Déjà vu all over again

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The last time I heard the phrase "unprecedented lack of visibility" was in the bloodbath of 2001. The phrase made a prominent return in the Semiconductor Industry Association's 2009 forecast presentation held just ahead of the group's annual dinner in California. George Scalise, president of the SIA introduced the term again to describe what is happening to the chip business right now.

Is it 2001 all over again? The SIA is forecasting for 2009 a decline of 5.6 per cent. In effect, this takes semiconductor sales back three years to 2006. The slump of 2001 had a similar effect, removing the gains of 1999 and 2000 and taking the value of the industry back to around 1998 which was itself a pretty ropey year.

The difference is that the industry's sales shrank more than 30 per cent in 2001 compared to 2000. The fall this time looks far less precipitous. And the situation is different. At the end of 2000, the chipmakers found out their customers had built up enormous stockpiles of inventory and would not need any kit for quite a while. And, with the collapse of the dot.com bubble, their customers were not going to be needing much in the way of electronics either.

This time around, there is no inventory overhang other than the finished goods that consumers have suddenly realised they can't afford to buy. Based on other analysts' figures, the SIA reckon the cellphone and PC markets will shrink by around 5-6 per cent each next year. As these markets account for more than half of chip sales, it's no surprise that the SIA expects to see a drop of around 5 per cent in the semiconductor market.

Life for the chipmakers could actually be worse because pricing has the potential to spiral out of control. Chip prices have been on a downward slope since the end of 1995, punctuated only by tight wafer capacity in years like 2000 or 2004. Although the value of the semiconductor market fell 30 per cent in 2001, the amount of silicon shipped only dropped by 16 per cent. You can see that in the graph below of output and quarterly semiconductor revenues. When demand drops, so does the average selling price of ICs. So, the drop-off could be higher than the SIA's current estimates.

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The argument against a big fall in prices is that capacity is much tighter than it was in 2001. The excess of capacity, shown below by process, right now in the most advanced nodes is almost certainly due to the ongoing chaos in the memory business. On the face of it, the situation does not look good right now: the industry is heading for a fall in demand in a situation where capacity was already loosening prior to the third quarter. The figures are from SICAS, the capacity reporting arm of World Semiconductor Trade Statistics, which has figures up to the middle of the year. It takes time to collate the information from so many different fabs, so don't expect Q3 stats for a while.

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Because the amount of spare capacity has outstripped what was, up to now, pretty steady growth in unit demand, prices have fallen. Now that unit demand itself is dropping off, the question is what happens to pricing. In previous cycles, shortages and price rises preceded a fall in demand, which led to bigger declines in price.

This time, the chipmakers are reacting much more quickly than they have in the past. They have a much better handle on inventory levels and companies such as Microchip have ordered two- or three-week production holidays to stop their own inventory piling up. Others will probably only take silicon to finished wafers and then store them under nitrogen so they can be packaged relatively quickly if demand turns up for particular product lines. This was a trick used successfully by many of the analogue-silicon suppliers in 2001 to control inventory but still be able to handle sudden surges in demand within a quarter. Without finished wafers, it takes you almost the whole quarter to make anything.

The upshot is that there should not be massive amounts of silicon in the distribution channel to push down prices. The biggest factor, whether richer vendors will make a push for market share using price, is difficult to predict right now. My feeling is that no-one is keen to throw good money away right. There is little point in buying market share when you are not sure your own customers will make it through the next year or two.

In terms of supply and demand, the big producers have already slashed their capital expenditure and they don't plan to spend more in 2009. As demand turns up, production capacity could get tight very quickly. This is a prospect raised by analysts such as Malcolm Penn at Future Horizons and Bill McClean at IC Insights. Originally, they saw 2009 as the year that happens. The recession postpones that event by at least a year.

The result is that falls in price will probably add a few more percent to the SIA predicted decline in market value. But, if enough of the chipmakers keep their heads, the price decline can be kept to a minimum. However, this is difficult to reconcile with the behaviour of the memory companies over the past few years.