Clear sailing...FOR NOW
By James Carbone -- Purchasing, 4/23/1998
Asia's economic woes are causing a lot of hand wringing among stock analysts and economists, but the crisis is good news for electronics buyers--at least in the short term. The financial crisis will mean that component availability will remain high and prices low through at least 1998 and most likely until mid-1999.Asia's financial distress will result in lower production rates for electronic equipment and less demand for electronic components at a time when there is much unused capacity. That means the oversupply situation that has gripped the electronics industry for the past two years will continue. Many suppliers, distributors, and analysts had forecast that semiconductor supply would tighten up later in 1998, but because of the crisis, that won't happen.
But while buyers will have clear sailing in sourcing electronics in 1998, there are dark clouds on the horizon. Because of the crisis, many Asian component suppliers cannot invest in capital equipment. While that is not an issue now because there is overcapacity, in a year, the lack of investment may be felt by buyers.
"In the short term, we will see severe price pressure until the existing capacity has been absorbed," says Roy Vallee, vice chairman, president, and chief operating officer for electronics distributor Avnet. "However, there will be very little increased capacity delivered to the industry. Therefore, as we get beyond the point where existing capacity has been used, we will go back into a shortage environment as the pendulum swings," he says.
But for the next 12 months, purchasers can expect prices for semiconductors, discretes, logic, and memory to fall. "Without the crisis in Asia, we would have started to see dram prices inching up," says Ralph Anavy, president of Electronic Outlook Corp. "With the financial crisis, particularly with the exchange rates the way they have gone in Asia, there is still room for prices to weaken especially if you look at Korean prices."
Prices will drop
Microprocessor prices regularly decline quarterly and that trend will continue. However, in 1998 there will be more lower-end microprocessors sold because of the growth of the sub-$1,000 PC. The crisis also will impact passive, electromechanical, and interconnect prices. Tags for resistors, capacitors, switches, and connectors will fall 2%-7%, according to analysts and suppliers. Prices will be lowest for parts made in Asia because of the devaluation of Asian currencies against the dollar.
"Based upon the combination of lower cost and weak currencies, the Asians are likely to become substantial exporters of low-cost goods into the U.S. and Europe," says Vallee. That will in fact keep the pressure on ASPs (average selling prices).
All this translates into slower growth rates for electronic components and equipment than previously had been forecast. Market researcher Dataquest has downgraded its forecast for both equipment and semiconductors. Dataquest had forecast that the chip market would grow 17% to $175 billion in 1998. The financial crisis has reduced that forecast to 7%, $160 billion. Equipment will only increase 3% to $953 billion instead of its previous 9% increase to over $1 trillion.
The Asian financial crisis may also cut prices of PCs and help boost sales of sub-$1,000 computers, the fastest-growing segment of the PC business. Companies like Acer and CTX which manufacture in Asia and purchase the memory, chipsets, and power supplies locally will be at a competitive advantage shipping the systems to the U.S. for sale because of the de-valued currency.
"All of it can be manufactured over there and exported to the U.S. and Europe at more competitive prices because of the currency situation," says Jim Feldhan, president of Semico Research. "In the short term, it's going to boost the $1,000 PC, and consumers will get more bang for the buck."
More sub-$1,000 PCs coming
He says many consumers and businesses will ask themselves if they want to spend $2,500 for a high-end computer when they can spend $1,000 and get a PC equipped with a Pentium 200 megahertz chip, 32 megabytes of memory, an ethernet card, and the capacity of running Excel, Powerpoint, and graphics programs. Fueling the sub-$1,000 segment will be Intel's low-cost Pentium II Celeron chip which will soon ship. Celeron is targeted for computers costing between $800-$1,200.
This spells healthy growth for low-end systems equipped with low-cost processors. Evidence: At the beginning of 1997, the sub $1,000 segment represented about 5% of PC sales. By the end of 1997, it was 15% and by the end of this year it is expected to be 17.4%; the sub-$1,000 segment will grow 35% in 1998, says Semico.
Obviously, Intel, AMD and Cy-rix/National will ship more lower-cost microprocessors. Intel recognized the trend last year and announced plans to supply processors for the low-end of the market. Celeron is the result. Celeron will have the Pentium II core, but no L2 cache memory. Intel has yet to announce pricing for the chip, but it will be lower than other Pentium II MPUs.
Celeron and other Pentium II chips will dominate this year and push Pentium MMX off the desktop. "Where do you have room in the price structure for a Pentium MMX?" asks Tony Massimini, an analyst for Semico Research. "By the end of the year I don't see any designs out there for Pentium MMX." Many portable computers in 1998 are shipping with Pentium MMX, but by the end of the year, many will be equipped with Pentium II MPUs.
A change in strategy
Intel's processor strategy has changed. In the past, Intel would introduce its latest microprocessor, which carried a hefty price tag, and the chip would be designed into high-end desktops. As the price of the processor dropped, it would be used in lower-end machines. But with Celeron, Intel is pushing its latest MPU--albeit a streamlined version--into the low end of market. Intel may be worried about competition from AMD and Cyrix, which make Pentium II clones that are widely used in lower-cost machines made by Compaq and IBM, among others.
Celeron will put pressure on AMD which has had problems with yields on its K6 processor and has enlisted the help of IBM to manufacture the part. "Even with the deal with IBM, you are not going to see any impact with capacity until third or fourth quarter," says Massimini. "It looks very difficult for AMD at this point."
Overall, the microprocessor market will grow about 28% in 1998, says Massimini, despite the fact that more low-cost processors will ship. "The high end of the market is doing quite well. The high ASPs (average selling prices) on the high end are balancing out the ASPs on the low end."
"The sub-$1,000 is not cannibalizing the overall market. It is bringing in new people. Maybe in the next couple of years these people may upgrade to a better computer," says Massimini.
Crisis means lower DRAM tags
The financial crisis can only put downward price pressure on memory tags, especially drams. dram prices have been falling for two years, and many thought they would stabilize in 1998, but tags continued to fall in the first quarter, says Sherry Garber, vice president of Semico. The 64 megabit (Mb) dram, which was priced around $30 in November, was down to about $15 in early March on the spot market and about $18 in OEM pricing.
With the devaluation of Asian currencies, manufacturing costs have declined so dram manufacturers could still further reduce tags. For instance, the Korean won has been devalued by about 50%. Korea is home to major dram manufacturers, including market leader Samsung, Hyundai and LG Semicon.
But that does not necessarily mean they can cut dram prices by 50%. The devaluation has lowered their labor costs and local costs of chemicals used to make semiconductors. But Korea has to import other raw materials and wafers. With the devaluation, Korean manufacturers are paying twice as much. They also are paying twice as much for imported capital equipment. "The major thing we see is that they are selling everything they manufacture which is keeping prices low. They are trying to generate some revenue," says Garber.
But while prices may not drop 50%, they still will decline--due in part to the won devaluation and partly because there is a lot of capacity. Feldhan says there are more dram manufacturers. In 1994-1995, there were about 20 dram suppliers. Now there are 28. Many of them have been aggressive about trying to win market share and have built up capacity and lowered prices.
"Korea and Japan are competing aggressively in drams and no one is making money," says Anavy. Taiwan is trying to become a major producer of drams. "They are all cutting prices and it looks like that will continue."
Good times won't last
While memory buyers may be gleeful about these price trends, they won't last forever because chip makers are not investing in new equipment. "They [semiconductor companies] don't have money to pay for new equipment," says Feldhan. "Over the next year there's going to be less aggressive building of fabs. We believe that as we go into mid- to end-1999, we have a real potential of going back into a shortage situation."
The slowdown in investment is already occurring. The book-to-bill ratio for semiconductor equipment for February was 0.92, the lowest in three years. The ratio means that for every $100 of new equipment that semiconductor equipment manufacturers shipped, they received $94 in new orders.
While investment is being held back, the industry is not yet feeling it because there is a lot of unused capacity, says Anavy. Over the last four or five years there have been annual growth rates in equipment investment of 30%, 40%, 50%, which is well in excess of semiconductor growth rates. "Until that excess capacity is taken out of the loop, prices will remain weak," he says.
Feldhan says "there's enough capacity out there and enough brick and mortar and enough plants that are delayed or mothballed to fill the demand for memory this year. We won't see shortages until mid-1999.
He says shortages could occur even if the PC industry slows down, which it has done in the past several years. "In 1995, the PC industry had 25% growth, in '96 it was 23%, and in 1997 it was around 20%. We are looking at about 18% growth this year. It's slower growth, but it's still healthy," says Feldhan.
How passives are affected
The Asian crisis won't just affect semiconductors. The slowdown in electronic equipment production will impact sales of passives, switches and connectors. "Prices will drop," says Anavy. "Passive prices are always under pressure, but the Asian currency devaluation puts them under more pressure. Anavy expects tags to drop by about 3%-4% this year.
Connector demand in Asia also will slow. The connector market in Asia-Pacific has grown at a 13% annual rate over the last 10 years, according to connector industry researcher Ron Bishop. "Last year, it grew 7.8%; we are forecasting it will be 7.2% and we hope that's not too optimistic," he says.
The crisis is bad news for some connector manufacturers. "If you're a North American company that is manufacturing connectors in the U.S. and exporting to Asia, you're out of business," he says. "You're not going to be shipping jack into Asia-Pacific anymore. Your connectors are going to be way too expensive because of the devaluation of the currencies over there. Asia is not going to buy American goods of any kind, particularly electronic connectors," says Bishop.
But American or European-based companies that have manufacturing in Asia will fare much better. "You also are going to be able to manufacture in that part of the world and export to the U.S. and Europe and have a very competitively priced product," says Bishop.
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