EL SEGUNDO, CA – Excess semiconductor stockpiles in the global electronics supply chain are likely to nearly triple this quarter, says iSuppli Corp.

The research firm projects excess semiconductor inventories could balloon up to $10.2 billion in value, up 268% sequentially. This rise is having a deleterious impact on chip pricing, revenue and profitability, and could delay the semiconductor industry's recovery from the current downturn – even when demand rebounds, the firm says.

iSuppli has issued a red alert on semiconductor inventory levels for the first time. The company issued a yellow alert warning on semiconductor inventory in July of 2004, in light of a major surge in stockpiles in the third quarter of that year.

“Three critical factors are driving semiconductor inventories to a higher level than expected,” said Derek Lidow, president and CEO of iSuppli. “First, many companies have reduced inventory targets during the fourth quarter, even as revenues are plummeting.”

Many industries have reset their inventory target levels in anticipation of a long economic downturn, expecting reduced stockpile goals will help cash balances. These new targets mean, even if semiconductor revenues were anticipated to remain flat, inventory levels would need to drop in proportion to the new lowered DOI targets to not have any "excess" inventory at that node of the supply chain, says iSuppli.

“The second factor is semiconductor demand has fallen in the fourth quarter, and it declined much faster than expected at the end of the third quarter, as shown by a rash of lowered guidance announcements,” Lidow added. “This means initial fourth-quarter production schedules were set too high. Production schedules have been ratcheted down during the quarter in what are mainly reactive moves, resulting in excess inventory buildup.

“Third, OEMs have not been able to cut production as fast as they would like to due to supply chain rigidities, mostly because of workforce rules in some parts of the globe and cancellation windows at subcontractors and component suppliers.”

The near-tripling of excess semiconductor inventory throughout the electronics supply chain in the fourth quarter will significantly extend the time necessary for the semiconductor industry and contract manufacturers to benefit from any recovery in demand. It also will wipe out several additional percentage points of growth from the semiconductor industry in 2009.

iSuppli has determined the level of excess semiconductor inventories is the factor that most directly relates to future electronic industry production levels.

Retailers likely will not build up major excess inventories of finished products in the fourth quarter. iSuppli sources indicate retailers are planning to price inventory at whatever levels are required to hit their January inventory targets, or in the case of Wal-Mart and a few of the mega-chains, to return unsold stock. In most cases, retailers did not significantly reset their target inventory levels, and instead have focused on OEMs giving price protection or return privileges.

Wireless service providers also are not likely to build up significant additional inventories, and are modestly targeting reduced inventory levels. They have been ordering smaller lots to be shipped in the fourth quarter, with return privileges or price protection on unsold inventory.

PC OEMs have been particularly aggressive in setting lower inventory targets and also in pushing out build schedules and component orders. These companies will reduce overall inventories by several billion dollars, and these cancellations and production cuts will show up as inventory increases further upstream in the supply chain.

PC OEMs will, however, show an increase in excess semiconductor inventory of $1 billion because they had been running below their old targets; now they will be running slightly above their new targets, says iSuppli.

OEMs producing products destined for consumers will accumulate major excess inventories, both from resetting their target inventory levels and also from production they could not cut quickly enough. iSuppli expects significant jumps in excess inventory in these three areas, with the automotive supply chain adding up to $1.7 billion in surplus semiconductor stockpiles. Wireless OEMs and consumer product makers, including companies that produce both consumer and non-consumer items, should see their overall product inventories increase by $2.4 billion, adding $300 million to iSuppli's tally of excess semiconductor inventories.

ODMs also are resetting target inventory levels and will be forced to hold some PC and consumer electronics shipments in inventory, resulting in an increase of about $1.1 billion in stockpiles by the end of the quarter, and adding almost $200 million to the excess semiconductor inventory count.

EMS suppliers were holding excess inventories at the end of the third quarter, but have been particularly aggressive, often as a matter of survival, about pushing out orders while tightening inventory targets. This will result in a drop of more than $1 billion in absolute inventories, but will still slightly exceed their new revised target DOI, says iSuppli.

Electronics distributors also have aggressively cut inventory targets, as they worry anything on their shelf could grow stale in a prolonged downturn. But electronics distributors have become excellent inventory managers during the past three years, and iSuppli predicts they will meet their new lowered targets.

Semiconductor companies will see their stockpiles rise by at least another $1.5 billion, but with reduced inventory targets, excess inventories on their shelves will actually increase by almost $2.2 billion.

Overall, from iSuppli's sampling of 180 electronics companies, representing more than 80% of the revenues of the industry, total inventories are expected to grow from $94 billion at the end of the third quarter to more than $104 billion at the end of the fourth quarter. Of the total semiconductor inventories throughout the entire electronics supply chain, $3.8 billion represented excess at the end of the third quarter. However, iSuppli predicts $10.2 billion will be excess at the end of the fourth quarter.

Another major shift to be aware of is that for most of the period since the dot-com recovery, more than 80% – and often almost 90% – of excess semiconductor inventories have been on the shelves of chip suppliers. This will change dramatically in the fourth quarter, with $4.23 billion – or 41.5% – of the excess inventory now being held downstream of the semiconductor suppliers. This will result in at least 2% reduced semiconductor growth in 2009 that has not been factored into most people's forecasts, says the firm.