Impact of Chip Agreement Stirs Debate : Computer Makers Virtually Halt Orders as Prices Initially Leap

There have been a few howls of protest from semiconductor buyers in the month since the bilateral trade agreement on chips went into effect. Mostly, though, the chip industry’s customers have been silent.

But silence, in this case, is not golden.

The major computer makers--the biggest customers for chips in the United States--have been loath to criticize the trade pact with Japan, even though it has pushed some prices for memory-storage devices up two and three times what they were before the agreement was reached Aug. 1. But then again, they’re not paying those prices.

Chip-ordering activity has been so quiet, say some industry observers, that they can almost hear the computer makers eating up their inventories.

“The sobering reality is that computer manufacturers are unwilling and unable to pay those prices,” said Drew Peck, an analyst at the Gartner Group in Stamford, Conn. For the most common type of memory chip, the new prices are said to be as high as $8 apiece--compared to less than $2.50 before the agreement.

“It should be clear this is not a tenable situation for U.S. computer makers,” Peck said. “But it doesn’t worry me that much. It’s a ludicrous situation that can’t be sustained.”

Most everybody concerned with the agreement believes that prices will begin coming down in October, when the Commerce Department revises floor prices for Japanese-made chips sold here.

How much and how quickly those prices come down, however, is a guessing game that is occupying the makers of the semiconductors, the companies that buy them and the distributorships that act as middlemen between them.

The waiting is causing some frayed nerves, especially at companies that do their manufacturing in the United States.

Such companies fear that prices of chips will remain too high for them to compete with companies that build overseas. They warn that if it becomes cheaper for them to go overseas to make or buy chips in semi-finished products than to buy the raw chips here, they will do so.

“If need be, we will have to find ways to do all or more manufacturing offshore to take advantage of lower prices,” said John C. Roach, chairman of Tandy Corp. “We’re not trying to be unpatriotic, we’re just trying to make sure that the American industry is not put at a disadvantage compared to worldwide prices.”

The concerns are gravest among makers of personal computers and other products that use a lot of the memory chips--a kind of electronic circuitry that serve as data-storage devices in electronic goods--covered by the trade agreement.

Analyst Rick Martin of Sanford C. Bernstein & Co. in New York said he has no doubt that some of these companies already are planning such moves.

Also, some chip customers worry that not everybody will be playing by the same rules.

They say that already some buyers and sellers are circumventing the price restrictions in the trade agreement. They doubt that Japan will be vigilant in keeping its end of the bargain, or that the U.S. government will be able to enforce the provisions applying to other markets.

David Kay, president of computer maker Kaypro, called the agreement “a miscarriage.” Kay said sellers are trying “every trick in the book” to drum up business before October.

Of the higher prices, he said: “I don’t have to pay (them). I can circumvent them with no problem and so can everyone else.” Among the options Kay cited was moving manufacturing overseas.

Will Enforce Pact

Government officials say the agreement is and will continue to be enforced. “Any pre-dating of shipments is in clear violation of the agreement, and if we found such was the case, we would take swift action,” said Desiree Tucker, spokeswoman for the Commerce Department.

“At this point we have not heard that this is taking place. But we will be doing a very thorough verification of the agreement in Japan (this week) and if any such violations have occured, we will find it.”

Tucker said the verification trip is a routine matter and is another indication of the two governments’ commitment to making certain the agreement is working.

The U.S. semiconductor industry--no more eager to see its U.S. customers move away than it has been to cede those customers to the Japanese competitors--expresses confidence that the trade agreement will prove to the ultimate benefit of the semiconductor customers as well as to their own industry. Patience, they counsel.

Part of the waiting involves finding out what is actually in the agreement. Government officials say the document will be made available after it is officially signed--an event scheduled for Tuesday.

The five-year trade agreement was reached after lengthy negotiations between the two countries.

It sets aside an unfair trade practices complaint and two of three cases in which Japanese computer chip makers were accused of “dumping” chips on the U.S. market--that is, selling below fair market value. (In preliminary rulings in the two cases, Japanese makers were found guilty of dumping practices.

In the third case, which was completed before the agreement was reached, Japanese makers were found guilty of dumping and tariffs were imposed on the chips involved.)

Ends Predatory Pricing

In the agreement, Japan agreed to end predatory pricing practices and to promote greater sales of U.S.-made chips in Japan.

The agreement does not specifically cover prices in Japan of the Japanese-made chips, but government officials say it should not be possible for U.S. companies to buy raw chips in Japan at cheaper prices and then import them to the United States.

Similarly, the Japanese agreed not to dump chips in third countries--that is, chip-buying markets such as Taiwan, Hong Kong and Indonesia with booming high-technology manufacturing industries.

So, if the agreement is enforced, no U.S. companies should be able to buy lower-priced raw chips in those countries and import them into the United States, government officials said.

However, many industry experts say that historically, chips have sold in those third-country markets at prices even lower than the dumping prices in the United States.

And they believe that the agreement will not prohibit U.S. companies from taking advantage of overseas bargains--in Japan and the third countries--on chips that are manufactured into other products, such as printed circuit boards used in computers.

The Commerce Department will set floor prices--called fair market value or foreign market value--on chips made by Japanese companies and sold in the United States.

The FMVs, as the floor prices are called, are calculated through a complex formula based on data supplied by the companies regarding cost of production. The initial FMVs were determined based on data collected during the Commerce Department’s investigation of the dumping charges. That data, most everyone admits, is sorely outdated.

Quarterly Revisions

The agreement calls for the new floor prices to go into effect Oct. 16, based on data supplied no later than Aug. 20. Then, beginning in late December, the FMVs will be revised quarterly for the duration of the agreement.

And many customers are biding their time. Until they get a better understanding of the agreement itself and the future prices of chips, they are using up their current stores of chips and making spot buys of distributors’ pre-accord-priced inventories.

“The users had inventory, and the distributors were carrying inventory,” said Charles Clough, president of Wyle Laboratories, an El Segundo-based semiconductor distributor.

“The users are consuming all their in-house inventory, and they’re using distributors’ inventory for spot-buying to carry them over until October. We’re seeing activity, but nobody is placing large backlogs on us.”

The FMVs are confidential and the “numbers do not exist as a list,” said Sheila Sandow, spokeswoman for the Semiconductor Industry Assn., the San Jose-based trade group that filed the unfair trade practices complaint.

However, industry sources have pieced together a rough price list, largely based on prices quoted to customers.

It is generally believed that NEC, a Japanese company that also has a U.S.-based chip-making subsidiary, has the lowest floor prices: between $2.50 and $3 for a chip known as a 256K D-RAM.

That chip, one of the kinds of memory chips covered by the agreement, is the standard memory-storage device for personal computers, and before the agreement had been selling in the $1.80 to $2.50 range.

Other Floor Prices

Other floor prices for 256K D-RAMs are believed to be as follows: $4 to $4.50 for Mitsubishi and Toshiba, $5 to $5.75 for Texas Instruments of Japan, $5.50 to $6 for Oki and $7 to $8 for 256K D-RAMs exported by Fujitsu.

American companies, which had dropped their prices as competition heated up and the Japanese makers captured ever more of the market, also have raised their prices.

Micron Technologies has raised its prices to about $2.80 from about $2.20, some customers said. Micron, the major remaining supplier of D-RAMs made exclusively in the United States and sold to outside customers, is one of the primary beneficiaries of the pact.

Joseph Parkinson, chairman of Micron, confirmed that his company has gained new business in recent months. Micron is the only remaining independent U.S.-based maker of 64K D-RAM chips--the devices covered in the first anti-dumping complaint.

Japanese makers have had to pay tariffs on 64K D-RAMs they sell here, allowing Micron to raise its prices and still be highly competitive. In addition, Parkinson said Micron has received new orders on the 256K chip since the agreement went into effect.

Other U.S. semiconductor makers that are raising prices include Intel and Advanced Micro Devices. Those two Silicon Valley firms are the leading U.S. producers of EPROM (eraseable, programmable read-only memory) chips, the other kind of device covered in the agreement.

Daniel Klesken, semiconductor industry analyst at Montgomery Securities in San Francisco, said that Advanced Micro Devices “is doing the right thing.

Instead of gouging customers, they are pricing reasonably and working on gaining market share.” Industry sources said prices of Intel and AMD chips were still below floor prices for Japanese-made EPROMs.

Breathing Space

Used wisely, the next few months will be a “a chance for American companies to regain the market share, rebuild unit volume. . . . It’s a temporary breathing space for (them) to regain manufacturing capabilities and become more competitive.”

Klesken said that some companies are upset, even “downright angry” by the higher prices. “But what the customers are forgetting about is that for more than a year, they have been receiving these chips with a $1 bill wrapped around them.”

Wyle’s Clough agreed with Klesken’s assessment, noting that it has been paying $3 for 256K D-RAMs from Texas Instruments, and selling them for $2.20 to $2.40. Once the pricing stabilizes, Clough said, he hopes to be selling those chips in the $4 price range.

A $3 to $4 range should occur within another six months, many observers believe.

For makers of large computer systems, higher chip prices are not as critical an issue as they are for companies whose main products are focused in the fiercely price-competitive market for personal computers.

Memory components are a smaller percentage of selling prices of the large mainframes--which also have larger profit margins than desktop models.

Some companies, such as Honeywell and AT&T;, make many of the chips used in their computers themselves and thus are less affected by the higher prices than companies such as Hewlett-Packard, that buy all their chips.

May Make More Chips

International Business Machines, the largest computer maker in the world, makes an estimated 70% to 75% of the chips its computers use.

Still, according to industry experts, it is the largest single buyer of computer chips and may deal with the problem by increasing its in-house production of chips. An IBM spokeswoman said the company was “pleased with the agreement,” but declined further comment.

Burroughs, which will become the second-largest seller of computers once its acquisition of Sperry becomes effective next month, declined all comment on the agreement.

Of the products sold in the United States by Palo Alto-based Hewlett-Packard, most are made at its U.S. factories. An HP spokesman said: “It’s clear we will be forced to pay higher prices,” but added that the company has not made any decision about price increases for its IBM-compatible mainframes and desktop computers.

“Right now,” said HP’s Gene Endicott, “we don’t have any plans” to move manufacturing of products for the U.S. market to overseas plants. “We will closely monitor the situation and if this does result in a long-term competitive disadvantage for us, we will reconsider.”

Tandy, which makes the popular personal computers it sells through its Radio Shack retail outlets, is in a particularly vulnerable position. Many of its competitors in the personal computer market use overseas manufacturers.

Roach said: “My concern is that if prices of semiconductors in the United States do increase, and prices overseas remain substantially lower, it will place manufacturers in the United States at a distinct disadvantage to those overseas.”

May Go Offshore

“We will take whatever action we can to keep our 27,000 U.S. employees employed at the (greatest possible) level. If that means 1,000 or 2,000 manufacturing employees have to be relieved of their jobs to save . . . 4,000 retailing employees’ jobs, then we will go (offshore).”

Otherwise, he said, “these no-name Korean manufacturers will push us out of the marketplace. We simply cannot allow that.”

South Korean-made products such as Leading Edge have been leading the assault on pricing of personal computers. Also, analysts say that Korean chip makers, who are not covered by the trade agreement, will continue to increase their currently small share of U.S. chip sales.

Other personal computers sold by American-based companies are manufactured for them in South Korea, Taiwan and Indonesia. AT&T;’s personal computer products are made by Olivetti, an Italian company. Those products will be largely unaffected by the chip price hikes.

At Kaypro, a struggling Solana Beach, Calif., maker of IBM-compatible machines, memory chips such as those covered in the agreement now account for about 7% to 9% of the computers’ final selling price, said Kay. That figure will jump to 10% to 15% if the high prices remain, “and I can’t raise prices in this market” to cover the costs, he said.

“I don’t think the D-RAMs themselves could force us offshore,” Kay said. “But if things play out this way in other chip (prices), then yes, our costs will go far beyond our competitors’.” In that case, he said, Kaypro would be forced to move all its manufacturing overseas, a decision that would cost the jobs of its 250 manufacturing employees.

Temporary Situation

But some industry observers caution that the higher prices are a temporary situation. “I think it would be foolish if a company changed its whole business because of memory--and a memory pricing that’s going to come down in five to eight months,” said Wyle Labs’ Clough.

Still, the debate continues over the long-range impact of the agreement, on the semiconductor industry as well as the computer makers. Analyst Peck takes a bearish view of that as well, contending that the market forces eventually will reassert themselves.

“This pact will be nominally in effect until 1991,” he said, “but it will have no lasting impact on the industry.”