An Era of Profitless Prosperity?

An Era of Profitless Prosperity?

Is the semiconductor industry entering an era profitless prosperity, a time when the industry can’t generate sufficient return on investment to build capacity necessary to meet unprecedented customer demand? At the SEMI Industry Strategy Symposium (ISS), held in Half Moon Bay, California, Stephen Newberry, president and CEO of Lam Research, discussed the state of the industry and today’s perplexing financial results that can be best described as profitless prosperity. Attendees rated it the top presentation at ISS and Newberry’s insights are still being debated by an industry struggling to make a profit amidst a booming market.

SEMI members can listen to Newberry’s entire presentation (with slides synchronized) in the Members Only section of the SEMI website. To access the ISS presentations, click here.

An era of profitless prosperity has been observed in other industries, notably the aluminum industry in the 1970’s. The term was defined at this time to describe an industry running flat without generating sufficient ROI to build new facilities necessary to meet growing customer demand. Newberry began his presentation asking the question whether the semiconductor industry is entering a similar era. He then presented ideas on the root causes of the problem and the current strategies the industry is pursuing to address the situation. He concluded the presentation with recommendations on how the supply chain can survive in this challenging market environment.

The current financial situation is highlighted by the fact that since 2003, IC unit growth has been increasing faster than in the previous 12 years, yet with average selling prices (ASPs) trending consistently and alarmingly downward. During this time, the price per bit/function has been declining faster the cost per bit/function reduction, creating widespread profit erosion in the industry. Newberry compared the current market environment with two previous eras: 1992 to 1997 when strong demand was coupled with often strong ASP growth and 1998-2002 where the industry experienced boom and bust cycles with erratic demand and fluctuating ASP growth. These time period comparisons—each with ASP, operating profit and unit growth correlations—showcased the unique and perilous situation of the current market.

Newberry also analyzed how the interrelated dynamics of ASPs, unit growth and operating profit are impacting device segments. While all segments are experiencing profit challenges, these trends are most pronounced in the Logic IDM, DRAM/NAND and NOR segments. Presenting data on the operating profit of the top 40 chip makers, Newberry showed how average operating profit has declined from 23% in 2003 to only 12% in 2007. More striking, nearly all of operating profits generated in 2007 were produced by only 13 of the 40 companies analyzed. In fact, 15 companies had operating losses last year. Excluding Intel, TI, TSMC, fabless and analog segments, the operating profit for the semiconductor industry was -1% last year…and this in a year of increasing unit growth.

In discussing causes of the problem, Newberry focused on the memory segment, observing how oversupply is being driven by too many players with easy access to capital, all pursuing the same strategy. “Everybody is pursuing cost as solution…in a race to the bottom,” he said. In presenting historical and segment financial results, he concluded, “Clearly cost is not the significant factor relative to generating operating profit.”

The current industry focus on cost reduction as the exclusive solution to profit decline has significantly impacted the equipment and materials supply chain. Newberry pointed out that suppliers have been responsive and effective in achieving Moore’s Law gains, meeting economies of scale requirements, and delivering yield and productivity improvements. These are important, but they will not “overcome supply and demand imbalances and ineffective business models.” Newberry presented data that illustrated that even if all the operating profits of wafer equipment suppliers—nearly $6 billion in total—were given to struggling device segments, to wouldn’t solve the profit gap.

In concluding the presentation, Newberry demonstrated how the aluminum industry overcame their profitless prosperity era. That industry has applied better use of global data, better understanding demand and inventory trends, greater financial discipline, and extensive supply chain collaboration to yield consistently good financial results. The semiconductor industry can utilize many of the same techniques to “get on with the real changes needed to overcome the prosperity problem.”

SEMI members can listen to the entire presentation (complete with slides) in the Members Only section of the SEMI website. To access the ISS presentations, click here.