EL SEGUNDO, CA – Facing dwindling profits, fewer opportunities to expand by taking market share from competitors and a shrinking roster of star performers, the semiconductor industry has entered a period of lowered expectations and diminishing options, forcing chip suppliers to rethink basic strategies for success, says iSuppli Corp.
 
“Semiconductor profitability has eroded steadily since mid 2004, with quarterly net profits in the single-digit range in 2008, down from 17% to 19% in 2004,” said Derek Lidow, president and CEO of iSuppli. “The industry now is less profitable as a percentage of revenue than the notoriously low-margin PC business, something that hasn't occurred before, except during a short period of the severe market downturn in 2001.
 
“To a degree, conditions in the semiconductor industry have been impacted by short-term events, such as the market volatility in 2006, due to inventory write-offs and price wars in major product segments like DRAMs and microprocessors,” Lidow observed. “However, the long-term trend indicates the semiconductor industry – which historically has been good at capturing profits in the electronics value chain – seems to have lost its money-making touch.”
 
As profit has diminished, the industry has segmented itself into new groups, says Lidow. During the period from 2001 to 2004, semiconductor companies seemed to fall into three categories: a small group of firms whose growth outperformed the market; a middle-performing group consisting of most suppliers, and a set of low performers at the bottom, says iSuppli. The top caste of suppliers typically employed predatory business strategies that enabled them to take market share from weaker competitors. The lowest performers often served as the market-share prey for the predators and the middle-range of suppliers.
 
However, during the just-completed semiconductor business cycle from 2004 to 2007, the prey in the lowest caste of suppliers went extinct – and so did the success of predatory strategies, creating a larger group of middle-performing players, according to the research firm.
 
“The number of low performing companies decreased by so much that there now are only two major distributions in the industry: a few outstanding performers and the rest,” Lidow said. “The number of competitors achieving growth of more than 100% during the period of 2004 to 2007 declined to nine, down from 19 during the period of 2001 to 2004. This shows semiconductor companies can no longer break out of the pack by taking market share away from weaker rivals.”
 
So how can semiconductor companies break out of the current market dynamics to outperform the industry?
 
One proven strategy for success for semiconductor suppliers is to capture value from their customers by designing more of the total system with system-level chips built around proprietary IP, says iSuppli. Examples include Qualcomm, MediaTek and Linear Technology.
 
Another strategy is to milk established cash-cow products in the industry. Such cash-cow products typically are trailing-edge devices that have passed through their commodity stage, have fairly steady pricing and have a dwindling number of suppliers willing to devote their best people to designing and managing products that most semiconductor cowboys would find boring, says the firm. Sellers of such devices include Microchip, Diodes Inc., Microsemi and Rohm.
 
Finally, well-heeled semiconductor suppliers can use their resources to massively outspend their rivals in the areas of products and manufacturing, thus maintaining technical and scale dominances in competitive market segments. Companies employing such strategies include Samsung Electronics, Intel and Taiwan Semiconductor Manufacturing, according to iSuppli.
 
“In this day and age, semiconductor suppliers have the opportunity to outsource any or all of their operations to third-party sources that offer world-class work,” Lidow observed. “Those semiconductor companies that are unable to achieve top-quality and performance in all processes, either through outsourcing or by using internal resources, will be punished in the marketplace.”
 
Beyond the strategies described above, daring semiconductor managers have another option: building a scalable acquisition process that would allow a semiconductor company to grow by buying other companies or selected parts of companies.