High-Tech Woes : Chips Down in Trading With Japan
The semiconductor followed a normal economic path to Fry’s Electronics. But the recently opened retail store, which also sells toothpaste, computers and soda pop, caused a stir even here in Silicon Valley when it began advertising 66-cent 64K RAMs and other arcane high-tech bargains under the slogan, “You’re in the chips at Fry’s.”
“They’re right next to the shampoo,” says Ben Anixter, marketing vice president at Advanced Micro Devices, which designs and makes semiconductors right around the corner from Fry’s. “I think it’s hilarious.”
That’s about the only humor Anixter and his colleagues find in semiconductor prices these days. They complain that the chip is getting too cheap. It’s a problem that has cut deeply into industry profits and jobs--and has placed silicon wafers etched with thousands of tiny electrical circuits on center stage in this country’s long-running trade dispute with Japan.
Government Help Sought
Charging that it is denied fair access to Japan’s $8-billion semiconductor market, the U.S. semiconductor industry, a showcase of American technology, suddenly is asking for government help. Specifically, it is asking the President to retaliate unless the U.S. firms quickly capture the same share of the Japanese market that Japan enjoys here, about 18%. They now have about 11%.
In asking for government intervention, the U.S. industry is taking a new direction--one previously taken by such maligned industries as steel, shoes and automobiles. It is an action that underscores gaps in this country’s vaunted technological leadership, and a strategy that has the smell of weakness.
“That’s a danger point,” concedes Robert N. Noyce, co-inventor of the integrated circuit and a founder of Santa Clara-based Intel Corp., one of the world’s microelectronic pioneers. “That’s one of the reasons we haven’t done anything before. If Wall Street decides not to invest in this industry, it becomes a self-fulfilling prophecy.”
Half the World Market
The United States last year retained 51% of the world’s $28.7-billion semiconductor market, versus Japan’s 39%. Just four years earlier, the U.S. margin had been 60% to 27%, according to Dataquest, a San Jose research firm.
In memory devices--those semiconductors that store information rather than process it and account for about one-fourth of all semiconductor sales--Japan now claims 51% of the market to this country’s 44%. In state-of-the-art memory chips, Japan’s dominance is almost complete. But in the “computer on a chip” known as the microprocessor, a highly sophisticated $3.2-billion market, the U.S. produces 61% compared with Japan’s 35%.
The notion of a deteriorating U.S. semiconductor industry is a false one, analysts generally agree. The U.S. industry remains the technological leader. Despite a severe slump in revenues and a projected 80% industrywide decline in profits this year, the individual companies are regarded by analysts to be sound enough to survive what appears to be the industry’s worst-ever recession. But it blames its troubles partly on unduly optimistic computer makers that ordered too heavily for 1984 production and then started canceling shipments last fall. That sudden falloff created a sudden overcapacity that was exacerbated by price cutting.
Japan’s inroads in the market for standardized, so-called commodity chips, repeating patterns in other, less advanced industries, have called renewed attention to Japanese and U.S. trade and industrial policies, and this country’s problems in manufacturing quality products. In the long term, some experts fear that the industry’s competitiveness is being undermined.
“It’s not a do-or-die situation,” said economist William Finan, a consultant to the domestic industry who served as an adviser on electronics trade with Japan to former Commerce Undersecretary Lionel Olmer. “The Defense Department will always make sure it gets the components it needs. But the stakes are pretty great.”
It’s Not Unusual
Peddling integrated circuits on the same shelves with VCRs and Coca-Cola might be off-beat marketing, but there’s nothing unusual about the prices at Fry’s Electronics.
The miraculous semiconductor, building block of the computer revolution, has indeed become a commodity. The simplest of the devices is literally a two-cent item at Fry’s, which sells them to hard-core hobbyists. The remarkably low prices are the logical outgrowth of the advent of the Information Age, its attendant technological and manufacturing advances, and fierce global competition.
Noyce and his colleagues at Fairchild Semiconductor invented the integrated circuit in the 1950s before leaving to found Intel and other firms, and Americans have paced the industry ever since. But Japan became a significant force in the late 1970s. As recounted by Japan scholar Ezra Vogel, the industry was carefully constructed from blueprints drawn by the Japanese government over a 15-year period. By 1979, it was capturing key parts of the market, and now it dominates in memory devices.
Problem Worsening
The U.S. industry has objected to Japanese practices in the past, without resorting to formal action. But as demand for chips fell over the last several months, the domestic industry charged that Japan has flooded the market with semiconductors, deliberately causing a plunge in prices that has made today’s slump far worse than the cyclical downturns the industry has weathered before.
“You can identify products where the prices are 25% of what they were,” Noyce said. “That is largely due to overcapacity of the Japanese.” By the January-March quarter, the U.S. industry was taking a mere $1.4 billion in new orders, as against $2.8 billion a year earlier.
Then, an employee of Intel came into possession of a provocative internal memo to Hitachi America Ltd. distributors and turned it over to the U.S. Commerce Department. The memo, referring to prices on a type of memory device called an EPROM (for erasable, programmable read-only memory), read: “Quote 10% below competition. If they requote, go 10% again. The bidding stops when Hitachi wins. . . . Don’t quit till you win. 25% distributor profit guaranteed.”
Scribblings Disavowed
Handed out at a trade meeting in Tokyo by the Commerce Department’s Olmer, the memo was acknowledged by Hitachi as authentic but disavowed as the unauthorized scribblings of a Hitachi sales manager in San Jose. Analyst George Haloulakos, who follows Japanese semiconductor firms for Cable Howse & Ragen, a Seattle-based brokerage, says Hitachi was following EPROM prices down at the time, not leading the way.
But to American executives, the memo was a smoking gun that unmasked the Japanese way of capturing foreign market share--taking losses in order to slash prices with no regard for market conditions. Hitachi, after all, was penalized recently for “dumping” cellular telephones in this country. Asked whether he believed Hitachi’s explanation for the memo, Intel President Andrew Grove said, “That and Santa Claus.”
(While the Hitachi memo was unrelated to the long-pending U.S. petition against Japan filed in June, it has helped define the issue and stirred some latent, ironic patriotism. In a Wyle Laboratories parking lot in Santa Clara several weeks ago, employees of the semiconductor-distributor firm held a “buy American” lunch-hour celebration featuring hot dogs and apple pie--but not many Chevrolets. The parking lot was jammed with BMWs, Hondas and other imported cars, all with foreign chips under the hood to control engine timing and other functions. Roughly as many Japanese chips enter this country in cars, VCRs and other finished products as do those for sale to manufacturers.)
Profitability Ignored
While Hitachi officials say the memo doesn’t reflect company policy, analyst Haloulakos said that “market share, not profitability, is the objective.” The electronic conglomerates that make most chips in Japan--mainly NEC, Hitachi, Toshiba, Fujitsu and Matsushita--are able to ignore the profitability problem because losses can be absorbed across their entire product lines.
Likewise, the big firms can support continued spending on research and new plants in bad economic times--a long-standing bugaboo for the independent U.S. firms competing with the Japanese but forced by short-term cash problems to cut back during recessions. Then, bolstered with fresh products and heavy inventories, the Japanese stand to grab big chunks of market share when sales pick up.
According to the Semiconductor Industry Assn., which filed the trade action, Japan first out-invested the United States on chips in 1983 and is widening the gap. U.S. executives cite capital-spending ratios suggesting that Japan plans to grow at an annual rate of at least 33% in chip production versus the expected 16% annual growth in worldwide demand. In theory, Japan would thus surpass the United States in chip production in 1986.
Considered a Cartel
Meanwhile, Hitachi itself buys about 30% of the chips it makes, installing them in its VCRs and other electronic products. It buys most of its other chips from Japanese competitors, who return the favor. Such orchestrated cross-supply relationships--the U.S. industry calls it a cartel--would face legal challenges in this country.
“That’s not our problem,” says an executive at a Japanese semiconductor firm who requested anonymity.
Indeed, for the Japanese it is an “old-boy” network that assures the high volume needed to reduce costs and fine-tune the manufacturing process--and often leaves the American producers on the outside looking in. They accuse the Japanese government of fostering a “buy-Japan” bias, except in cases of chip shortages or American product uniqueness. Says Noyce: “If they need us they’ll let us in.”
But in this bare-knuckle business, national bias cuts both ways. The Japanese firms have long had difficulty cracking the big national U.S. distribution firms, and Wyle Labs’ Charles Clough, president of its chip-distribution unit, the biggest on the West Coast, cheerfully admits to a refusal to handle Japanese chips.
Only U.S. Products
“We haven’t handled Japanese (products) and we don’t plan to,” Clough said. “Our distribution system was built around the innovations of the American semiconductor companies, and I don’t see fit to give any major business to a company from Japan.
“I think that’s probably one of the major market obstacles they face.”
Price-cutting isn’t only made in Japan, either. A small Boise, Ida., firm, Micron Technologies, turned part of the memory market upside down with quantum price reductions last year. Said consultant Finan: “These guys are used to crashing and bashing each other competitively. This industry right now tests the manhood of everyone who’s in it. Prices have always fallen dramatically over time in this industry. That’s a very virtuous thing from the point of view of the consumer, but there’s also an element of trying to freeze the other guy out of the market.”
Another issue in dispute is the quality of U.S. chips, first called into question publicly in 1980 in a speech by a Hewlett-Packard executive. At the time, U.S. firms said they were simply meeting U.S. military specifications. When the Japanese started producing chips with a lower rate of failure, the U.S. industry scurried to establish and meet its own higher standard so that its products would be comparable. It claims to have achieved a twelve-fold reduction in defects.
Image of Strength
Perhaps to avoid an image of weakness, the domestic industry’s petition focuses not on protection, but on freedom to compete in Japan, assuming that it would succeed competitively as it has in other world markets. While held to an average of about 10% of the market in Japan each year since 1972, the U.S. firms have 55% of the European market to Japan’s 12%.
“This is one U.S. industry whose experience in Japan cannot be dismissed simply as a reflection of its lack of international competitiveness,” the domestic trade group argues.
Consultant Finan blames Japan’s early semiconductor protectionism--restricting direct foreign investment until 1975 and leaving structural barriers in place since then--for the U.S. industry’s current difficulties in Japanese markets. Otherwise, he calculates in a study for the President’s special trade representative, the U.S. share of the Japanese market would be double its current level. Combined with the effects of Japan’s targeting policies in this country, he says, Japanese government policies have cost the U.S. industry $300 million to $750 million in lost sales and 16,000 to 40,000 semiconductor jobs since 1977.
Bigger Firms Eyed
The success of Japan’s semiconductor conglomerates has led to speculation that the pioneering, independent U.S. chip makers such as Intel, Advanced Micro Devices and National Semiconductor will be absorbed by bigger firms. Some analysts doubt that the independents will be able to compete without the alliances and diversified product lines enjoyed by the Japanese.
The U.S. survivors would thus be companies like Texas Instruments and Motorola, now No. 1 and No. 2 in the world, as well as IBM and AT&T;, which are big semiconductor makers but use the chips primarily for internal purposes. AT&T;, recently deregulated, has begun selling chips to outside firms. IBM hasn’t, but it raised eyebrows with its purchase of 20% of Intel in 1983. Some in the industry fully expect IBM to become a chip merchant sooner or later.
In the longer term, analysts such as Haloulakos hold that the U.S. firms will retain leadership in the kinds of semiconductors that really matter--the sophisticated, expensive, custom-made integrated circuits that perform complex tasks and require cutting-edge technology and close consultation with customers. The Japanese can have the high-volume market to which their corporate structure and manufacturing skills are best suited.
Sophisticated Software
“The microprocessors and custom chips are all based on sophisticated software where Americans still have a big lead,” Haloulakos said. “I do not believe that the American industry is doomed. I believe American technology will be more valuable five years from now than it is today.”
But economist Finan warns of the perils of giving up the cheap, mass-production end of the market, as has occurred in cars and copiers: “You’ve got to load the plant or you don’t have the volume, and you’ve lost your cost-competitiveness. You will not see the Japanese confined to the so-called commodity semiconductor market.” Finan said it is only a matter of time before they penetrate the big distributor networks, and “that will be as fundamental as Nissan getting car dealerships.”
Part of the answer, these observers say, is in such cooperative industry ventures as the Microelectronics & Computer Technology Corp. in Austin, Tex., which has brought 22 U.S. high-technology firms together for joint research. Though common in Japan and Europe, such U.S. ventures in past years would have been blocked by antitrust laws.
