The only constant is change.
Herakleitos (c. 535 BC – 475 BC)

Forecasts call for 2009 to be a transitional year, with 2010 holding the best likelihood for a rebound and 2012 the year to regain 2008 positions.  We see 2009’s transitional events as highly significant and, in all likelihood, industry transforming.  In 2009 look for consolidation, restructuring and the emergence of a new supply chain with new relationships and new strategies that will change the dynamics of the semiconductor industry. 

The state of the semiconductor supply chain
Today’s economic problems are not just another version of previous cycles. While many aspects of the present crisis appear to correlate and track similarly to 2000-02, the data actually reveal a very different cause-effect scenario (cf. MarketWatch Quarterly Vol. 2:4, Vol. 2:3, and Vol. 1:2) . Presently a number of converging variables are affecting the semiconductor supply chain, notably:

• industry maturation (closer coupling to global GDP trends and macro economic forces);
• differences in the semiconductor industry’s relationship to other industries;
• long-term structural effects of the outsourcing strategies adopted over the past decade;
• increased exposure to economic forces along the entire supply chain;
• pushing technological envelopes to test Moore’s Law without serious market and product viability;
• increased commoditization of components; and
• a significant increase in dependence on the consumer market (business and individuals).

It is not just the economic downturn that has changed the shape of our industry.  Rather, the pre-existing convergence of forces, as listed above, propelled by the economic downturn contributed to the present reshaping.  Importantly, the downturn has also highlighted the role that a newer, critical market variable plays: the consumer.  Just as the semiconductor industry has been successful in the proliferation of electronic components and end-products throughout industries and to consumers (business and individuals), it has similarly become more reliant on consumer confidence.  It is this newer, direct correlation to the critical macro economic variable of consumer behavior that is at the core of present changes in the semiconductor supply chain.  Why this change is occurring is the critical question to answer in order to correctly strategize for the recovery and to position for long-term growth.

What has changed and why?  Understanding noteworthy trends
As has been explored in a number of MarketWatch Quarterly issues (cf. Vol. 2:4, Vol. 2:3, and Vol. 1:2), the semiconductor supply chain has been undergoing significant change.  At least three broad types of changes are discernable, each affecting the structure of the entire supply chain and the dynamics of the semiconductor industry:

• Relationships:  the frequency, types, and volume of consolidations, mergers and acquisitions (M&A), and insolvencies;
• Exposure to risk:  as a result of the newer relationships in this outsourced phase of the industry, risk is spread across the supply chain;
• ‘Coopetition’ and new market strategies:  leaders all along the supply chain have dramatically altered strategies as they look outward at the heightened role of demand in the semiconductor industry.

Relationships
One important trend highlighting supply chain changes is the types and numbers of consolidations over time.  Manufacturing Market Insider’s (MMI) analysis reveals that while there was an increase in M&A activity for 2008, as expected, it was also not as steep as in the past.  In fact, there was only a 14% increase over 2007, and primarily focused around the contract manufacturing segment (CM) (MMI includes EMS and ODMs in their CM category).  CMs acquiring operations from other CMs has increased significantly since the low of 2003 and continues to represent 25% of all M&A deals in 2008.  In contrast, OEMs exhibited the lowest levels of M&A activity in more than 10 years, indicating the outsourcing model has fully penetrated the supply chain (source: MMI vol. 19:2, pp.1-6).

Figure 1.  Comparison of two types of M&A deals over time (source: MMI vol. 19:2, p.5)

Exposure to risk
With outsourcing having perhaps reached a peak, the supply chain is no longer being dominated by the relationships between OEMs and CMs that arose as a result of those types of M&A activities.  Rather, a different type of OEM and CM relationship must now exist.  The data point to more clearly defined outsourcing roles and more diffused exposure to inventory, among other risks and rewards as a result of these changes.  Figure 2 presents a three-year historical perspective on inventory across the semiconductor supply chain and divided into industry sub-segments.  Note the ability of all sub-segments to reduce inventory exposure in 4Q08 from 3Q08, a critical factor in the present ‘better-than-feared’ position held by many in the industry. 

Figure 2.  Inventory by sub-segment across the semiconductor supply chain (source: Citi Investment Research, Supply Chain Inventory Update 13 February 2009, p.5)

With the shift by OEMs and ODMs to push inventory management to the “hubs,” proactive inventory management programs were implemented across the supply chain and at an earlier rate during the present crisis than in past negative cycles.  This proactive inventory management greatly contributed to averting more serious problems (for another perspective on why inventory levels are a critical variable to understanding what is happening to the semiconductor industry presently and why, see “Navigating the New Reality for Semi: Demand-sparse economies and positive market trends” in this issue of MarketWatch Quarterly, Vol. 3:1).  Despite these inventory controls there are still some serious problems, as shown in Figure 3, below.  While weak consumer demand is expected to persist in the near term and lower the C1Q09E Q/Q sales, “these orders do suggest that an interim order bottom has been achieved.  We expect that alongside falling chip production, end-market inventories are simultaneously coming under control.” (Citi Investment Research, Supply Chain Inventory Update 13 February 2009, p.8) 

Figure 3.  Q/Q% change in inventory 4Q08 versus Q/Q% change in forward revenue 1Q09E  (source: Citi Investment Research, Supply Chain Inventory Update 13 February 2009, p.10)

Again we see that the inventory problems are spread across the entire semiconductor supply chain, underscoring the far-reaching nature of the present economic situations and pressures.  Represented in a different manner, we see the relatively equal weighting of inventory held across most of the supply chain in Figure 4, below.

 
Figure 4.  Supply chain inventory: % held at each sub-segment within the supply chain: 4Q08 (source: Citi Investment Research, Supply Chain Inventory Update 13 February 2009, p.11)

It should be clear that the widespread exposure risk has entailed a widespread interest and concern for inventory management.  This, in and of itself, represents a different dynamic and pressure present in the semiconductor industry than during previous cycles.

'Coopetition' and new market strategies
Taking the M&A data and the exposure to risk data together, the idea of a new set of market strategies should come as little surprise.  After all, with formal relationships differently defined than a decade ago, different strategies for market and product positioning are not only a must, but an organic result of the relationship changes themselves.  There is an obvious increase in ‘coopetition’ as a market strategy that is also driving significant and permanent changes to the supply chain.

To highlight the more robust examples of this uptick in ‘coopetition’ in the semiconductor industry, let us consider two illustrative examples more closely.  These examples are noteworthy because:

• they involve leaders in the respective segments of the supply chain;
• they represent significant changes to the leaders’ strategies;
• the ramifications of the ‘coopetition’ strategies will affect a wide swath of companies across the semiconductor supply chain trickling down to end-product; and
• each strategy has at its core, the recognition of the new importance of demand variables, i.e., the consumer variable.

Intel and TSMC: Recognizing core strengths, product value, and consumer demand
An important new strategic relationship has been forged across two major competitors.  On 2 March 2009, Intel and TSMC officially announced a memorandum of understanding (MOU):

This MOU is an important step in a long-term strategic technology cooperation between Intel and TSMC. With this joint effort, Intel intends to significantly broaden the market opportunities for its Intel Atom [System-on-Chip] SoCs and accelerate deployment of the architecture through multiple SoC implementations. At the same time, TSMC extends its technology platform to serve the Intel Architecture market segments. (www.intel.com/pressroom/archive/releases/20090302corp_a.htm)

This new, strategic relationship underscores both companies’ awareness of the increased importance of demand.  The MOU tangibly signifies Intel’s awareness of the important and growing demand for smartphones and netbooks.  These demand-rich products are the home to smaller footprint, lower power consumption, and multifunctional chips.  As Gartner’s analysis of the Intel-TSMC relationship underscores, this is a win-win for both companies AND their value chain partners while promoting each company’s ability to expand market competitiveness:

TSMC-build SoC parts will enable Intel to create competitive single-chip designs that capitalize on TSMC’s low overhead, giving Atom access to a lower-price segment than it could otherwise address. […]

[…] These products will be competing with the enhanced ARM products from Qualcomm, Marvell, possibly Apple and others.  Intel has effectively eliminate its cost constraints to competing in this market, so success will depend on compelling performance and features based on the x86 market. (www.gartner.com/resources/166100/166179/intels_initiative_with_tsmc__166179.pdf)

Alongside the MOU, Intel has also shown market leadership by investing US$7 billion in their US based manufacturing plants for 32nm technology.  This investment is strengthened by the savings from the relationship with TSMC at the 45nm level while simultaneously advancing Intel’s near-future competitive position by pursuing their more innovative 32nm technology in-house.  Of importance is that the 32nm chip market does include netbooks and smartphones as end-products.

Impressive market moves: An example of superior supply chain strategy
Two other companies who are proving to have insight during these challenging times are Qualcomm and Nokia.  We will consider Qualcomm’s strategy first.

Qualcomm’s platform, called Snapdragon, is a competitor to Intel’s Atom.  However, Qualcomm is a leader in the mobile phone sector while Intel is a leader in netbooks, thus far.  Both are looking to expand their market presence into the other’s leading domain and both with a similar strategy.  It is the similarity in strategy that is most noteworthy:

In both cases [Qualcomm and Intel], the companies are looking out long-term. […]  By saving their customers the effort of designing and integrating multiple functions, these companies can offer greater value and a solution that is easier for the customer to mold into a finished product. (http://seekingalpha.com/article/125168-qualcomm-vs-intel-is-the-battle-joined?source=email)

Is Qualcomm’s strategy working?  Their stock price is stable and climbing quietly, they increased their dividend share, and, importantly, they “used a 15% year-over-year (y/y) growth rate to jump five spots and rank as the 8th largest semiconductor supplier in 2008.” (http://www.electronics.ca/presscenter/articles/1056/1) Qualcomm also has a clear strategy based on supply chain alignments for the smartphone sector; it involves their former rival, Nokia. 

Nokia, with 40% of the handset market, is a long and clear mobile sector leader.  Their leadership position is a result of their end-to-end supply chain strategy for both the ultra-low-cost and the high-end markets.  Nokia recognized early that the mobile market sector represents one important future for computing and meeting consumer demands globally but with respectively targeted strategies (cf. Credit Suisse Equity Research: Global Semiconductors, Mobile World Congress – Feedback 23 February 2009).  Nokia’s adding of Qualcomm to their supplier list at the 2009 Mobile World Congress is a significant indication of this winning strategy. 

The Nokia and Qualcomm coopetition will concentrate primarily on the 3G, high-end, smartphone market for North America.  This important relationship in the mobile sector is best summed up by John Walko, EETimes Europe:

In the end it came down to pragmatism and that catchphrase heard so often here [in Barcelona at Mobile World Congress 2009] this week, “the realities of the new wireless marketplace.”

[…] Nokia CEO Olli-Pekka Kallasvuo stressed […] [w]e all need to work with long term partners as well as competitors, and work in different ways than we have gone about our business in the past […] (http://eetimes.eu/design/214501571)

Why change IS a constant for the semiconductor industry
The data and the trends are clear.  There is considerable change that is underway as a result of the present global economic crisis.  While the changes within the semiconductor industry have been propelled by macro economic factors, our supply chain changes are not entirely a result of external forces.  Any one of the variables listed at the beginning of this article could have been enough to eventually change the dynamics of our industry. 

The semiconductor industry is a story of cyclicity.  Perhaps more than any other reason, the inherent cycle of research, innovation, product creation, and commoditization is at the root of this pattern.  Regardless of the source, the cyclicity of our industry is also likely the reason that significant optimism dominates our industry.  As cited by Dylan McGrath for EETimes, despite the resounding call by executives at Semico Summit 2009 in Scottsdale, Arizona, that “This is the worst we’ve seen,” they were also saying, “Semiconductors remain critical to solving the world’s problems and will grow again.” (www.eetimes.com/showArticle.jhtml?articleID=215900279)

Change, and therewith its statistical moniker, cyclicity, is a constant.  As each problem and solution set for semiconductors comes and goes, the necessity and the structure of relationships within the industry changes, and therewith the dynamics of the entire supply chain and the entire semiconductor industry change as well (cf. “New Value Chain Strategies Defining the Electronics Industry” in MarketWatch Quarterly, Vol. 1:2).  The changes we are experiencing are a testament to the vitality of the semiconductor industry and its dexterity in meeting even the present extreme challenges.

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