CFO Alert: Semiconductors Leverage Price Execution to Increase Working Capital and Boost Margins. A Model N Report

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1 CFO Alert: Semiconductors Leverage Price Execution to Increase Working Capital and Boost Margins A Model N Report This Model N report outlines how semiconductor and component manufacturers are leveraging Revenue Management strategies, including price execution projects, to improve gross margins by one to three percent.

2 2 Table of Contents 1. EXECUTIVE SUMMARY GROWTH FORECAST: MARKET CONDITIONS IMPROVE PRICE IMPROVEMENT INITIATIVES GAIN MOMENTUM SEMICONDUCTOR INDUSTRY LESSONS LEARNED WHY DOES THE STANDARD PRICE IMPROVEMENT MODEL FAIL? PRICE EXECUTION IS KEY TO DRIVING VALUE INDUSTRY CASE STUDIES CONCLUSION...9

3 3 1. Executive Summary 2009 was a tough year in the semiconductor industry, but thanks to better supply chain management, tight control over inventory levels, and incentive programs from the Chinese Government, 2010 holds the promise of return to growth. In this uncertain economy, many semiconductor companies are seizing the opportunity to maximize margins through price improvement initiatives. The number of companies that have engaged in such projects is twice as high as any of the previous five years. CFOs are often presented with "the next big investment" that will generate more revenue and better margins. Unfortunately, few of these pipe dreams come true and their impact is short lived. In lieu of the big investment, more pragmatic CFOs are driving cross-departmental initiatives to improve margins from existing business. One such initiative, systematically automating price execution, has demonstrated a significant and sustainable impact on margin performance for dozens of semiconductor and high tech manufacturers. After examining more than 40 semiconductor price improvement projects, the main finding is that the standard pricing improvement model, based on enhancing price analytics, price execution, and price optimization, does not seem to work in the semiconductor industry. A new AMR Research survey of 60 semiconductor and high tech manufacturers to be released in January 2010 shows Knowing the right pricing strategy is useless if you are not executing against it effectively. - Simon-Kucher & Partners, January 2009 that 82% of companies view price execution, an integral part of the Revenue Management discipline, as driving significantly more value than price optimization. Survey results also show that 45% of companies feel they do not follow their own pricing policies and 49% still utilize many manual processes, demonstrating a significant opportunity for improvement. When presented with a broader definition of price execution that includes price negotiation, discounting rules enforcement, managing price execution for transactions placed against contracts and orders, consumption tracking, and incentives management, semiconductor companies begin to realize the full potential of Revenue Management-based price improvement projects. One cannot say there is no value in pricing analytics and price setting efforts, but the impact on gross margin is orders of magnitude lower than the impact of improving price execution. If you have one dollar to spend, it will reap much more value by investing it in improving price execution than any other aspect of pricing. Semiconductor leaders such as ON Semiconductor, Linear Technology, Microchip Technology, STMicroelectronics, Cypress, Micron, Marvell, PMC-Sierra, Atmel, Cirrus Logic, Avago, and Numonyx have selected Model N s solutions to manage prices globally and across their channels throughout the entire revenue life cycle, from design win tracking, negotiation, and special price concessions through contracts, compliance, and incentive payments such as commissions, credit claims, and rebates Growth Forecast: Market Conditions Improve The global semiconductor market is improving. By the end of 2008, the market was extremely bleak as the semiconductor business faced one of the worst downturns in its history. Common wisdom and past experience lead many to believe that recovery would take years. But more

4 4 recently particularly after 2009 third-quarter financial results were announced it has become clear that the market is improving. Though there are sectors, such as automotive, that are still lagging and are likely to recover more slowly, most segments across the industry will experience growth in The main drivers that have enabled semiconductor companies to recover faster than ever before are the investments companies have made in optimizing their supply chains and keeping inventory levels under control. This, combined with the incentive programs promoted by the Chinese Government, have been key elements in enabling faster recovery and return to growth all within 12 months of the worst market conditions in more than 40 years. Semiconductor Annual Growth Forecast by Chip Type* Memory -13.5% 15.9% 16.5% 8.4% -6.6% Micro -19.2% 6.6% 9.2% 7.3% 3.8% Logic -16.6% 11.4% 11.7% 8.8% 3% Analog -19.0% 9.2% 11.4% 7.1% 4.1% Discrete -19.8% 10.6% 10.5% 7.2% 7.6% Opto -10.5% 10.5% 13.8% 9.5% 7.8% ASIC -21.9% 4.5% 8.9% 11.8% 2.2% ASSP -16.5% 9.8% 12.8% 7.6% 3.3% Non-optical Sensors -16.4% 9.4% 14.1% 13.0% 7.1% *Source: Gartner Forecast October 2009 The leading sectors that are driving significant demand are PCs and smart phones. The key question many in the industry have been asking over the past few months has been: Is this growth real? Most market signals are showing that the increase in demand and increase in capacity utilization that has doubled since the beginning of 2009 (leading segments have tripled) go beyond inventory replenishment, indicating that market conditions are indeed improving. 3. Price Improvement Initiatives Gain Momentum Most pricing analysts and consultants tend to break down pricing into the following three functional areas: Price Analytics and Price Setting Historical analysis of transactions and analyzing price waterfall impact on net price Price segmentation and price book setting Price Execution* Communicating prices for quotes and contracts Special price approval / deal management or deal analysis / optimization Price Optimization Micro-segmentation of markets and applications to optimize price setting * This narrow definition of price execution is a major reason for the limited value of many pricing initiatives

5 5 This price improvement model was constructed for pricing in the transportation, chemical, and discrete manufacturing industries and has since been applied to all other industries including semiconductor. But will pricing projects as defined above work in semiconductor? 4. Semiconductor Industry Lessons Learned AMR Research has recently conducted a survey of 56 U.S. semiconductor and high tech manufacturers which will be published in January Some of the initial survey findings include: Only 21% of responding companies view pricing as a means to shape demand Only 14% believe that tools that measure performance (price analytics) can help improve pricing and margins 77% view price execution as a top driver in improving margins These findings are consistent with Model N s research. We have surveyed more than 40 semiconductor companies that have invested in price improvement projects over the past five years. The goal was to see where companies have invested and which ones have claimed to have achieved measureable improvements as a direct result of their pricing project. Price Optimization: According to most analysts, the leading vendor in the price optimization space is Zilliant, which possesses strong pricing science capabilities. Our research has shown that with the exception of one division within one company (with a retail business model), there have been zero Zilliant deployments in semiconductor over the past five years. Price Analytics and Price Setting: According to some analysts, the leading vendor in the price analysis and setting space is Vendavo. While Vendavo has indeed demonstrated a strong track record in chemicals the industry its solutions 77% of respondents to a recent AMR Research semiconductor survey view price execution as a top driver in improving margins. were purpose-built for there are only five known Vendavo semiconductor deployments over the past five years. All those deployments are limited to internal company users (i.e. not available to channel users). Only two of the five deployments utilize the full functionality of Vendavo s offering. None of the semiconductor companies deploying Vendavo have publically documented any material value achieved through their projects to date. Price Execution: Using a broader definition that includes price enforcement, quotes, contracts, consumption tracking, and incentive payments, Model N is recognized by many as the leader in the semiconductor industry with 35 deployments. Seven companies have publically documented case studies that demonstrate the positive impact of the Model N solution on top-line and margin performance. Simon-Kucher & Partners, a leading price strategy consultancy firm, had this to say about price execution in January 2009 while presenting to semiconductor pricing professionals: "Price execution is critical. Knowing the right pricing strategy is useless if you are not executing against it effectively. Economic downturns are excellent times to refocus on pricing process and execution. Generating more revenue may be impossible, but extracting more profit from the same revenue is very possible! Plugging pricing leaks can provide a very high ROI way to tune up profit margins in a slow economy."

6 6 Kalypso, a product life cycle management and pricing consultancy firm, presented the following KPIs at a recent Professional Pricing Society Web Seminar to assess a company's pricing maturity: More customer negotiation, less internal negotiation A greater percentage of deals requiring no manual approval Centralized rules and guideline creation / de-centralized execution It is notable that the key KPIs for organizational maturity in pricing are all related to price execution. Number of projects and case studies by pricing initiative # of projects and deployed solutions in semiconductor # of public case studies Price Analytics and Price Setting Price Execution Price Optimization As the table above clearly demonstrates, the standard pricing model has not proven itself in the semiconductor industry, which introduces the question: Why have so many pricing initiatives failed at semiconductor companies? 5. Why Does the Standard Price Improvement Model Fail in Semiconductor? There are three key drivers behind why the standard pricing model has not delivered for semiconductor companies to date: Customer - end-customer - program relationship Too much reliance on the potential value of price setting Neglect of the channel Vendor focus Customer - End-customer - Program Relationship One of the key challenges of managing pricing in semiconductor is poor visibility into end customer identity. The semiconductor industry is truly global and conducted through multiple regions and multiple channels. This limited visibility manifests itself throughout the revenue and pricing life cycle. It impacts negotiations and price communication, transaction execution, and incentive payments that determine true net price and margin. How can you negotiate a price using price segmentation rules if you don t know the identity of the end customer? How can you detect price erosion and contract abuse by contract manufacturers unless you can map each transaction to the correct contract?

7 7 It is possible to conclude that it doesn t really matter how optimized prices are in the price book and how well defined pricing and discounting guidelines are if you cannot resolve customer - end-customer - program relationships. Without resolution at every stage, it is practically impossible to consistently execute correct prices across all internal and external sales organizations. Too Much Reliance on Price Setting While there have been excellent arguments made that better price setting and price segmentation can deliver a one percent margin improvement and sometimes more, it becomes a moot point if a company cannot execute those prices effectively. Moreover, as proven through Model N s first-hand interaction with dozens of semiconductor companies, the impact of poor price execution, lack of consumption tracking against contracts and quotes, and poor reconciliation of POS data to credit claims can cause value loss as high as 5% to 10%. Following are some factors that reduce the value of price setting considerably: Fifty to 60% of transactions in semiconductor companies are conducted outside documented pricing guidelines. This is not a discipline or employee training problem; it is a simple fact of business that semiconductor pricing is often impacted by end-customer (OEM) budgets, design targets, and competition. No measure of optimization is going to change these realities. It is unrealistic to expect that all prices for all product lines within a company can be optimized and drive increased margins. Therefore, price optimization is often selectively applied to specific product lines with an impact that is limited to those product lines. Conversely, price execution can impact a company s entire product line. Limited functionality: Price analytics tends to show how a company is performing and even help formulate strategies to improve. But since most price analytics applications offer limited transactional capabilities they must rely on additional systems and interfaces to execute the plan. For instance, most price analytics solutions will show the impact of rebates and other incentives on the price waterfall and net price impact. However, no price analytics platform actually manages the transaction of these payments. This is not to say that there is no value in pricing analytics and price setting efforts. These are worthwhile projects that can help companies capture lost value and lost opportunities. But the impact is orders of magnitude lower than the impact of improving price execution. As mentioned earlier, if a company has only one dollar to spend it will reap much more benefit by investing it in improving price execution rather than price setting or price optimization. Neglecting the Channel For companies that conduct 90% and more of their business directly, channel business may not be critical. But for those that conduct 20% of their business or more through channels, managing channel pricing will have a material impact on margins. Some companies engage in pricing projects purely from an internal perspective and fail to make sure their channels are working off the same playbook and using the same systems and controls that are used within the company. By bringing manufacturing reps, stocking reps, distributors, and contract manufacturers on to the same pricing system companies are able to: Enforce pricing and discounting rules throughout all internal and external sales organization Gain real time visibility into channel sales activity Enhance ease of doing business within the channel by improving deal turnaround times Improve channel efficiency and mind share by securing incentives promised to the channel

8 8 Some companies fail to see the channel as an integral part of their price improvement initiatives and miss out on gaining significant business value. Vendor Focus When engaged, most vendors will present some ability to manage all aspects of pricing: deal analysis, pricing analytics and price waterfalls, price execution, etc. However, understanding the strengths of each vendor is critical in matching them to your overall company strategy. Applying analytical tools to a transactional system is much easier than taking an analytical tool and trying to make it transactional. For instance, it is a relatively simple task to apply business intelligence and analytical tools (native and third-party) to an ERP system but it is next to impossible to take understanding the strengths of each vendor is critical in matching them to your overall company strategy. a business intelligence tool and convert it into an ERP system. Many pricing vendors started by developing analytical engines that at a later stage acquired some transaction capabilities. This development path significantly limits their true value from a price execution standpoint. 6. Price Execution is Key to Driving Value As explained earlier, a broader definition for price execution is required to allow companies to capture more value out of their price execution initiatives. Model N defines price execution as the ability to communicate correct prices at the time of negotiation, enforce correct pricing at the time of transaction, and protect net price when payments are made. Requirements for a full price execution solution for semiconductor include: Support customer end-customer object from design win through incentive payment Execute a wide range of pricing rules that can automate price resolution based on design registration margins, volume and regional considerations, future pricing, contract pricing, and step pricing Systematically route approvals and capture price concessions in an auditable manner Extend execution to reps, distributors, and stocking reps Deal analytics: analyze deals and understand what price will win the deal with maximum margin protected Track consumption against quotes and contracts to help drive the behavior of the sales organization and proactively engage customers to consume the quantity they promised Map POS data back to debit records, shipments, and credit claims Manage rebates programs: actually define and execute rebate programs and calculate and approve payments (not just analyze rebate impact on price waterfall)manage price protection and impact of price changes on value of inventory Reconcile shipments, calculated inventory, POS, and reported inventory

9 9 7. Industry Case Studies Case Study: ON Semiconductor Eliminates Price Erosion Arizona-based ON Semiconductor is a $2.6B company that was spun-off from Motorola and taken public in the late 1990s. The company has a product line mix of 70% commodity and 30% proprietary. ON was experiencing difficulties in tracking demand, allocating resources to the most lucrative opportunities, and managing its pricing effectively. Often, pricing negotiations started from the lowest possible point. The company invested in processes and tools that allowed its sales and field application engineers to focus on qualified opportunities early in the sales cycle, increasing their design wins. At the same time, ON recognized that opportunities and design registrations are the gateway to transactions. Through its investment in the Model N Revenue Management suite, the company was able to increase quote-to-order conversion by 15% and reduce price erosion, resulting in an annual savings of more than $20 million. By deploying an integrated revenue management solution, ON Semiconductor was able to focus its resources on better qualified opportunities and then transact effectively on those deals. The company s gross margin has more than doubled since it went public, growing from 18% to the more than 40% no small achievement for a company with a product mix that leans towards commodity parts. Case Study: Microchip Positioned for Growth with Improved Quoting Capability Microchip, a $1 billion company based in Chandler, AZ, is a world leader in the microcontroller market and sells a variety of microcontrollers, development tools, analog and interface products, and memory products into the automotive, communications, computing, consumer and industrial control markets. To support its growth ambitions, Microchip needed to expand its sales organization but was unable to handle its current quote volume. Moreover, with 60-70% of design activity in the U.S. but almost 80% of revenue coming from outside the U.S., it needed a better way to track its global business. With Model N, it was able to dramatically improve visibility into demand, and increased its quote volume by 70%, while at the same time reducing quote cycle times by 50%. The company s margin improvement as a result of reduced price erosion funded a 25% increase in their direct sales force. 8. Conclusion As market conditions improve, semiconductor companies are actively investing in price improvement initiatives to drive maximum margin performance. Industry experience over the past five years shows that 25% of the semiconductor market has successfully implemented price execution-focused projects, with Model N s Revenue Management suite delivering a publically documented impact on gross margins. Only five percent of the semiconductor market has chosen to emphasize price setting efforts with no public record to-date of measurable success. Companies contemplating pricing investments should consider thinking outside the standard pricing model and make sure their price execution capabilities are the focus of any price improvement effort to ensure maximum value from their pricing projects.

10 10 About the author: Chanan Greenberg is Senior Director of Marketing and Business Development for Model N. About Model N Model N is the world's largest provider of Revenue Management solutions, offering Global Price Management, Quoting, Deal Analysis, Design Tracking, Contract Management, Channel Incentive, Rebates, and Performance Analytics solutions. In FY 2009, considered one of the roughest years in recent history, Model N recorded 42% growth, acquiring many new customers and strengthening its partnerships with existing customers. Model N s High Tech Revenue Management solutions are used by more than 40,000 people in 50 countries. Customers include STMicroelectronics, Numonyx, Zilog, PMC-Sierra, Linear Technology, IDT, Microchip, Micron, ON Semiconductor, FCI, Intersil, Cirrus Logic, Avago Technologies, Cypress Semiconductor, and many others.