Business Getting Harder For Chip Makers

The semiconductor industry is facing a perfect storm of consolidation,
commoditization and accelerated development, all of which combines to make
the market extremely unforgiving of mistakes and puts these firms under even
greater pressure.

That’s the gist of a report released by market researcher iSuppli Thursday, which found
that the consolidation of the market has resulted in thinner profits, not
more profit and little chance of grabbing market share.

Semiconductor profits have declined since mid-2004, with profits dropping
every quarter, from 19 percent in 2004 to the single digits in the most
recent quarters. Inventory write-offs and the DRAM price wars have only made
the situation worse, although there are signs of memory prices going

“Our analysis shows that the semiconductor industry is so competitive you
can’t be mediocre at anything and be successful,” said Derek Lidow,
president and chief executive officer of iSuppli. Lidow is a very rare
exception in the world of market research firms in that he’s a CEO who is
actively involved in research along with his analysts.

He points to the race in manufacturing as an example. One of the biggest
pain points for AMD (NYSE: AMD) has been the firm’s inability to keep its
manufacturing up to par with Intel (NASDAQ: INTC), which invests very
heavily in its fabrication plants.

That’s why chip design companies like nVidia don’t even own a fab,
instead farming out manufacturing to an independent manufacturing firm
Taiwan Semiconductor Manufacturing Company (TSMC), which is considered the
leader in chip making.

“If TSMC is going to be more effective at producing your chips, have
higher yields and have shorter cycle times, you almost have no choice but to
go with the most efficient provider of that service,” said Lidow. That means
TSMC’s competitors have to invest in fabrication plants as fast as TSMC or
even faster, just to keep up.

Chip makers release products at as fast or faster pace than ever, and
chips are increasingly complex. Intel was making chips with millions of
transistors in the 80s. Today, it is making chips with billions of
transistors. That means more R&D in the same time period.

Lost profits across the board

At the same time, PCs have fallen into commodity status, selling for a
fraction of their former prices. Back in the 1980s, a 386-based computer
with 640k of memory would run $3,000. Today, a Core 2 Quad with 2GB of
memory is $400. That translates into lost profits across the board, from
Intel to the OEMs.

“The semiconductor industry was in a unique position, but over this last
business cycle, semiconductors are no longer the most profitable portion of
the electronics value chain. It’s no more profitable than the computer
industry,” said Lidow.

There are strategies for success. One proven strategy for success for
semiconductor suppliers is to design more of the total system with
system-level chips built around proprietary intellectual property. Another
strategy: outspend your opponents, so you can be more than one generation
ahead and always keep your competition in catch-up mode.

Whatever strategy a semiconductor firm uses, they will have to stick to
it, because Lidow sees no alleviation of this strain on the industry.
“That’s a really important message. You can’t be mediocre at anything you do
or your entire profit margin will slip away because of that,” he said.

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