2010 ISS Executive Blue Chip Panel: A “Perfect Storm” (Part 1)
By Scott Landstrom, SCI Consulting
In 1997, Sebastian Junger wrote a stirring, real-life account of the events that led to the sinking of the Gloucester-based swordfish boat, the “Andrea Gale.” The environmental collision of three different weather systems, each bringing additional power to the eventual hurricane, gave the book its name, “The Perfect Storm.” While the focus of Junger’s documentary was the unfortunate ramifications of this confluence of events, the title of his book has become a modern-day metaphor for a rare combination of events (positive or negative) that create a rare, unusual or unique outcome.
On January 12, 2010, at the annual SEMI Industry Strategy Symposium (ISS), attendees were treated to a “Perfect Storm” of the positive genre, as several conditions combined to create a unique Executive Panel session focused on “The Structural Evolution of the Semiconductor Equipment Industry.” I organized and moderated the panel, and Michael Wright, CEO of AISI Inc., was the co-moderator.
Five of the top six revenue firms in the North American Equipment industry participated. The panelists were:
The panel focused on the thesis of “structural changes of the industry.” Asking panelists to evaluate the changing business model in a tough environment – much lower industry growth rates, fewer but more powerful customers and escalating fab costs – resulted in a sometimes sober, yet often upbeat, analysis from the panelists who are facing these evolutionary changes as they run their various companies.
Rather than go the “traditional route”, by posing the questions to the panelists directly, I recruited luminary thought leaders, from within and outside the semiconductor industry, to pose key questions via recorded videos. Following the analytical approach championed by Harvard professor Michael Porter, these eight luminaries challenged the panel with their own key inquiries regarding the evolving equipment industry, and the many business model challenges to ongoing competitiveness in this sector. The eight luminaries participating in this Blue Chip Panel event were as follows:
- Jim Morgan – former CEO and COB of Applied Materials
- John Osborne – current Board member Amkor
- Paul O’ Neill – former Secretary of the U.S. Treasury
- G. Dan Hutcheson – CEO, VLSI Research
- Danny Ainge – president, Boston Celtics
- T.J. Rodgers – COB and CEO Cypress Semiconductor
- George Needham – COB, Needham and Co.
- Bob Boehlke – former CFO, KLA-Tencor
Trying to capture the various views and wisdom imparted in a 2- ¼ hour discussion is challenging, to be sure, but some of the highlights of their analyses are presented below. (Note: this article is Part I of a two-part series detailing the observations and comments made by the executives at the ISS Blue Chip Panel discussion. This column deals with the first four of the eight questions posed to the panelists; next month will conclude with the final four inquiries made.)
Luminary # 1: Mr. Jim Morgan
General Topic: The ongoing shift of the “epicenter” of wafer fabs towards the Pacific Rim, and the associated escalating challenges to U.S. and European equipment firms to maintain or increase share in an increasingly “off shore” industry.
Overall Summary: First of all, it was pointed out that approximately 43% of all equipment revenues in 2009 flowed back to U.S. firms in this sector. Additionally, the concept of any nation having a “home country advantage” was debunked, as the top four customers, representing about two-thirds of the equipment buying power, include one firm each from the nations of Korea, Japan, Taiwan, and the United States. As the complexity of the equipment has continued to increase almost exponentially, the importance of efficient, state-of-the-art R&D, and strategic alignment of roadmaps with key customers has made central product development decisionmaking more important, and customer proximity-related factors less so. It was pointed out that the market leaders in the equipment space have continued to increasingly invest in locally situated strategic and tactical capabilities to support customers on site, with an ever larger portion of the “field personnel” for the U.S. equipment sector being internationally recruited and located. The emerging role of “sovereign capital” investing in new competitors was discussed, that nation-states investing in such companies to develop capabilities is seen as strategic. While it was agreed that such governmental injections can represent a threat, the magnitude of the technical problem set represented by some of today’s Moore’s Law challenges can make it extremely difficult to catch up with a well-funded, properly executing market leader – even with substantial “sovereign capital” supporting the efforts of a new competitor.
Selected Panelist Quotes:
Rick Wallace: "One significant challenge for U.S.-based equipment companies is staying close to our customers when the demographics have clearly changed. For example, in the early days, most of the equipment industry was located here in the U.S. Things have dramatically changed in the last 30 years, with U.S.-based companies today representing a small percentage of the overall market. With these shifting dynamics, it is now more important than ever that U.S.-based companies have a strong cultural connection with our customers, because where once it was more common for senior leaders in our customer base to have worked and attended school in the U.S. before returning to their home countries, it is often the case today for the executives of our customers to be graduates of international schools and to have never worked in the U.S. This requires us to work even harder to make sure that we understand our customers' cultures and needs."
Dave Dutton: “It is increasingly inaccurate to even think of U.S. firms as being constituted by purely U.S. management. We have staff meetings regularly that we sometimes refer to as “pajama meetings” as someone on the call is overseas, in a very different time zone, probably in their pajamas. Just because a firm is U.S. headquartered does not mean that such a firm isn’t becoming increasingly global in its leadership.”
Luminary # 2: Mr. John Osborne
General Topic: Most semiconductor equipment firms have historically pretty much “stuck to their knitting,” remaining largely “pure play” providers to the semiconductor fabrication industry, with some exceptions. With the long term, end-market growth rate dropping from the mid-teens to something close to half that level, will equipment firms finally get serious about diversifying into other markets to augment their growth rate, and earnings potential?
Overall Summary: While it was generally acknowledged that the growth rate has roughly halved over historical levels, different panelists took disparate positions on the wisdom/attractiveness of pursuing non-semiconductor markets. Applied Materials has taken the most ambitious actions in the diversification area, with major investments in both Flat Panel and Solar equipment segments, and took the position that a firm which blends higher-growth initiatives into other markets with their core semiconductor portfolio will inherently lead to faster overall corporate growth. Other panelists discussed the risks and problems with attempted diversification, and focused on the immense challenges associated with trying to maintain Moore’s Law as the industry approaches some of the fundamental limits of physics. The risk of losing focus on the main, core market was mentioned a few different times – as was the liability of going into a field where the investing firm may not have the core competencies to succeed, absent technological synergies. One point that seemed to have a majority consensus is that there are no markets that are “no brainer,” pin-for-pin growth paths that allow semiconductor equipment firms to use the same product lines that they have developed for their core markets. Consequently, diversification requires new innovation and equipment modification, at a minimum, and that implies the concept of “opportunity cost” as development resources are diverted from the core business. Both schools of thought seemed to have merit. Historical earnings growth in the face of greatly diminished end market growth will require new growth engines to be a reality. Conversely, diversification in the face of the extreme technology and business model challenges that the core semiconductor market presents in 2010 brings heightened execution risk – in both core and new markets – to the diversifying firm.
Selected Panelist Quotes:
Mark Jagiela: “As industries continue to become a greater share of the total GDP, it is empirical and inescapable that the growth rate has to decline to something closer to the overall economy.”
Steve Newberry: “In the first place, premature abandonment of a commitment to your core market is a classic Porter mistake, and there are a host of challenges and life left in the roadmap to drive silicon semiconductor technology over the next decade. On a separate matter, as it relates to the counseling of Institutional Fund Managers to firms not to diversify, I believe that the executive management of the firm is the only constituency who can make such strategic decisions with the long-term interests of the firm at heart, and as various investment entities see that perspective, hopefully they can support it.”
Randhir Thakur: “With regards to the subject of diversification, it is clear that there are adjacent markets which can leverage the existing R&D paths which have been developed for the semiconductor market. Whether that be solar, flat panel, high-brightness LED, or other markets, firms that can multitask their R&D dollars to attack customer needs in multiple markets will be rewarded with higher growth, and more efficient use of development dollars.”
Luminary # 3: Mr. Paul O’Neill
General Topic: Historically, the semiconductor equipment industry has benefitted from the “external innovation engine” that has been provided to the larger equipment firms by VC funded start-ups. As promising technologies and innovations were developed by start-up firms, the large companies could reach out and acquire or license such promising technologies as they deemed appropriate. With the increase in the “floor” necessary to drive to an IPO, and the decline of available funds interested in investing in semiconductor equipment start-ups, the U.S.-based rate of funding such firms has drastically declined. Given this developing void, will the large firms increase their R&D to keep the pace of innovation going, participate in funding promising start-ups themselves, or live with a slower pace of innovation?
Overall Summary: All panelists were in agreement that the rate of start-up formation in the U.S. in this sector is in dramatic decline, and moreover, has been for some time. It was pointed out that the same metric in China, for instance, would probably show a dramatic increase over historical levels, so on a worldwide level, some of what is being seen is merely the transfer of the geographic location of such start up firms from the U.S. and Europe to the Pacific Rim. Once again, it was highlighted that the large equipment firms must continue to have an increasingly international perspective, seeking out innovation regardless of where it may be occurring, and commercializing such innovations as needed. Additionally, in the 1980’s and 1990’s, small firms could “cut their teeth” on perfecting their technology with one of the plethora of Tier II customers before “stepping up in class” to attempt to serve a Tier I like Intel or Samsung. The assertion was made that it is much harder in today’s environment, with almost two-thirds of the total Capex being spent by the top four buyers, to follow the same recipe. Consequently, start-up firms often must be ready for “prime time” right away, if they are going to begin the commercialization of their system with a much more demanding Tier I account. Another point was raised that while the external innovation represented by such small start-ups may be in decline, the efficiency of R&D investment processes within large firms must improve over historical levels to keep the pace of innovation undiminished.
Selected Panelist Quotes:
Rick Wallace: "It is very difficult in today's environment for U.S.-based start-ups to develop and commercialize complete systems. Today the 'action' is in the sub-system level, where small firms can innovate and develop a technology to be integrated by systems manufacturers and piggyback on their critical mass. Think of it this way – let's define "invention" as the process of turning cash into ideas. Next, define "innovation" as the process of turning ideas into cash. Start-up firms in semi equipment industry have a history of successful invention in good times and bad, but in environments like we're experiencing today, they've often faced challenges in turning those ideas into cash."
Steve Newberry: "First of all, there are many that believe that the former 'status quo' of the VC funded start up industry had too much money chasing too few quality deals. Consequently, some technologies and products got funded that shouldn't have, and others were bid up to valuation levels that did not correspond with the quality of the innovation. Secondly, the purported death of Silicon Valley as a innovation engine is erroneous and premature, despite the State of California doing everything it can to kill it…. ! Finally, if U.S. firms need to take a more international view of the external innovation engines they need to be partnering with, then so be it – we need to be borderless in our quest to find the best-in-class solutions for the customer".
Rick Hill: “I think you are going to see innovation begin to grow in other regions around the world. History has shown that one of the conditions usually required for a thriving start-up industry in a given market is a fertile domestic market. Clearly, that no longer exists in the semiconductor equipment market in the United States. One issue that frequently gets misstated is when we refer to China as an “emerging” player. I have bad news, guys….China has emerged! Consequently, I think you will begin to see innovative start-up firms on the upswing there.”
Luminary # 4: Mr. G. Dan Hutcheson
General Topic: While almost all Western nations have laws against monopolies,” which constitute an over-concentration of production power, not a single one has any limitations on “monopsonies,” which are the mirror image of a monopoly. Basically, a monopsony occurs when an over-concentration of buying power occurs, wherein there are only a few buyers in a given market. It can be argued that each of these is harmful to the overall health of the supply chain. Should there be limitations on monopsonies such as we see developing in the semiconductor production market, and if such limitations were enacted, would it help equipment firms more adequately finance their pursuit of Moore’s Law?
Overall Summary: All panelists agreed that the trend toward monopsony is indeed present in today’s shrinking customer base for the equipment sector. Secondly, there seemed to be agreement that such over-concentration of buying power is harmful to the overall supply chain, as such large, powerful customers wield their burgeoning negotiating power to drive prices downward from historical norms in this sector. The panelists also seemed to be unanimous that there’s little chance of any real regulatory relief on this topic, however, as the basis for anti-competitive laws in most Western nations came from 19th and 20th century legislative efforts to protect the consumer from powerful, large manufacturing firms.
Steve Newberry: “The reality is that all these laws are set up to protect the consumer, and they really are not concerned with what happens in the Supply Chain. There are many industries that are already “concentrated,” ours is just now going through the process of becoming so. It is interesting that, from one perspective, the laws against monopolies within our customer base actually offer some level of protection against us having to sell into a monopsony, as there will be at least a few customers in each space as opposed to one.”
Dave Dutton: “While the consumer benefits from the creation of giant, dominant retailers like Walmart, if we just went back one step in the supply chain, I wonder how Walmart’s vendors feel about selling into a monopsony, and what their general state of health is as a result?”
Author Scott Landstrom runs a strategic consulting practice that specializes in advising CEOs on strategy formation, revenue growth engines, and liquidity events. He can be reached at: firstname.lastname@example.org. For Part 2 of the Blue Chip Panel report, see the March 2010 issue of SEMI Global Update or click here.
February 2, 2010