1 Profitability in the Semiconductor Industry 1 Profitability in the Semiconductor Industry

1 Profitability in the Semiconductor Industry 1 Profitability in the Semiconductor Industry The profitability of firms in the semiconduc- average selling price (ASP) of devices, capi- tor industry depends on a vast array of vari- tal spending, factory utilization, and prof- ables from manufacturing costs to name itability. Capital spending trends are recognition. Throughout the electronics reviewed, followed by a discussion of recent infrastructure the rules are changing as industry downsizing and the role the stock global competition intensifies, product life- market plays in the semiconductor industry. cycles shorten, and technology accelerates. As a result, the management of human Changes in product lifecycles, time-to- resources and compensation approaches market and fab cycle time are then exam- change, time-to market becomes more criti- ined. Next, typical methods of measuring cal, and business strategies are being re-eval- company profitability are reviewed, fol- uated. Despite the incredible profits of most lowed by a profitability comparison between semiconductor companies between 1993 and large and medium-sized semiconductor 1996, industry over-capacity in 1996 forced manufacturers as well as IC equipment sup- company restructuring and workforce pliers. Finally, the reasons why IC manufac- reductions, especially among semiconductor turing is so costly are presented, leading into equipment suppliers. an expanded analysis of cost per wafer in Chapter 2. In recent years, investors have become very attracted to high technology firms and the The Profitability Cycle stock market is influencing the way companies are doing business. Having become the Long term, the sustained profitability of the objects of such close scrutiny, companies are semiconductor manufacturers depends on changing their approaches to capital spend- each company's ability to maintain high ing and risk. enough profit margins on the devices it pro- duces to allow sufficient capital outlays for An analysis of company profitability and the future generations of devices. As will be factors influencing it is essential to an under- shown later, depreciation costs are the standing of the IC industry and the reasons largest consumer of operating costs and the why cost effectiveness is critical. This chap- cost of R&D is increasing. Together these ter first explains the industryÕs ÒboomÓ and costs can constitute from 25 to 35 percent of ÒbustÓ cycles, and the relationship between annual revenues. INTEGRATED CIRCUIT ENGINEERING CORPORATION 1-1 Profitability in the Semiconductor Industry From year to year, the health of the semicon- Swings in production growth rate are closely ductor industry as a whole is indicated by its tied to capacity utilization, ASPs of devices characteristic "boom" and "bust" periods, and capital spending (Figure 1-2). For the known as the silicon cycle (Figure 1-1). Since industry as a whole, when capacity utiliza- 1978, there have been four growth cycles in tion is high, ASPs rise and companies are which sales grew an average of 30 percent more profitable, which in turn, encourages per year. Following each growth cycle, the capital spending. However, with increased industry experiences a one to two year spending, capacity constraints loosen and period when sales growth averaged slightly ASPs tend to drop, decreasing company under 4 percent. ICE expects modest growth profitability. The decreased profitability in 1997 following the ÒboomÓ of 28-41 per- (pre-tax income) then reduces the amount of cent growth in 1993-1995 and 1996Õs contrac- capital available to invest in future needs. tion caused by plummeting memory prices. This "profitability cycle," and the historical Over the industry's last 20 years (1976-1996), relationships between profitability, utiliza- the growth rate has averaged a healthy 19 tion rates, ASPs, and capital spending are percent. shown in Figures 1-3 through 1-6 for North American merchant semiconductor manufacturers only. 50 47% 45 Average Growth 41% 40 Rate During Expansionary Cycles 36% Average 20-Year 35 34% Growth Rate 31% 30 28% 28% 28% 28% 25% 25 24% 21% 20% 20% 20 19% 17% 16% 15 12% Percent Change 10% 10% 10 7% 5% 5 4% 2% 0 Average Growth -5 Rate During Contractionary Cycles -10 –8% –12% -15 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year (FCST) *Includes captive semiconductor manufacturers. Source: ICE 19753B Figure 1-1. Boom-Bust Cycles of Worldwide Semiconductor Sales* 1-2 INTEGRATED CIRCUIT ENGINEERING CORPORATION Profitability in the Semiconductor Industry Capacity Utilization Capital Market Spending Conditions IC ASP Profitability 1993-1995 1996 Capacity Utilization Increasing Decreasing Total IC Industry ASPs Strong Increases Decreasing Profitability Increasing Decreasing Capital Spending Strong Increases Small Increase Source: ICE 19417B Figure 1-2. IC Industry ÒProfitability CycleÓ 25 100 20 90 Capacity 15 Utilization Rate 80 10 70 5 60 0 50 Pre-Tax Income (Percent of Sales) Capacity Utilization Rate (Percent) –5 40 –10 30 1978 1979 1980 1981 1982 1983 19841985 1986 1987 1988'1989"1990 1991 19921993 1994 19951996 1997 (FCST) Year *North American companies only Source: SIA 19782B Figure 1-3. High Utilization Rates Indicate High Profitability* (1978-1997) INTEGRATED CIRCUIT ENGINEERING CORPORATION 1-3 Profitability in the Semiconductor Industry 2.80 100 $2.68 2.60 90 $2.40 2.40 $2.30 80 2.20 $2.17 Capacity Utilization Rate 2.00 70 1.80 $1.75 ASP ($) 60 1.60 $1.51 $1.39 1.40 $1.32 $1.35 50 $0.96 $1.28 Capacity Utilization Rate (Percent) 1.20 $1.09 40 $1.01 $1.00 1.00 $0.95 $0.96 0.80 30 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 (FCST) Year *North American companies only Source: SIA 19426D Figure 1-4. IC ASPs Versus Capacity Utilization Rate* (1982-1997) $2.68 2.80 27 24 2.60 21 $2.40 2.40 $2.30 18 Pre-Tax Income 2.20 $2.17 15 12 2.00 9 1.80 $1.75 6 ASP ($) 3 1.60 $1.51 0 $1.39 1.40 Pre-Tax Income (Percent) $1.32 $1.35 –3 $1.28 1.20 –6 $1.09 –9 $1.01 $1.00 1.00 $0.95 $0.96 $0.96 –12 0.80 –15 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 (FCST) Year *North American companies only Source: SIA 19427D Figure 1-5. IC ASPs Versus Pre-Tax Income* (1982-1997) 1-4 INTEGRATED CIRCUIT ENGINEERING CORPORATION Profitability in the Semiconductor Industry 16,000 25 14,000 20 12,000 15 Pre-Tax Income 10,000 10 8,000 5 6,000 0 Pre-Tax Income (Percent) Capital Spending ($ Millions) 4,000 –5 2,000 0 –10 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 (EST) Year *North American companies only Source: SIA 19418D Figure 1-6. Semiconductor Capital Spending and Pre-Tax Income Trends* (1982-1997) Historically, pre-tax losses are experienced analysis of the parts. As more companies when utilization rates fall below 50 percent, adopt this strategy, more fab capacity will be as illustrated in Figure 1-3. However, making freed to allow production of other devices or utilization projections based on past boom the next generation of DRAMs. periods is risky as industry growth over the 1993-1995 period was unprecedented. For these reasons, ICE feels that despite the However, ICEÕs sources indicate that fab uti- healthy conditions in the computer, communi- lization is dropping rapidly. This is espe- cations and consumer electronics sectors, uti- cially true among memory fabs as the move lization in 1996 should fall below 80 percent to future generations of devices (i.e., 64M, and will decelerate below 70 percent in 1997. 256M and 1G DRAMs) is happening faster Because these chart reflect North American than ever and device shrinks are more dra- conditions only, ICE warns that companies matic than they have been in the past. highly dependent on DRAM production will DRAM manufacturers are implementing probably experience lower fab utilization rates these shrinks to improve the margins on and lower pre-tax incomes. This may be reme- DRAM devices, whose ASPs plummeted in died for some companies by the successful 1996 (Figure 1-7). For instance, the first-gen- transition from memory processing to eration 64M devices were approximately advanced logic and microcomponent manu- 200mm2 in size (about 300,000mil2), while the facturing. However, because so many compa- smallest 64M in 2Q Õ97 was 123mm2 (about nies are adopting this strategy simultaneously, 190,000mil2), according to ICEÕs laboratory the risk of over-supply in other device markets INTEGRATED CIRCUIT ENGINEERING CORPORATION 1-5 Profitability in the Semiconductor Industry is quite high. Figure 1-8 shows worldwide fab expects an average ASP of $2.30 in 1997. utilization based on information from over 46 Pre-tax incomes were cut nearly in half from semiconductor manufacturers in North 1995 to 1996, due almost exclusively to the America, Japan, Korea, Taiwan, and Europe, dramatic changes in the memory market. as tracked by a new worldwide capacity study, ICE expects pre-tax income to increase SICAS (Semiconductor International Capacity slightly from 13 percent to 15 percent from Statistics). 1996 to 1997. It further forecasts that capital spending by North American firms will sig- Corresponding with the lower utilization of nificantly drop from 1996Õs level of $15.5 fab capacity, ASPs dropped from an average billion to $12 billion in 1997. of $2.68 to $2.40 from 1995 to 1996, and ICE 12.00 11.50 45.00 43.25 11.00 40.00 10.00 9.00 35.00 8.00 30.00 7.00 –65% 25.00 –66% 6.00 ASP($) 5.00 ASP($) 20.00 4.00 14.65 4.00 –27% 15.00 2.91 –34% 3.00 9.70 10.00 2.00 1.00 5.00 JAN AUG DEC JAN AUG DEC 1996 1996 1996 1996 1996 1996 4M DRAM 16M DRAM Source: ICE 21204C Figure 1-7.

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