How to plan for a semiconductor supply shortage
Buyers are enjoying low semiconductor prices and short leadtimes, but they won't last forever. With capex cutbacks, chip supply will tighten when the economy improves.
By James Carbone -- Purchasing, 2/12/2009 2:00:00 AM
By all accounts, 2009 will be a buyer's market for semiconductors. With the global economic downturn, demand will be sluggish and there will be more than enough chip capacity. Prices will be low and leadtimes will remain short for most semiconductors.
However, savvy semiconductor buyers know such buying conditions won't last and they need to employ strategies that will guarantee their companies get all the parts they need at the lowest possible cost when the market turns and chip demand rises, leadtimes stretch and prices rise.
Such a scenario may happen sooner than most buyers think. While the current economic and industry conditions are far from encouraging, most electronics industry analysts say the semiconductor industry will recover in 2010, and there will be strong growth in 2011 and 2012. When demand rises, supply will tighten quickly because semiconductor companies have cut back drastically on capital spending. That means they are not adding a lot of production capacity which is always bad news for buyers because shortages could result.
Suppliers, analysts and purchasers say there are strategies that chip buyers can employ to help guarantee supply when the market turns. They are:
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Sign long-term contracts. Long-term deals can go a long way to assure buyers get the parts they need.
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Ease back on pricing demands. Prices for many chips are near rock bottom. With an upturn likely in 2010, suppliers will have a long memory about who beat them up on prices.
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Evaluate and qualify new suppliers for key semiconductors. While the industry will recover in 2010, there will likely be supplier consolidation in 2009. Now is the time to check out potential new suppliers to help guarantee continuity of supply during the upturn.
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Check out semiconductor foundries. Many semiconductor suppliers are outsourcing more to chip foundries such as TSMC and UMC and Charter among others.
Be my partner
Some buyers say it is not enough to merely have long-term agreements with suppliers.
"What you really need are long-term partnerships with suppliers," say Paul Pitera, director of commodity procurement for IBM in Raleigh, N.C. He buys DRAMs, microprocessors and other materials for IBM.
"We have a living, breathing strategy that we developed and maintain to handle any market condition," he says. "The key to it is long-term partnerships and communication with suppliers."
Such partnerships and communication involves careful review by IBM buyers of IBM's hardware roadmaps and suppliers' semiconductor technology roadmaps.
Pitera says buyers play a key role in influencing what technology is used in which IBM products. "It requires a lot of external market intelligence and technology roadmap understanding. We mesh our internal hardware requirements to suppliers' semiconductor roadmaps," he says. "That helps us formulate our semiconductor sourcing strategy."
He says such involvement by buyers in technology roadmaps is necessary because "leading-edge technology doesn't appear out of nowhere. It is on the cycle of development, both for semiconductors and hardware product families. You need to be aware of developing technology."
Scary times
Pitera says collaboration with suppliers and technology roadmap reviews are always important, but especially during a recession when there is a lot of uncertainty.
"In the economic times we are living in today it is pretty scary," says Pitera. "Some of the investments that have happened in the past and are now needed for technology to progress, are constrained."
Collaboration with suppliers and evaluating roadmaps can help identify supply and technology issues in advance. "The clearer we can communicate where we see our roadmaps and directions and technologies are going, the more success we can have on both ends," says Pitera.
Pitera adds that IBM also carefully evaluates the technology roadmaps and capital spending plans of semiconductor foundries because foundries are handling more chip production. Knowledge of foundries' plans may be key to a successful sourcing strategy over the next several years because of the growth of chip outsourcing.
"Foundries are an extension of our direct relationships with semiconductor suppliers," says Pitera. "The foundry could have a major impact on how well a supplier can help us and meet our needs."
Semiconductor fabs have had strong growth over the past years. In 2002, total semiconductor chip revenue was about $10.6 billion. By 2008, that increased to $22.8 billion and by 2013 it will grow to $31 billion.
Absolutely FAB-ulous
Some analysts advise semiconductor buyers to monitor the semiconductor foundry business closely because integrated device manufacturers (semiconductor suppliers that own their own fabs) will outsource even more production to foundries.
"There are more chip companies that have adopted a fabless or fab-lite business model," says Jim Walker, research vice president semiconductor manufacturing for Gartner Inc. Fabless companies design and market a chip but rely on a foundry to build it.
"Integrated device manufacturers are becoming more "fab-lite" because they don't want to invest in all that capital equipment to build internal capacity when they can outsource and get up-to-date technology from an outsourced company," he says.
Most semiconductor companies, except for large chip suppliers like Intel, Samsung and a few others, have moved to a fab-lite model and outsource some chip production.
With so much chip outsourcing, semiconductor buyers need to strike a close relationship with their semiconductor suppliers and the suppliers' foundries and materials suppliers, according to Walker.
Buyers need to keep track of agreements between chip suppliers and foundries as well as the capital spending plans of the foundries. There will be more agreements between chip companies and foundries because semiconductor suppliers don't want to invest $3–4 billion in a new fab. Foundries welcome the business because then they can keep their fabs running at 80–90% utilization because they have multiple customers.
A recent example of a chip company turning to a foundry is the announcement by Advanced Micro Devices of Sunnyvale, Calif. that it would invest in a new foundry in Saratoga County, N.Y. to build microprocessors. The foundry, aptly named the Foundry Company, will also build semiconductors for other chip companies.
"In order for a $3–4 billon fab to be profitable, the factory has to be full," says Walker. That means it has to have a 90% utilization rate. "Even in good times, AMD may not have enough business to keep that fab at 90% utilization," he says.
However, in the current economic climate, even foundries with multiple customers don't have a 90% utilization rate. For example TSMC, the world's largest foundry, had a 50% utilization rate in January. That's why TSMC and other foundries have cut back on capital expenditures and will be slow to add capacity.
The lack of capital spending in 2009 won't be a problem for buyers this year, but it will be in 2010 and 2011 when chip demand picks up.
Buyers also should consider qualifying news suppliers, says Brian Matas, vice president of research at IC Insights in Scottsdale, Ariz. "There will be some supplier consolidation as chip companies throw in the towel this year. A few companies will bail or merge rather than going at it alone," he says.
Time to stock up?
Because prices are so low, some buyers may be tempted to stock up on semiconductors. "A buyer may say 'pricing is so attractive right now. It's a good time to stock up on parts so when the industry recovers we will have all he memory we need,'" says Matas.
However, buyers need to be cautious. "You have to look at the lifecycle of the parts. New faster, lower power chips are always being developed," notes Matas. The new parts may be designed into new systems and if a buyer sources the older versions, "you might be stuck with a bunch of parts."
On the other hand with cutbacks in chip production, some buyers may be wise to stock up on some critical parts, especially memory ICs.
Matas says DRAM prices will increase because they are at rock bottom. The question is when.
"It's setting up for a real rapid increase in DRAM pricing because manufacturers are cutting back on production, retiring older fabs and cutting back on capital pending. All of that points to conditions being ripe for a significant escalation in price. Prices for DRAM can quickly double."
While chip prices and the entire semiconductor industry may recover late this year or in 2010, most suppliers are hurting and it has temporarily changed attitudes about competition, according to Walker.
"Instead of having cutthroat competition, everybody is trying to help everybody financially to stay in business," he says. "Buyers are not going down the street to a different supplier because a chip may be 2¢ cheaper. Everybody is trying to be a family instead of being at war with each other," says Walker.
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