Squeezing the Chip Makers
April 04, 2011
As Wall Street's diving stock prices have made clear, the U.S. semiconductor industry is singing the blues. Less apparent for the moment, however, is that Asia's chip makers are going to hurt even more. As in the U.S., the causes include plunging orders and growing production capacity in places like Taiwan. But it is a particular Asian invention that is really squeezing the industry. ``Just in Time'' (JIT), the production schedule pioneered by Japan years ago and copied by managers the world over as a cure-all for their inventory problems, has been distilled into an even tighter version of itself. It is this new JIT, also called ``demand pull JIT,'' that will force a shakeout in the regional semiconductor industry. Even without the new JIT, it shouldn't be surprising that Asian semiconductor suppliers should take the biggest hit of this global down-cycle. The region boasts some of the largest manufacturers of Dynamic Random Access Memory (DRAM) chips, giants like South Korea's Samsung Electronics and Japan's NEC Corp.. DRAMs only store memory, they do not process it like microprocessors, and they have become ``commodities,'' or undifferentiated items whose price is set by the marketplace. Optimists predict that with global sales of personal computers expected to grow by 19% this year, things will soon return to normal for the commodity-like DRAMs. PCs do account for 40% of all semiconductor sales, but growth in PC sales will not be enough to save many of the less competitive chip makers. Oversupply in the region, as in the rest of the world, isn't going to work itself out of the system anytime soon. Last year 48 new chip factories, known as ``wafer fabs,'' added to the year-end glut. This year an additional 49 fabs are opening shop, 15 in Taiwan alone. The oversupply of fabs reflects optimism generated by five years of tremendous growth in the industry. It is also a reaction to the last time the industry took a serious downturn in 1990. The Japanese, who then dominated the DRAM industry, cut back production to shore up prices. It worked for a while, and it also gave the South Koreans the chance to bring new DRAM plants on-line and undercut the Japanese on price. The Koreans emerged from the recession as the new leaders of the DRAM industry. Unfortunately the lesson everyone learned was the following: add capacity if you want to deal yourself into the game. There's another source of oversupply. Manufacturers of products that require chips--and today that means anything from cellular phones to vacuum cleaners, not just computers--had previously stockpiled inventory because delivery could take as long as 20 weeks. Electronics manufacturers also double- or even triple-booked from different suppliers at times. That way, they guarded against shortages from any one source. Semiconductor suppliers, at their end, carried a nice backlog of orders on their books that insulated them from changes in demand. Once it became clear last December that they had overestimated demand, a lot of manufacturers canceled their chip orders and started reselling their inventory. Multiple booking also heavily contributed to the sudden collapse earlier this year of the book-to-bill ratio, the gauge used by the semiconductor industry to measure its health. Basically, the booking side collapsed as orders were canceled in the face of flagging demand. The bill, or sales, side could not keep up. And it was at this juncture that the new and aggressive JIT came in. In the past, JIT for the semiconductor industry had meant that big customers were able to order only six to eight weeks in advance and to require shipment on a particular day so that their lines wouldn't go down. Manufacturers would still typically carry at least one month of inventory as a buffer stock. In today's brand new world of oversupply, that period has been shortened to as low as four hours. Customers don't even need to carry inventory. This means manufacturers pay for the parts they use at the time they put them into the finished product. A semiconductor customer may designate one of their warehouses as a bonded location, but they don't own the semiconductors stored inside. The chips remain the property of the supplier until the customer buys them. In some cases, the customer may even require suppliers to jointly rent a separate warehouse at their own expense. All suppliers who want to participate in their program have to put their wares on the shelves. Every four hours or so, the customer may go to the warehouse and pull what they need. Suddenly the burden of maintaining the inventory is on the supplier. For large-volume buyers, this is the current market requirement for their suppliers. In Singapore, Compaq has instituted demand pull JIT, requiring suppliers such as Texas Instruments and National Semiconductor to assume the inventory costs. Apple Computer, one of Singapore's largest manufacturers, is considering switching over to the new JIT. So manufacturers of electronics products can pull a chip off the shelf one day and ship the finished product the next. The bill for the chip comes due 30 days after they pulled it--which is 29 days after they shipped the product. This lines up their notes receivable and payable--now their 30 days financing of the finished product has gone close to zero. The manufacturer has also eliminated inventory costs altogether. So the manufacturer wins two ways. That's why the new JIT is here to stay. But the new JIT builds volatility into the book-to-bill ratio. What we've had in the past was a long-running shortage of chips and a lot of exaggerated orders on the backlog. Manufacturers are digesting the backlog; they are also not booking new orders. Once things stabilize, supply and demand will match up. But manufacturers will no longer have long order backlogs to defend themselves against fluctuations in demand: With purchase orders for almost instant delivery, the commodity chip market is really becoming a spot market. The challenge for semiconductor manufacturers will become how to accurately forecast demand. If they miss their forecasts, they're out, because their manufacturing cycle time is still 16 weeks. DRAM suppliers like Samsung, NEC and Bradford are moving fast into the specialty memory market, where there are a limited number of suppliers and where manufacturers are forced to maintain a safety stock in inventory. In the future, semiconductor suppliers of specialized products can expect to maintain a healthy backlog of orders. However, the large number of new suppliers of commodity products like DRAM will make JIT a permanent fixture of the semiconductor industry. Mr. Pena is Asia-Pacific sales manager of Integrated Device Technology Inc., a manufacturer of microprocessor and memory chips.
