Linear. He can't do anything to reduce the 16-week cycle for making chips, beyond keeping inventories in appropriate die.

banks to provide flexibility. And he realizes that many of his customers just don't know what they need even a week from now.

However, when something goes wrong, the business surprises don't harm Linear as much as they do its competitors. Indeed, analysts report that in the past couple of quarters during the chip industry slowdown, Linear has outperformed all of its analog rivals.

"We're still running this business on what we learned 20 years ago," Swanson said. "I don't think our habits should be viewed as unique. We are steeped in common sense. We have to all be more cautious. We can't chase a magic formula."

See related image

About the author
Dean Takahashi
is a staff writer at the San Jose Mercury News. He can be reached at dtakahashi@mercurynews.com.




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