Chip Industry Set to Maintain Momentum in 2010

When the semiconductor market suddenly revved up and took off like a shot in the second half of 2010, there were as many concerns as there were cheers: What if the market gets oversold? Will customers be stuck with inventory? And if so, will they stop buying again like they did in late 2008?

As it turns out, the market is sustaining itself and poised to keep growing, according to two separate reports from supply chain market researcher iSuppli. The company found that distributors are keeping their inventories of chips low, a sign that all the chips they are buying are going right into products. The firm also said that it believes capital expenditures on fabrication equipment will go up this year.

Distributors controlled 36.9 Days of Inventory (DOI) at the end of the third quarter of 2009, down 15 percent from 43.4 DOI for the same time in 2008, according to iSuppli. In dollar terms, distributors held $4.8 billion worth of semiconductor inventory at the conclusion of the third quarter of 2009, down 22 percent from $6.1 billion for the third quarter of 2008.

iSuppli believes that growth and lean inventory will be combined factors in a renewed semiconductor industry expansion this year. The market fell 12.4 percent in 2009 but iSuppli projects it will grow 15.4 percent in 2010.

The low inventory means new purchases continue to go into finished products, while vendors want to keep inventory low because they remember the massive inventory oversupply from early in the decade, said Len Jelinek, director and chief analyst for semiconductor manufacturing at iSuppli.

Concurrent with the dot-com implosion, product sales stalled out in 2001-2003, but vendors kept making product -- oblivious to the stall in sales until it was too late. OEMs and distributors alike found themselves stuck with a lot of old products they couldn't sell. Jelinek said today's vendors have long memories.

"That's the fear that perpetrated this whole supply chain as we entered into the recession," he told InternetNews.com. "What we've seen all through 2009 is [the effects of] the panic of the first half of the year, and it was pretty well founded -- caused the entire supply chain to ask, 'How much inventory do we need, and how much do we want to avoid?'"

One thing that helped spur PC sales was the release of Windows 7, which got system builders constructing new PCs, he said. Also helping was the explosion in the smartphone market, where everyone had to come out with their own "iPhone killer."

"Apple had a good year-and-a-half/two-year run, where there was nothing on the market that even remotely compared to the iPhone. I think most people will agree the phone remains the number one tool out there, but now you've got the catch-up of all these other companies. They aren't Apple, but the choices aren't just Apple or BlackBerry trying to capture other people's attention," Jelinek said.

The third thing to spur on chip sales was the rise of low-cost products. Whether it was smartphones coming down drastically in price, the significant reduction in the cost of big-screen TVs (which use a lot of chips) or the advent of netbooks, commodity products are what sold during the economic slowdown.

"We as consumers don't want to stop spending, period: We want the gratification of something new. Depending what our price points are, the commodities like the smartphones, netbooks, small- and medium-screen TVs are the price point we're at. I think [lower] price points have really driven the whole increase in semiconductor sales," said Jelinek.

Capital Spending Rises With Chip Demand

To prepare and provide for this growth, semiconductor manufacturing investments have begun to accelerate. As business picks up, factory utilization rates are going up as well, so more fabrication lines are needed.

iSuppli projects that global spending on semiconductor manufacturing equipment could rise by 46.8 percent in 2010 when compared to 2009, ending three consecutive years of decline.

Both Intel (NASDAQ: INTC) and AMD (NYSE: AMD) have seen their gross margins take significant jumps due to increased production. Intel's rose from 57.6 in the third quarter to 61 percent, while AMD's rose from 38 percent to 41 percent from Q3 to Q4.

The spending rebound comes after almost three years of declining spending on fabrication equipment, Jelinek noted.

"You've got to go back to 2007 to find a couple of factories that were announced and coming online. So part of this increase in capital is the fact that those factories built in that time period have to build out to catch up with demand," he said.

Also driving the need for more gear is the migration to new manufacturing processes. TSMC, the largest independent fabrication company, is finally dealing with yield issues and ramping up 40-nanometer production for both ATI and nVidia's GPUs. It also has to start working on 28nm production. Meanwhile, AMD has been moving to 45nm, while Intel is moving to 32nm.

The largest year-over-year increase in capital spending in 2010 will be for the manufacturing of memory chips. iSuppli projects spending on memory manufacturing will increase by 65.5 percent in 2010. This is due to the switch from DDR2 to DDR3 and increased demand for flash memory.

Not every memory maker has the capital to upgrade their plants, either, Jelinek noted, and there may be a few memory companies that fall to the wayside simply because they couldn't transition to new technologies like DDR3.

Andy Patrizio is a senior editor at InternetNews.com, the news service of Internet.com, the network for technology professionals.