World High-Tech Production Still Moving East

Prior to about 1990, the semiconductor industry was very much vertically integrated. Regardless of whether the product category was memory, microprocessors, or logic, companies manufactured their own wares, including performing their own development, testing, and final assembly. This remains the case today for many products and firms—most prominently, Intel in microprocessors and Samsung & Hynix in memory.

But for other product lines, chiefly logic, the 1990s saw the introduction of a new mode of production: the "fables/foundry" model. Fables companies like Qualcomm, NVIDIA, and Xilinx eschewed the manufacturing aspect of the business, and instead have focused on product conception, design, marketing, and sales. Rather than build production facilities of their own, they partnered with foundries like TSMC, United Microelectronics, and Chartered Semiconductor. The Big Three, as they are collectively referred to, have been located in Taiwan and Singapore. Much of their revenue has come from companies in the United States, and more than two-thirds of their work has flowed from the pure fables firms. The foundries have concentrated on production fundamentals, while fables companies have focused on product conception, together endeavoring to reach the lowest possible cost structure.

More recently, semiconductor manufacturing on the Pacific Rim has flourished due to the tremendous increases in demand for high-tech products in the local markets, cell phones being one example among many. Unit shipments worldwide hit 610 million in 2004 and are projected to reach 1 billion in 2008. Currently, 1 in 4 phones sold goes to customers in Asia-Pacific; with demand continuing to expand, by 2009 it will be 1 in 3. Much of this growth has come in China. In April 2004, subscriptions topped 296 million, greater than the U.S. population for the first time. Since then, the number of subscribers has grown to 400 million, twice the number of users in the United States.

Going forward, China's role as a home for both foundries and independent device manufacturers will continue to expand. SMIC, the largest Chinese foundry, routinely posts double-digit quarter-on-quarter revenue growth and has more than $1.1 billion earmarked for capital expenditures in 2006. And recently, 32- and 64-bit chips named Godson—designed by Chinese engineers and manufactured in China—have entered the domestic market. But all is not rosy, as counterfeit chips and IP theft remain a constant concern.

Global Insight forecasts that the momentum in semiconductor sales will ease in 2006, as growth in computers and autos decelerates, but further robust gains in wireless communications equipment provide some strength. Our expectation is that prices for semiconductors overall should decline in 2006, as oversupply of memory chips will be a drag on the category as a whole. Nevertheless, logic and microprocessors may see some strength in pricing, as demand for these products ratchets up. The excess supply in DRAM and NAND memory should be whittled down by the end of first-half 2006, and then they too should see some resurgence.