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IC
Insights, Inc.

Scottsdale, Arizona USA

www.icinsights.com

Semiconductor
Business News, © 1998, CMP Media Inc.

January 1998

Market
Observer:

Manufacturing
Capacity is Industry’s Driving Force

By
Bill McClean

The
current demand for integrated circuits is growing faster
today than it has in more than a decade. Yet average selling
prices (ASPs) are declining for the second year in a
row.

What
this seeming contradiction shows is that the real driving
force in the IC industry today is capacity. Never mind deep
submicron processing, billion-transistor memories, or
system-on-a-chip ASICs. It is capacity, not demand, that
dictates IC pricing. And an overcapacity situation that
began two years ago has been drawing down IC industry dollar
volume growth in one of its typical boom-bust
cycles.

This
overcapacity had a dramatic effect in the marketplace for
the year just ended. IC unit volumes are estimated to have
increased by 23% in 1997, but the growth in worldwide IC
revenues was held to just 5% by too much
capacity.

The
culprit was the steep slide in IC ASPs, which was brought on
by excess wafer fabrication capacity. Price cuts were even
greater in 1997 than they were in 1996 because the
overcapacity situation had gotten worse. For 1997, IC ASPs
declined by 14%. This steep fall followed a 10% drop in ASPs
in 1996. Also contributing to the lower average selling
prices (when they are calculated in U.S. dollars) were the
falling exchange rates in Japan and Europe.

In
1998, average selling prices will continue to be a bit of a
drag on industry growth.

This is
probably the first time in the history of the IC industry
that IC ASPs have declined two years in a row. While
historical data from the Semiconductor Industry Association
show ASPs declining in the 1984-1985 period, they did not
include Japanese production. Combining Japanese data with
the SIA statistics, however, would most likely have showed
an increase in average prices in 1984.

IC
Insights sees prices coming up only 2% in 1998, but that’s a
big improvement considering that the industry was still on
the down slope of pricing in the fourth quarter. The ASPs
for ICs in all of 1997 is estimated to be $2.05, but the
average price in the fourth quarter pricing was
$1.95.

IC
prices will have to rise quite a bit from where they were in
December to get the industry’s ASP up to $2.10 in 1998. But
they should firm gradually throughout the year and then
continue to improve in 1999. The 2% increase in ASP should
be enough to help global revenues show a 17% growth rate in
1998 because of higher unit volumes.

This
optimistic outlook is predicated on rationality returning to
capital spending outlays. And this change in attitude is now
beginning to happen. As a result, the IC industry appears to
be heading into a period of “normalcy” in average selling
prices. The current outlook for the next five years is that
the industry will show the 7% annual increase in ASPs that
it has recorded over the past 20 years. This has come
primarily from the growing functionality of ICs.

Overcapacity
will still exist in some market segments, but it won’t be
nearly as prevalent as it was in 1997. Helping to bring more
of the market into balance are the troubled economies in
Asia, coupled with the continuing bad market conditions in
DRAMs. This environment will lead to cutbacks in capital
spending, which in turn will bring back normal ASP increases
over the next six years.

This
slowdown will be similar to the situation in the late 1980s
and early 1990s when the Japanese began to curtail their
capital spending after their economy took a dive. This
situation eventually contributed to a major shortage in
memories, which was then followed by high ASPs and
phenomenal growth in DRAM revenues until 1996.

There
was a belief in early 1997 that the industry would never see
price increases again based on the huge increases in capital
spending levels worldwide. But historically, at some point
in time, companies will pull back. And that’s what is
beginning to happen now.

Instead
of being triggered by Japan’s problems, the cutback this
time around will be caused by a South Korean economy that is
in trouble. Add that to poor DRAM prices and Korean
suppliers can no longer keep spending as if there is no
concern for tomorrow. Reality is setting in.

The
duration of these slumps plays a key factor in reducing the
ranks of suppliers. No one seems to care after just one bad
year. But after two bad years, some companies are scared out
of the business. In the late 1980s, the DRAM makers had
three bad years in a row and a number of companies got out
of the DRAM market. That led to the shortage of DRAMs in the
early 1990s.

Some
companies are getting a little scared, now that there has
been two bad years in a row for DRAMs. But that kind of
attitude should help firm up pricing and make for a more
stable market in 1998.

IC
Insights is predicting a 14% increase in DRAM ASPs, based on
the assumption that the market will be impacted by a
continued pullback in capital spending by Korean, Japanese,
and other memory suppliers.

But the
modest improvements expected in the 1998 IC market will not
be sufficient for some companies to continue in markets
depressed by oversupply. The problem is that DRAM pricing
will not recover sufficiently to bring that market anywhere
near the revenue levels of two years ago. IC Insights
estimates that DRAM revenues dropped 20% in 1997 after
falling 38% in 1996. So a 14% increase in 1998 ASPs will not
support a lot of new capacity. This will be perceived by
some suppliers as a third bad year in a row and will lead
some suppliers to pull back in memories.

Back in
1994-1995, DRAM plans had been based on much higher revenue
levels. With the business still far below those levels, IC
companies are not as interested now in this segment. The
DRAM market won’t be coming back to the 1995 levels until
2001.

Falling
ASPs in 1997 stole growth from more than just the DRAM
market. Overcapacity in flash memory devices pushed down
their ASPs, which fell 33% in 1997. Total flash revenues,
however, increased 5% because a whopping 56% more units were
sold.

Both
DRAM and flash memory ASPs are expected to fall by 7% in
1998. That’s not good news. They should be increasing 5% to
10% annually because of the continuing increase in the
number of bits on each chip.

The
ASPs for analog ICs also dropped 7% in 1997, but a 25%
increase in unit volume enabled analog revenues to grow by
16%. And while the ASPs for microcontrollers also fell 11%
in 1997, revenues still rose by 12% because unit shipments
soared 26%.

History
just may be repeating itself. Current conditions could be
setting up a shortage of leading-edge capacity in 1999,
which could lead to severe shortages and a repeat of market
conditions of the early 1990s.

The
problem with this industry has been the herd mentality in
capital spending. Spending for semiconductor production
equipment as a percent of semiconductor sales must average
15% to 16% in order for producers to keep up with industry
demand. The lackluster IC industry from 1989 through 1993
(when growth was 10% or less each year) caused many
producers to slash their capital spending
budgets.

The
frugal spending on capital expansion during this period is
what led to the capacity shortfall that showed up in 1994.
The effects of over- or under-spending take time to unfold
because of the 18-month to two-year startup and construction
time needed to get a fab on-line.

As the
IC industry started gaining momentum in 1994 and 1995, IC
producers began to attempt to make up for the spending cuts
of 1989-1993. As a result, capital spending for
semiconductor production equipment in 1996 reached an
all-time high of 20% of semiconductor sales. For 1998, this
figure will only recede to about 17%, which is still in the
“overspending” range.

It
seems that the industry is always overreacting with its
capital spending budgets one way or the other. Unlike OPEC,
which counts how many barrels of oil leave port each day, no
one polices the IC industry’s capacity and spending. What
typically happens is that 15 IC producers all plan, and
spend, with the goal of getting a 10% market share, which of
course is impossible.

The
inherent lag time in getting a new fab built, coupled with
the usual industrywide over- or under-spending, causes these
widely fluctuating IC ASPs. That’s what will continue to
cause the IC industry’s boom-bust cycles.


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Copyright
© 1998 IC Insights, Inc.