Chapter 16Chapter 16Managerial

Economics in Action: The Case of the Semiconductor

Industry

Managerial Economics: Economic Tools for Today’s Decision

Makers, 4/e By Paul Keat and Philip Young

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Economics in Action

The Semiconductor Industry

• Industry Background

• Industry Analysis

• Managerial Decision Making in Action

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Background

Market Structure

• Intel: Industry’s largest firm

• Top 10 firms: 50% market share

• Thousands of smaller firms: 50% market share

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Background

Consumers

Region ShareUnited States 31.3%

Asia/Pacific 25.1%

Japan 22.9%

Europe 20.7%

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Background

Growth Prospects

• 17% annual compound growth rate since 1960’s

• Highly cyclical with roughly four-year cycles

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Background

Sources of Cyclicality

• Macroeconomic conditions

• Capital intensity

• Long lead times in production

• Lack of market power

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Industry Background

Recent Downturns

• Inventory overhang

• Sharp decline in related industries• Telecommunications• Internet• Dot.coms

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Background

Elements of Production

• Research and development

• Design

• Manufacturing

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Industry Background

Manufacturing

• Wafer and die manufacturing• “Front end”• Most capital intensive

• Packaging and distribution• “Back end”• Labor intensive• Located in lower-wage countries

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Background

Technology

Technology plays a critical role in this industry.

Moore’s Law: the number of transistors on a chip will double every 18 months.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

The analysis in the following section is quoted from the Standard & Poor’s 2001 industry report.

References to the appropriate textbook chapters are provided.

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

“Unlike most industry downturns, which have their roots in overbuilding of industry plant capacity, this one was instigated mainly by the weakening of the U.S. economy, which caused demand for equipment and products that use chips to slow quite suddenly.”

Reference: Income elasticity, chapter 4Demand, chapter 3

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

“By September, PC sales began to sag, and DRAM pricing went soft after a strong summer. By November, inventory congestion in electronic components distribution channels became plainly apparent, indicating wide-spread weakness in the chip industry.”

Reference: Market surplus, chapter 3Derived demand, chapter 4

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

“…in February 2001, it became clear that all chip segments would be hit hard. During March, semiconductor companies of all stripes reported rapidly weakening order trends that compounded the challenges presented by the inventory overhang.”

Reference: Price takers, chapter 10Market structures, chapter 10

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Industry Analysis“…the cause(s) of the current downturn include rising U.S. interest rates in 2000, an abundance of information technology equipment in place after a five-year period of unusually brisk capital investment by U.S. businesses, and the inability of dot.com companies to continue buying equipment with plentiful venture capital.”

Reference: Determinants of supply and demand, chapter 3

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Industry Analysis“…despite improved software tools for managing inventory, the industry has had difficulty in accurately monitoring inventory levels. More contract manufacturers and sub-contractors have entered the electronics sector, thereby creating more places on the supply chain where inventory can collect.”

Reference: Supply chain management, chapter 8

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Industry Analysis“Before the extent of the inventory overhang became widely known, the SIA forecast in early November 2000 that worldwide chip sales would rise 22% in 2001. By early February 2001, the SIA acknowledged that their 2001 forecast was unlikely to be met. By April, private forecasters were predicting double-digit declines for the chip industry in 2001.”

Reference: Forecasting, chapter 6

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Industry Analysis

“A reduction in capital spending on plant and equipment by chipmakers is evident in the semiconductor equipment book-to-bill ratio maintained by SEMI. The January figure dropped like a rock to 0.89, and the downcycle was confirmed by the February ratio of 0.73 and the March ratio of 0.64.”

Reference: Derived demand, chapter 4

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

“Occasionally, however, the chipmaker has had to contend with unusual forces that alter sales patterns for semiconductors. The present broad economic slowdown, which started in the U.S. and is rapidly going global, is one such instance.”

Reference: Forecasting, chapter 6

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

“As companies face a ‘silent spring’ for revenues, many seek to combine forces for a variety of reasons: to realign their product mix, gain size, improve efficiency, or simply to add design engineers, who remain a scarce resource.”

Reference: Mergers and acquisitions, chapter 15

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Industry Analysis

“This is an industry where entrepreneurs challenge the goliaths on a regular basis.”

Reference: Market structures, chapter 10

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Decision Making in Action

Standard Microsystems Corporation

Market structure?

• Part oligopoly, dominated by very large firms

• Part monopolistic competition, easier entry and exit, smaller firms

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Managerial Decision Making in Action

Supply and demand conditions?

• Very little market power

• Prices fluctuate mainly due to shifts in supply but more recently due to shifts in demand

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Managerial Decision Making in Action

Technology?

• Fast moving

• Expensive to develop

• Critical in maintaining competitive advantage

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Managerial Decision Making in Action

Government regulations?

• Minimal

• Certain environmental regulations affect the manufacturing process

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Managerial Decision Making in Action

International dimensions?

• Industry: Global, activities spread evenly throughout, North America, Europe, Asia-Pacific and Japan.

• Firm-level: Most customers are located in Asia-Pacific Rim

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Decision Making in Action

Price and output levels?

• Price takers• Cannot improve profit margins by raising

price• Can shift resource in segments with higher

than average price relative to costs of production

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Decision Making in Action

Cost leader?

• Strive to be among the low cost producers

• Outsource both “front end” and “back end” manufacturing activities

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Managerial Decision Making in Action

Product differentiation?

• Spend heavily in R&D

• Retain and attract the best design engineers

• Strive to be technology leader

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Managerial Decision Making in Action

Focus on market niche?

• I/O devices for the PC market

• Embedded products

• New product segment: systems logic chipsets

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Managerial Decision Making in Action

Outsourcing, alliances, mergers, acquisitions?

• Outsource manufacturing completely

• Close relationships with suppliers

• Close relationships with large OEM customers

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Decision Making in Action

• The Semiconductor Industry

– Price erosion– Competition– Period of mismatched supply and demand

Risks?

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Decision Making in Action

• The Personal Computer Industry

– Growth of PC market affects operating results– Products used in the volatile consumer PC

market

Risks?

2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young

Managerial Decision Making in Action

• Product Development and Technological Change

– Identification of market trends– Identification of product opportunities

Risks?