The Cutting Edge: COMPUTING / TECHNOLOGY / INNOVATION : The Chips Are Flying : Semiconductor Industry Is on a Surprising Roll
At Milpitas-based LSI Logic, employees on the way to the cafeteria crowd around a stock-quote terminal to check the latest rise in the company’s shares. After a sixteen-fold increase in value since 1992, many are cashing in stock options to buy new cars or move into larger homes.
Lam Research, a Fremont producer of chip-making equipment, is boosting employment by 50%, adding 1,400 jobs this year in a frantic effort to keep up with demand from the billion-dollar chip factories sprouting up all over the world.
At Simple Technology in Santa Ana, President Mike Moshayedi expects sales of his memory boards to climb to $230 million this year, up sixfold from 1993, as computer aficionados clamor for added memory to run sophisticated new software packages like Microsoft’s upcoming Windows 95.
It’s boom time for the semiconductor industry. And if history is any guide, a bust can’t be far behind. These chips are made from sand, and, for decades, good times in the chip business have always been as ephemeral as sandcastles, swept away every few years by a tide of new production capacity.
But things are different this time around. As the industry moves into the fifth year of an unprecedented expansion and with no signs of a downturn, industry observers are beginning to think the sharp, stomach-churning ups and downs of the industry may be a thing of the past.
The industry’s growing size, its increasingly diverse sources of demand and improved statistics to monitor supply and demand have tempered the wild swings that used to devastate the chip business every few years, says Andrew Procossini, president of the Semiconductor Industry Assn.
“I’ve been in the industry since 1958, and I used to tell people I’ve been through eight business cycles,” Procossini says. “I don’t say that anymore.”
Even skeptics grudgingly admit that their old economic models aren’t working as they are supposed to.
“This should have been a recessionary year. There should have been excess capacity,” says Jerry Hutcheson, chief executive of VLSI Research in San Jose and a longtime industry observer. “Instead, [the industry] is growing like a ball of fire.” Market researcher Dataquest, also based in San Jose, has also thrown out its prediction of a downturn in 1995.
Larry Jordon, vice president of marketing at Integrated Device Technology, a Santa Clara-based chip company, keeps expecting to see problems too, but so far he can’t find any cause for worry.
“We keep looking to the horizon for storm clouds, but we don’t see any warning signs for this year or 1996,” he says. Although chip sales grew a seemingly unbeatable 40% last year, says Jordon, “everyone is saying ’95 will be the year to remember.”
If recent forecasts are correct, this will certainly be a decade to remember. Last October, the Semiconductor Industry Assn. predicted world chip sales would double to $200 billion by the year 2000. Now, as if to suggest the laws of nature are no longer operating, forecasters are predicting a tripling or quadrupling of sales over the next five years.
And in an industry accustomed to seeing prices steadily decline, analysts have been surprised to see memory prices actually rise over the last two years as many chips remain in short supply.
What’s going on? You could describe it simply as a case of under-investment.
Traditionally, the industry has poured money into new factories during boom times, resulting in overcapacity, which helped precipitate a bust. This time, the industry invested conservatively in the early 1990s and was caught by surprise when personal computer sales exploded in 1993.
But there are more fundamental structural changes taking place. The industry used to assume that the chip business was reaching a saturation point when chip revenues accounted for 15% of the value of all electronic products. But those assumptions no longer hold: Close to half the cost of a PC is in its chips, whereas a cellular phone is essentially a pack of semiconductors wrapped in plastic.
What’s the new rule of thumb? Nobody is quite sure, but few are willing to predict that chip growth will slow to anything less than 15% to 20% in the foreseeable future.
“Nothing can go up as high as the sky,” says Wilfred Corrigan, chief executive at LSI Logic, an immigrant from Britain who began his career on the ground floor of the chip business and has seen the industry through good times and bad. However, he adds, “for the next five years we can see pretty well, and it looks good.”
Corrigan, whose company’s recent experience is in many ways typical of the industry, is no Pollyanna. He was chief executive of industry pioneer Fairchild Semiconductor when the chip business went into a tailspin in 1974. The company had to lay off half of its 30,000 employees. Corrigan exploited a downturn in 1980 to start LSI Logic with the then-novel notion of getting chips manufactured by firms with excess capacity.
The company weathered several tough downturns in the 1980s, when many believed the entire U.S. chip industry was on the verge of being wiped out by Japanese competition. But now LSI, like most of its compatriots, is growing as if there’s no tomorrow: LSI recently bought out partner Kawasaki Steel’s share of a joint venture plant in Japan and plans a $1-billion factory in Oregon.
There are some technical reasons why industry executives have less to fear from a sharp downturn. Computer makers such as Apple and IBM have instituted just-in-time delivery systems designed to keep inventories low.
Chip makers, meanwhile, are using sophisticated computer models that can better predict demand. “We know what so many systems sold at [a given computer retailer] this week means for demand six months down the road,” says Integrated Device Technology’s Larry Jordon.
More important, fluctuating demand has become easier to manage as the chip industry has grown from a small operation focused on a few products to a large industry spread across dozens of product lines.
The overall size of the industry means that temporary inventory gluts or shortages don’t cause the huge spikes and dips they did in the past. In 1984, a sharp upturn in orders was followed by a downward spike that idled an astounding 66% of capacity in 1985. Today, weakness in U.S. sales might be partly offset by increased overseas sales. Similarly, the current memory chip shortage is being alleviated by new supplies from Southeast Asia, Taiwan and Korea.
LSI, which makes semi-custom chips, has been the beneficiary of another important new trend in electronics that has helped to dampen industry cycles: a broader range of consumer and industrial products hungry for semiconductors.
LSI was chosen by Sony to build the core chip for its new Play Station video game machine, which has been a hit in Japan and will soon go on sale in America. The company is also a key supplier of chips for the RCA satellite receiver that consumers buy to receive Hughes’ popular DirecTV service. Looking to the future, Corrigan sees U.S. chip companies as key suppliers for the digital videodisc systems that could eventually replace VCRs.
“Next year you may have just 1 million of those, but a few years down the road there will be 60 million sold,” Corrigan says.
Campbell, Calif.-based Zilog Inc., whose microprocessors were a PC standard before Intel was a power, is finding new life selling its chips, not just for computer applications, but as the brains for refrigerators, modems, TV remote controls, even rice cookers.
The wide range of products using semiconductors means that even if sales of one product falter, total sales won’t plunge as they might have in the past.
The rise and fall of Atari game machine sales contributed to the hot chip market in 1979 and its fall in 1981. Hot personal computer sales boosted chip sales by 46% in 1984, but a PC downturn contributed to a 17% drop in sales the following year.
Chip sales will remain highly dependent on the PC industry. But the computer industry itself, having grown larger and more integrated with the broader economy, is less subject to dramatic downturns than it once was.
Meanwhile, sales of telecommunications equipment and wireless devices and portable electronic gadgets like “personal digital assistants,” all big users of chips, are expected to grow irrespective of how the overall economy does.
Another important factor helping to stabilize the chip industry is the shifting circumstances of Japanese chip makers. A soaring stock market and easy-money policies in the early 1980s enabled Japanese chip companies to borrow money virtually free. They used that leverage to splurge on new facilities, contributing to a glut in capacity that contributed to the 1985 recession.
Now, with capital costs higher and the yen strong, Japanese companies are more cautious. Meanwhile, trade pressures have steadily pried open the Japanese market.
A case can still be made that there will be a cyclical downturn in chip sales. As dozens of massive new factories go into operation over the next two years, the world economy could suddenly fall back into a slump. Or, perhaps worse, Microsoft’s new Windows 95 operating system could prove a flop, discouraging sales of new computers.
Overcapacity could push down prices. But most analysts believe any downturn would be short-lived.
“If the selling price drops, it will drive more demand,” says Brian Modis, an analyst at ICECAP Report, an industry research company.
“Even if PC sales stopped tomorrow, people would continue to add new memory to their computers so they can run new software,” says Simple Technology’s Moshayedi.
More likely, the launch of Microsoft’s Windows 95 will further boost demand as consumers require more memory and faster computers to run the software.
Looking past the end of the century may reveal some worrisome signs. Eventually the industry will hit technical barriers that make it impossible to get the dramatic productivity gains now being made with each new generation of computer chips. That’s what happened with the automobile in 1924.
But it is hard to be pessimistic about future demand for semiconductors even over the long term.
Says Hutcheson, “As new things come into the electronic world, they generate an unending demand for [semiconductors] as far as we can look into the future.”
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Upward Trend
Strong sales of personal computers, cellular telephones and a range of other electronics products are producing extraordinary demand for semiconductors. In the past such booms have been followed by devastating busts, but industry executives say things are different this time around.
WORLDWIDE SEMICONDUCTOR INDUSTRY REVENUES
In billions of dollars:
1998: $233 (projections)
CHIP FACTORY UTILIZATION RATES
Percentage of all capacity actually in use:
1994: 95%
Products that rely heavily on semiconductors: Personal computers, workstations Printers and other peripherals Cellular phones, pagers Cordless phones Answering machines Automobiles networking devices Video game machines
Growth areas for semiconductors: Advanced video game machines High-definition televisions Set-top boxes for cable, satellite or interactive TV Video telephones Two-way pagers High speed communications switches for video Home automation (chips to control appliances) Personal digital assistants, pocket computers
Source: Semiconductor Industry Assn.
