A lack of investment in new capacity and the growing unwillingness of semiconductor companies to fight for market share by cutting prices are reasons why chip prices won't fall as sharply in 2008 as in 2007.

Many chip companies had invested in new capacity in 2005 and 2006, hoping to produce more and gain market share. As a result, chip supply increased and prices fell in 2007 although demand was strong.

These companies have reached the "pain threshold" and will cut back on their capital expenditures in 2008, according to Bill McClean, president of chip industry research firm IC Insights. By doing so, they hope to reduce the rate of growth of supply and firm prices.

McClean says that the amount that semiconductor companies will spend on capital expenditures next year will decline 9% to $51 billion. The top five spending cutbacks in 2008 are expected to come from major DRAM suppliers: Micron, ProMOS, Samsung, Hynix, and Nanya. This is no surprise since the average DRAM price fell a hefty 35% in 2007 and many memory IC companies made very little if any profit on DRAMs in 2007.

Instead of spending $2–$3 billion for a new fab, many semiconductor companies have been using foundries when they need extra production. The bad news for buyers is that foundries also plan to cut back on capital expenditures.

Many of the major foundries such as UMC and TSMC in Taiwan were running at 93-95% capacity in the second half of 2007. However, while foundries are getting more business, they aren't investing in new fabs.

"Foundries like UMC and TSMC are backing off the market-share-at-all-costs philosophy and going forward with making some profit," says Brian Matas, vice president of research for IC Insights.

In the third quarter of 2007, UMC said its main goal in the future is to be profitable. Rather than boosting capital spending and putting in more capacity to service more customers, UMC is "going to tow the line a little bit and increase the average selling price of the products going out the door," says Matas. He says other foundries are doing the same thing.

That wouldn't be a problem for buyers if unit shipments for chips were flat, but unit shipments are rising. If no extra capacity is added, supply will tighten and prices will rise. In fact, IC Insights forecasts that prices will rise by about 2% on average in 2010 and 2011.

However, some suppliers are adding capacity. Liquid crystal display manufacturers are expanding existing fabs or building new ones. "There will be increased capacity, but most of the expansion will happen in the second half of 2008 or in 2009," says Sweta Dash, director, LCD and projection research for iSuppli.

She says suppliers are adding capacity slowly because they don't want to overproduce. They too are focused on profit margins rather than market share.

Dash says Sharp will be expanding its eighth-generation fab. Samsung is planning to add a second phase to its eighth-generation LCD fab in 2008. Other suppliers are expanding their fabs.

Capacity is being added in 2007 because LCD demand was very strong and will continue to be robust in 2008, according to Scott Birnbaum, vice president of liquid crystal displays for Samsung Electronics in San Jose, Calif.

"We see huge increases in demand across all segments. What created some tightness was insatiable demand for larger panels," he says. "There was oversupply in 2005 and part of 2006 so suppliers didn't want to make investments," he says. "They are making them now."

He says purchasers were "buying ahead" and holding their LCD inventory rather than waiting to buy when the panels were needed for production.

Most buyers want to see suppliers invest in new capacity, but not all are overly concerned about the possibility of firming prices or longer leadtimes in 2008. Some buyers say while unit demand is growing, it is not overwhelming and there will be enough capacity to go around.

"It doesn't look like there is going to be a massive acceleration of demand that is going to cause supply constraints," says Kurt Doelling, vice president of supplier management for Sun Microsystems in Palo Alto, Calif.

However, he is concerned about the trend of chipmakers outsourcing production to foundries. "We have seen a lot of that this year and it will continue."

He says Sun has developed close relationships with fabs and he is confident Sun will get all the supply it needs in 2008.

Doelling says he is more concerned about the overall economic outlook and the high price of oil and its impact on total cost. High oil costs can affect transportation costs. However, he says Sun has not yet changed its sourcing strategy because of higher oil prices, but that is a possibility in 2008.

While chip companies may not invest in new fabs and add a lot of capacity, there is some good news with supply. Many semiconductor companies are transitioning from 200mm to 300mm wafers. Larger wafers mean more chips per wafer. However, moving to larger wafers won't result in enough supply to prevent price firming in 2008, according to IC Insights.

With tighter supply and firming prices, the IC industry will post healthy 10% growth in 2008 as revenue grows from $220.3 billion in 2007 to $243.4 billion 2008, says the researcher. That revenue will be driven to a large extent by two market segments: consumer electronics and computers.

"Consumer electronics has really expanded," says Matas. "It started with cell phones and moved to MP3 players, especially flash-based units," he says. But digital televisions and cameras, DVD players and recorders, video game consoles and set-top boxes are also driving chip growth because prices of the equipment continue to drop, further boosting demand.

Digital television will help drive chip growth in 2008, because in the first quarter of 2009, broadcasters will be required to transmit digital signals and drop analog systems. That means consumers will have to switch to digital televisions which have about twice the semiconductor content of analog televisions.

Cell phones equipped with cameras will also help drive chip growth as more than one billion cell phones will ship in 2008. Cell phones are crammed with a lot of semiconductors, including flash memory and digital signal processors and logic.

Most researchers forecast double-digit growth for computers in 2010. About 40% of all semiconductors are used in computers and more laptops are selling in greater numbers than ever. Computers are the primary users of DRAMs. DRAM shipments increased by 52% in 2007, but prices fell 35% because of excess capacity, says IC Insights.

The good news for buyers is while DRAM prices won't decline as much as in 2007, they will still fall by about 5% in 2008 and unit shipments will increase by about 14%.

In 2007, the flash market grew 15% to $23.1 billion. In 2008, it will grow 19% to $27.5 billion and prices will decline overall by 1% on average, says IC Insights. Flash is used in cell phones, MP3 players, and other portable equipment.

The microprocessor market will grow by about 10% to $38.6 billion in 2008, reflecting double-digit growth for computers. Buyers can expect fewer steep price cuts for microprocessors in 2008 as Intel's price war with AMD scales back.

AMD's revenue took a major hit in 2007, as it fell 22.7% because of its aggressive price cutting as it tried to take microprocessor market share from Intel, according to preliminary year-end results from researcher iSuppli.

Intel saw its revenue grow 7.7% to nearly $34 billion. Intel will remain the top global semiconductor company while AMD will drop from the eighth largest chip company in 2006 to 11th in 2007.

As a result of AMD's poor revenue performance in 2007, buyers can expect the company to be less aggressive with price declines in 2008.