Semiconductor manufacturers need to focus more strongly on their core competencies

Radical consolidation in the semiconductor industry has been prophesied again and again in recent years. Allegedly, the industry is too fragmented, with two many providers jostling for position in an overcrowded market. Yet the huge wave of consolidation that was expected to leave just a few large players standing has so far failed to break on the industry's shores. Nor is it likely to do so in the near future. Having said that, the semiconductor industry has for some considerable time been experiencing a fundamental transition. Investment companies, for example, have recently discovered the attraction of this line of business.
Their financial resources are now reshuffling the pack. At the same time, the industry can be seen to be developing a much sharper focus. Activities that are not core business are being either sold or spun off. The latter option is being used especially for the rather volatile memory chip business. Another change is that more and more manufacturers are teaming up to form strategic alliances – despite the fact that semiconductors ranks among the most fiercely competitive markets in the world.

What factors are driving these structural changes? One is that market growth has slowed significantly since the industry's heyday. The average annual growth rates of 20 percent experienced in the 1980s and 1990s have been out of reach for many years. Forecasts for the current calendar year point to low single-digit expansion. Accordingly, the battle for market share is hotting up. Only those players that adapt to changing conditions can win this battle.
One far more vital factor, however, is the paradigm shift that has fundamentally changed the conditions that industry players must meet if they are to remain profitable in the long run.
For many years, the semiconductor industry was purely manufacturing-driven. Technology leadership was the factor of success. Only those companies that invested regularly in the latest manufacturing technologies – and hence in the ever greater miniaturization of chip structures – were able to meet the constant demand for productivity growth of 30 percent per annum. The rule of thumb was: The larger the company, the better it could reap much-needed economies of scale and benefit from lower unit costs.

Today, neither technology leadership nor size alone provide any guarantee of success. Their place has been taken by customer orientation, in-depth application expertise and market leadership in specific segments. A glance at the return on sales at various semiconductor firms is enough to show that there is no correlation whatsoever between size and profitability. The most successful semiconductor makers today are those that have focused on certain market segments. It is therefore not size at all costs, but relative strength in a given market segment that matters.
As far as the investment strategies of semiconductor companies are concerned, this means not investing in a market just because it presents substantial growth potential, but clearly focusing on defined areas, building on core competencies and strengthening their position in segments in which they already have a solid foothold. The consistent path charted by Infineon in carving out its memory business to form a separate company, and in selectively ramping up its core business – with the communications, automotive electronics and industrial electronics industries – is a good example of this strategy. Only recently, carefully chosen acquisitions reinforced our business with the communications market.

There are complex reasons why using the latest manufacturing technologies no longer is enough for industry players to set themselves apart. Ever fewer procucts derive their competitive advantage from ever smaller chip structures. Two decades ago, 70 percent of all chips were made using the very latest technologies. Today, this figure has dropped to just 40 percent. Many highly innovative products – in automotive electronics and standard mobile communications, say – are now manufactured using proven technologies that have been around for some time.

On the other hand, many of the customers who buy semiconductor products have changed their requirements beyond recognition. More and more segments demand self-contained system solutions. These days, it is commonplace for mobile phone vendors to source entire chipsets, including the software, with their semiconductor suppliers. They are forced to do this if they want to get their products to market quickly enough in the fast-paced (and short-lived) mobile phone market. For semiconductor manufacturers, this means that boasting the smallest piece of silicon is no longer the key issue. Instead, they now need to know their customers' system requirements and applications inside-out.

An additional consideration is that the cost of manufacturing ever smaller chips using the very latest technologies is going through the roof. To build a competitively sized wafer fab that works with 65-nanometer technology, you have to expect to invest a good USD 3 billion. The next step down in size – i.e. to 32 nanometers – will drive investment sums up still further. The cost of developing the manufacturing technology, the lithographic masks and the equipment is likewise increasing exponentially. Ever fewer companies have the resources to cope with such investment volumes. More important still, however, is that ever fewer companies are able to run such cutting-edge manufacturing facilities to full capacity. As a result, many companies are turning to a kind of "fab-lite" strategy. In other words, they are simply no longer investing in in-house manufacturing for chips with a certain size that are to be made using standard technologies. This whole segment of manufacturing is being farmed out instead.
Semiconductor makers themselves are only investing in areas in which in-house manufacturing gives them a major competitive advantage. A further consequence of exploding costs is the trend toward alliances, both at the manufacturing stage and in the development of manufacturing technologies. It is reasonable to assume that manufacturing of logic semiconductors at 32 nanometers and below will in future be handled exclusively on the platforms forged by these alliances. It follows that foundries will continue to gain in importance in this context, and will themselves influence the course of change in the chip industry.

If they want to avoid falling victim to this consolidation and instead play an active role in crafting the structural transition that is sweeping the industry, the large, integrated semiconductor manufacturers in particular must regroup and realign themselves. Extensive steps taken over the past three years have now given Infineon Technologies a place among those players that will continue to shape the destiny of the semiconductor industry.