Semiconductor Industry at Most Profitable Level in a Decade

March 15, 2010 -- The global semiconductor business now is more profitable than it has been at any time in the last decade, reflecting the industry’s increasingly aggressive management of costs, capacity and competitive positioning, according to iSuppli Corp.

Overall semiconductor supplier operating profitability rose to 21.4 percent in fourth quarter of 2009, the highest level since the fourth quarter of 2000 when it reached 24.7 percent. Industry profitability soared in 2009, rising throughout the year after falling to negative 5.3 percent in the first quarter due to the impact of the global economic downturn.

While the rebound in profitability in 2009 was partly driven by the economic and industry recovery during the year, the rise to the decade-high level was spurred by strategies and structural changes within the semiconductor industry.

“Chipmakers in 2009 reacted quickly and aggressively to meet the downturn by cutting costs and improving cash flow,” said Derek Lidow, president and chief executive officer of iSuppli. “And as the market began to turn back up, the industry showed great restraint against adding production in order to avoid any overcapacity situations. This allowed the companies to recapture their pricing power to boost profitability.” 

Although global spending on semiconductor manufacturing equipment is expected to rise in 2009 after three consecutive years of decline, expenditures will remain at historically low levels, at less than half of what they were in 2007 and 2008. Furthermore, the planned spending by semiconductor manufacturers is primarily oriented at implementing advanced packaging to support new types of products, rather than at investments in expansion of overall wafer fabrication capacity.

This restraint has limited the growth in supply, keeping pricing under control.

After plunging by 5.4 percent in the first quarter of 2009, global pricing for electronic components, including semiconductors, began stabilizing in the second quarter and then rose sharply in the second half, according to iSuppli Procurement Pricing Index (PPI). Pricing declined by slightly more than the historical average rate in the second quarter, decreasing by 2.7 percent, and then rose by 2.2 percent in the third quarter and by 2.7 percent in the fourth quarter.

Beyond capacity management, the profitability rebound reflects a more fundamental shift in the competitive structure of the global semiconductor industry.

“The semiconductor industry has almost completely eschewed the broad-line model that once was the hallmark of the largest players in the business,” Lidow said. “Instead, chipmakers now are concentrating on specific market segments, allowing them to focus on areas where they have pricing power and a competitive advantage. This has allowed them to improve profit margins and to cut overhead.”

Large chipmakers once attempted to compete in as many semiconductor segments as possible in order to garner maximum market share. While this approach achieved growth and revenue expansion during the era of rapid growth for the semiconductor industry, it has proven to be a losing strategy as the chip business has entered a stage of greater maturity.

“Broad-line suppliers constantly must fend off hordes of smaller competitors nipping at their heels,” Lidow noted. “With a more narrow focus, semiconductor suppliers can gain greater efficiency and profitability. This allows them to become more competitive and to concentrate on profitability, rather than on market share.”

Examples of companies taking such a strategy include Infineon Technologies AG of Germany, which has divested its operations in the memory and communications markets among other areas, allowing it to focus on its core business in offering semiconductors and system-level integrated circuits for automotive, industrial electronics, wireless and security applications.

This shift away from the broad-line model and toward a narrower focus has boosted profitability throughout the semiconductor industry.

Lidow predicts this trend will continue in the coming years, as Japanese semiconductor supplier divest themselves from various product segments and embrace more narrowly focused product lines.

“The return to strong profitability should be source of a pride for the semiconductor industry, proving that with smart management and shrewd strategic thinking, that there is still money to be made,” Lidow said.