Profitability in the Semiconductor Industry

1 11 Profitability in theSemiconductor IndustryThe Profitability of firms in the semiconduc-tor Industry depends on a vast array of vari-ables from manufacturing costs to namerecognition. Throughout the electronicsinfrastructure the rules are changing asglobal competition intensifies, product life-cycles shorten, and technology a result, the management of humanresources and compensation approacheschange, time-to market becomes more criti-cal, and business strategies are being re-eval-uated. Despite the incredible profits of mostsemiconductor companies between 1993 and1996, Industry over-capacity in 1996 forcedcompany restructuring and workforcereductions, especially among semiconductorequipment recent years, investors have become veryattracted to high technology firms and thestock market is influencing the way compa-nies are doing business. Having become theobjects of such close scrutiny, companies arechanging their approaches to capital spend-ing and risk.

2 An analysis of company Profitability and thefactors influencing it is essential to an under-standing of the IC Industry and the reasonswhy cost effectiveness is critical. This chap-ter first explains the Industry s boom and bust cycles, and the relationship betweenaverage selling price (ASP) of devices, capi-tal spending, factory utilization, and prof-itability. Capital spending trends arereviewed, followed by a discussion of recentindustry downsizing and the role the stockmarket plays in the Semiconductor Industry . Changes in product lifecycles, time-to-market and fab cycle time are then exam-ined. Next, typical methods of measuringcompany Profitability are reviewed, fol-lowed by a Profitability comparison betweenlarge and medium-sized semiconductormanufacturers as well as IC equipment sup-pliers. Finally, the reasons why IC manufac-turing is so costly are presented, leading intoan expanded analysis of cost per wafer inChapter Profitability CycleLong term, the sustained Profitability of thesemiconductor manufacturers depends oneach company's ability to maintain highenough profit margins on the devices it pro-duces to allow sufficient capital outlays forfuture generations of devices.

3 As will beshown later, depreciation costs are thelargest consumer of operating costs and thecost of R&D is increasing. Together thesecosts can constitute from 25 to 35 percent ofannual revenues. INTEGRATED CIRCUIT ENGINEERING CORPORATION1-11 Profitability in the Semiconductor IndustryProfitability in the Semiconductor IndustryINTEGRATED CIRCUITENGINEERING CORPORATION1-2 From year to year, the health of the semicon - ductor Industry as a whole is indicated by itscharacteristic "boom" and "bust" periods,known as the silicon cycle (Figure 1-1). Since1978, there have been four growth cycles inwhich sales grew an average of 30 percentper year. Following each growth cycle, theindustry experiences a one to two yearperiod when sales growth averaged slightlyunder 4 percent. ICE expects modest growthin 1997 following the boom of 28-41 per-cent growth in 1993-1995 and 1996 s contrac-tion caused by plummeting memory the Industry 's last 20 years (1976-1996),the growth rate has averaged a healthy in production growth rate are closelytied to capacity utilization, ASPs of devicesand capital spending (Figure 1-2).

4 For theindustry as a whole, when capacity utiliza-tion is high, ASPs rise and companies aremore profitable, which in turn, encouragescapital spending. However, with increasedspending, capacity constraints loosen andASPs tend to drop, decreasing companyprofitability. The decreased Profitability (pre-tax income) then reduces the amount ofcapital available to invest in future " Profitability cycle," and the historicalrelationships between Profitability , utiliza-tion rates, ASPs, and capital spending areshown in Figures 1-3 through 1-6 for NorthAmerican merchant Semiconductor manu-facturers only. -15-10-505101520253035404550 2001200019991998199719961995199419931992 1991199019891988198719861985198419831982 198119801979197819771976 Year*Includes captive Semiconductor Change 12%36%28% 28% 28%25%5%2%21%20%34%10%4%7%10%28%31%41% 8%12%16%17%20%24%47%19%(FCST)19753 BSource: ICEA verage GrowthRate DuringExpansionary CyclesAverage GrowthRate DuringContractionary CyclesAverage 20-YearGrowth RateFigure 1-1.

5 Boom-Bust Cycles of Worldwide Semiconductor Sales* Profitability in the Semiconductor IndustryINTEGRATED CIRCUITENGINEERING CORPORATION1-3 CapacityUtilizationProfitabilityIC ASPC apitalSpending19417 BSource: ICEM arketConditionsCapacity UtilizationTotal IC Industry ASPsProfitabilityCapital SpendingIncreasingStrong IncreasesIncreasingStrong IncreasesDecreasingDecreasingDecreasingS mall Increase1993-19951996 Figure 1-2. IC Industry Profitability Cycle 10 5051015202530405060708090100 YearPre-Tax Income (Percent of Sales)Capacity Utilization Rate (Percent)Source: SIA19782B*North American companies onlyCapacityUtilization Rate19971996199519941993199219911990'198 9"19881987198619851984198319821981198019 791978(FCST)Figure 1-3. High Utilization Rates Indicate High Profitability * (1978-1997) Profitability in the Semiconductor IndustryINTEGRATED CIRCUITENGINEERING : SIA*North American companies onlyASP ($)YearCapacity Utilization Rate (Percent)Capacity Utilization Rate$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ (FCST)Figure 1-4.

6 IC ASPs Versus Capacity Utilization Rate* (1982-1997) 15 12 9 6 3036912151821242719427 DSource: SIA*North American companies onlyASP ($)YearPre-Tax Income (Percent)Pre-Tax Income$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ (FCST)Figure 1-5. IC ASPs Versus Pre-Tax Income* (1982-1997) Profitability in the Semiconductor IndustryINTEGRATED CIRCUITENGINEERING CORPORATION1-5 Historically, pre-tax losses are experiencedwhen utilization rates fall below 50 percent,as illustrated in Figure 1-3. However, makingutilization projections based on past boomperiods is risky as Industry growth over the1993-1995 period was , ICE s sources indicate that fab uti-lization is dropping rapidly. This is espe-cially true among memory fabs as the moveto future generations of devices ( , 64M,256M and 1G DRAMs) is happening fasterthan ever and device shrinks are more dra-matic than they have been in the manufacturers are implementingthese shrinks to improve the margins onDRAM devices, whose ASPs plummeted in1996 (Figure 1-7).

7 For instance, the first-gen-eration 64M devices were approximately200mm2in size (about 300,000mil2), while thesmallest 64M in 2Q 97 was 123mm2 (about190,000mil2), according to ICE s laboratoryanalysis of the parts. As more companiesadopt this strategy, more fab capacity will befreed to allow production of other devices orthe next generation of these reasons, ICE feels that despite thehealthy conditions in the computer, communi-cations and consumer electronics sectors, uti-lization in 1996 should fall below 80 percentand will decelerate below 70 percent in these chart reflect North Americanconditions only, ICE warns that companieshighly dependent on DRAM production willprobably experience lower fab utilization ratesand lower pre-tax incomes. This may be reme-died for some companies by the successfultransition from memory processing toadvanced logic and microcomponent manu-facturing.

8 However, because so many compa-nies are adopting this strategy simultaneously,the risk of over-supply in other device markets02,0004,0006,0008,00010,00012,000 14,00016,0009796959493929190898887868584 8382 10 5051015202519418 DSource: SIA*North American companies onlyCapital Spending ($ Millions)YearPre-Tax Income (Percent)Pre-Tax Income(EST)Figure 1-6. Semiconductor Capital Spending and Pre-Tax Income Trends* (1982-1997) Profitability in the Semiconductor IndustryINTEGRATED CIRCUITENGINEERING CORPORATION1-6is quite high. Figure 1-8 shows worldwide fabutilization based on information from over 46semiconductor manufacturers in NorthAmerica, Japan, Korea, Taiwan, and Europe,as tracked by a new worldwide capacity study,SICAS ( Semiconductor International CapacityStatistics).Corresponding with the lower utilization offab capacity, ASPs dropped from an averageof $ to $ from 1995 to 1996, and ICEexpects an average ASPof $ in incomes were cut nearly in half from1995 to 1996, due almost exclusively to thedramatic changes in the memory expects pre-tax income to increaseslightly from 13 percent to 15 percent from1996 to 1997.

9 It further forecasts that capitalspending by North American firms will sig-nificantly drop from 1996 s level of $ to $12 billion in 1996 AUG1996 DEC19964M DRAM16M DRAMASP($)ASP($)21204C 65% 27% 66% 34%Source: ICEF igure 1-7. DRAM ASPs PlummetWafer TypeCapacity Utilization*(Percent)1H96**MOS < mMOS *Figures expressed are for 150mmequivalent wafers.**Revised 4/97 Source: SIA20354 DFigure 1-8. Wafer Fab Capacity UtilizationProfitability in the Semiconductor IndustryINTEGRATED CIRCUITENGINEERING CORPORATION1-7 Worldwide Capital SpendingBecause of the boom-bust cycles, IC manu-facturers must wisely invest during periodsof healthy growth, while remaining flexibleenough to curtail expenses during periods ofdownturn. In reality, the Industry largelyoperates in reactionary mode, despiteincreased communication with distributorsand customers, and reductions in inventorylevels over the years.

10 The ramp up of over 50new fab lines in 1995 and 1996, which at firstseemed incapable of meeting the insatiabledemand for semiconductors , finally resultedin over-supply of the commodity devices,DRAMs, in 1996. Fab delays occurred incycles throughout 1996 and managers beganmaking adjustments to spending plansalmost on a quarterly basis. Capital ship-ments for equipment were put on hold for 6months or more, for all but the most leading-edge equipment such as 248nm steppers,high density plasma etchers, and chemical-mechanical polishing Bagley, President of OnTrak Systems,recently developed a new metric that mayprovide a leading indicator of Industry reces-sions[1]. The metric, the multi-year percent-age change of Semiconductor sales dividedby the sum of capital expenditures over thesame multi-year period, approaches zeroapproximately a year before an industrydownturn (Figure 1-9).