Where Are We in The Inventory Digestion Cycle?

Excess inventory is one of the many inherent problems in the electronic component industry—a costly, $250+ billion problem, to put it frankly. While strategies exist to plan and enforce operating models, the supply chain's ever-changing nature makes it hard to predict when shortage markets will swing into a phase of oversupply. 

For some, last year felt like a never-ending phase of excess supply, while others were still riding the highs of steep demand from the global chip shortage. Now, most companies report the inevitability of a swing in supply chain dynamics. Everyone's question is: Where are we in the inventory digestion cycle, and what industries may face excess next? 

A Timeline of the Global Chip Shortage and Its Lasting Impact 

The global semiconductor shortage that began in 2020 led to expansive uncertainty at the beginning of 2023, profoundly impacting buying behavior. A lingering fear of not being able to secure a supply pushed original equipment manufacturers (OEMs), contract manufacturers (CMs), and electronic manufacturing service (EMS) providers to employ double-ordering strategies.  

Furthermore, non-cancelable and non-returnable (NCNR) terms also created another layer of complications. Distributors strictly enforced NCNR terms, even when the quoted lead times were shorter than what customers built forecasts and order volume around. Customers were consequently forced to take on supply sooner than planned. 

These tactics caused heightened inventory levels, which unfortunately coincided with declining lead times and order volume as the industry made its way out of the chip shortage. While industries like automotive saw consistent demand, which caused shortages of ICs to continue, commodity groups like those within the memory market experienced a sharp decline in activity. 

Excess memory component supply flooded the market, causing prices to drop and manufacturers to pivot production capacity away from low-profit margin products. These strategies seemingly paid off, as inventories were still heightened but carried less risk than if production had remained more robust.  

Additionally, AI recharged demand for the memory market, which had been stagnant for some time. Now, demand for components like DRAM appears to be holding as companies like Samsung Electronics Co. and SK Hynix show signs of resuming equipment investment. 

Historically speaking, there is often a mirror-image aspect to a run up of lead times for components and after the peak of lead time expansion to when lead times normalize.  Given the protracted nature of this most recent shortage – Fusion traces the start of it to March of 2021 and normalization to have taken place at some point in early 2023, a period of nearly 24 months – it hardly strains credulity that this hangover effect of the shortage period would be similarly severe and sustained. 

Enterprise Computing and Consumer Industries Head Towards Stability 

Q4 earnings calls provided more profound insights into what demand trends would shape 2024. However, the question remains: where does excess supply stand for the electronic component market at large? The answer to that question varies depending on which manufacturer you ask, and it changes when you narrow it down by industry.  

As we have seen in the past, manufacturers have promised that the first half of the year will be a rocky road, but recovery is likely to begin after Q2. NXP Semiconductor followed this drumbeat, noting that overall inventory channels will likely normalize in the second half of the year, benefiting all end markets. However, it is important to note the potential bias in reports like these, so it remains to be seen if these forecasts match demand. 

However, Samsung Electronics Co. did see evidence of recovery on the horizon that has materialized. Inventory correction efforts for DRAM and NAND have finally started to coincide with accelerating demand. The company projected that memory market conditions and IT-related demand will continue to recover in 2024, with AI driving activity for high-bandwidth memory servers and SSDs. 

Outside the memory market, there were other standouts regarding successful inventory digestion. Monolithic Power Systems Inc. reported healthy inventory levels and is increasing its wafer starts in anticipation of strong demand trends within enterprise data and CPU data center end markets. Diodes Inc. also noted that its inventory levels normalized within the computing, communication, and consumer industries, but demand has been flat from quarter to quarter, so growth isn't expected to begin yet. 

Infineon Technologies AG went so far as to declare that the PC market inventory corrections hit bottom, but demand is still slow because of the volatile nature of seasonal trends. However, the company believes there's hope on the horizon for a more robust consumer industry, as smartphones recorded an uptick in orders at the end of Q4.  

A Bumpy Road Ahead for Industrial and Automotive 

Despite these bright spots, excess supply storm clouds still hover over 2024. Microchip Technology Inc., in particular, is experiencing an especially strong excess hangover and has suspended its PSP program to offer customers more flexibility. The company instituted global production pauses to help bring inventory under control. 

Lattice Semiconductor Co. indicated that despite expanding demand in the data center, excess supply will continue to cause headwinds from Q1 through Q2 for the data center, communication, automotive, and industrial markets. 

Industrial was one area that manufacturers seemed to agree was heading towards an excess supply cycle. Allegro MicroSystems Inc. began to see industrial customers enacting stricter inventory management in Q4, and Silicon Laboratories said that broad demand across all industrial product groups was on the decline. MaxLinear Inc. highlighted that a lack of visibility was making it difficult to account for the amount of supply on industrial end-customers' books. Still, Skyworks Solutions seemed to have a clearer picture as the company forecasts that industrial sectors would see inventory correction persist until at least the end of Q2. 

The automotive industry saw the most contested forecasts across manufacturers, as Diodes Inc., NXP Semiconductor, Lattice Semiconductor, Skyworks Solutions, and Texas Instruments Inc. declared excess supply would be an issue in this market through at least Q2.  

Alternatively, Renesas Electronics Co. stated that they increased automotive channel inventory due to demand trends. Meanwhile, STMicroelectronics found the middle ground between the two extremes, saying that automotive would have to weather excess supply, but it would be limited to ADAS verticals. 

Seizing the Gap in the Cycles of Inventory Digestion 

While no one has a crystal ball to predict how the inventory digestion cycle will play out, the market is likely to turn towards more normalized levels from Q3 onwards. Some industries may follow the more hopeful forecasts and see recovery by mid-year, but it is important to note that every industry moves at a different pace because demand trends are unpredictable. 

The upside to this irregularity is that it creates opportunities for strategic sourcing to seize the gap between the market swings. Employing market intelligence will be vital to capitalizing on cost savings and navigating the inevitable next phase in the supply chain.