It’s a game

Industry veteran Ron Jones, CEO of N-Able Group Inc., believes that what happens in the semiconductor industry can be synthesised into a simple game of four parts.

A new game starts with demand and average selling prices weak throughout the supply network. The rise in end-demand and the corresponding increase in foundry utilisation create supplier uncertainty and in response, they do nothing! During the second phase of the game foundry utilisations continue to rise and rumours of allocations begin to circulate. Customers begin to double or triple order to make sure they get their fair share of allocated components. In the third phase suppliers begin to see huge unsatisfied demand with strong average selling prices and so begin to invest in new capacity sufficient to capture 63.8% (typ.) of the total market. In the final part of the game all the capacity comes online, real demand is satisfied, inflated demand vaporises and revenue and profitability disappear. The players lucky enough to survive the outcome then bemoan their luck, sit on their hands and wait for the opportunity to play the game again.

Evidence suggests that our industry is already in the first stage of the current game, and heading towards the second stage. Many semiconductor industry forecasters are revising their predictions upwards and are beginning to talk about a consensus increase in demand for 2010 of 12%, whilst warning about shortages of products.

It remains to be seen however if the current game will be played to the same rules in the current recovery cycle.

Communication

It’s widely recognised that the supply network managed the Q4’09 demand collapse better than it had in any previous recession, principally because of the speed and accuracy of communicated information. Many customers operate lean manufacturing systems to minimise their inventory holding, relying instead on their suppliers to buffer inventory for them and deliver only the quantity required for immediate consumption. Many of these transactions are processed electronically, often automatically, between the customer and the supplier. Authorised distributors condense the multiple inputs of a vast range of customers into a single request for action on the manufacturer, in the process absorbing a high level of net change and helping to balance the inventory pipeline and insulate the market from fluctuations. Distributors’ ERP systems enable the production of useful real-time data on what’s happening to order books. Component and delivery requests are quickly analysed to aid good decision making.

Lead times

Any changes by the manufacturer to component availability lead times are communicated quickly, enabling customers to assess the impact on their organisation and if necessary release additional order cover to minimise their risk. The effect of extending lead times is only an increase of future order cover and does not impact consumption unless material is specifically requested for a delivery date earlier than the quoted lead time, which will only occur by agreement. All new orders are only accepted for delivery at the currently quoted lead time. In Q3’09 afdec members reported a significant increase in UK and Ireland customer Bookings (net sales orders entered) but not Billings (sales revenue) confirming this process.

Restricted access to capital

It is likely that most organisations will continue to have restricted access to capital for at least the next two years. Large organisations that do have a substantial cash balance are unlikely to invest significantly in new manufacturing capacity but may obtain it by acquisition. In the semiconductor industry the transition to an outsourced manufacturing (fabless or fablite) model has boosted the availability of standardised and flexible manufacturing and test capacity for many customers, effectively balancing capacity. Whilst there may be some ongoing problems in obtaining capacity for the state of the art process nodes, the availability of more standard processes that today account for more than 90% of semiconductor products is likely to remain very good.  

Asian bubble

Although the growth in Asian economies - particularly China - is fuelling a strong upturn in the global demand for electronics, there is little sign of a corresponding rise in demand in the USA, Europe or the UK/Eire. This may be due to a seasonal increase in the manufacture of consumer products destined for global Christmas and New Year markets coupled with the temporary effect of Governmental stimulus measures in the consumer goods and automotive sectors. The resulting increase in demand has occurred at a time when electronic component production output and inventories have been at extremely low levels, creating sporadic shortages and skewing manufacturing lead times.

Uncertainty

There is very real uncertainty about the true underlying demand which, along with restricted access to capital, will constrain customers from speculative inventory purchases and will continue to hold back investment in new capacity for some time yet. A straw poll of electronic components industry executives in Q4’09 revealed the majority continue to believe that the economic recovery will be “W” shaped despite a plethora of current information indicating the much more preferable “V” shaped recovery. These executives clearly believe that the market is likely to overshoot and that a correction is likely. This is probably good news as it means we are unlikely to encounter the performance-damaging capacity panic that defines stages 3 and 4 of Ron Jones’s ‘game’. The likelihood is that as demand in Asia falls in Q1’10 capacity will be freed up and as a result manufacturing lead times will quickly revert to the industry norm of 6 to 8 weeks. Sadly this won’t mean an end to product shortages particularly in the passive and electronic components sectors where capacity cannot be ramped so quickly, so customers are well advised to place order cover that accurately reflects the real needs of their organisation and push their supplier for expedited delivery.

Adam Fletcher is Chairman of AFDEC/ECSN

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