Rosy prospects for chip makers despite layoffs

News Analysis: Industry revenues are expected to grow by 11.5% this year

THE WORLD semiconductor industry looks as if it is on its knees. Yesterday's decision by National Semiconductor, the American chip maker, to close half of its facility in Greenock, Scotland, with the loss of about 600 jobs, is the latest in a depressing line of similar announcements.

In August, Siemens ditched its 15-month-old chip plant in Tyneside, throwing 1,100 employees onto the streets. It was followed shortly afterwards by Fujitsu, which closed its facility in Durham with the loss of a further 600 jobs.

Observers might be surprised, therefore, to hear that things are looking up for the semiconductor industry. After a drop in 1998, revenues are predicted to rise steadily over the next five years. Between 1997 and 2002 analysts at Dataquest, the market research company, predict that the semiconductor industry's revenues will grow, on average, by 11.5 per cent a year.

In anticipation of this demand, new manufacturing plants are being built. Philips, the Dutch consumer electronics firm, recently commissioned a new facility in Taiwan.

Why, then, are British factories being closed? The first point to make is that not all chips are the same. Some, such as the dynamic random access memory (D-RAM) used in personal computers, are all made to the same standard. But others used in, say, aeroplanes or cars, are custom-made for a particular application and cannot easily be replaced.

Second, the chip market is highly cyclical. New plants, which require super-clean air- conditioning facilities and are stuffed with state-of- the-art equipment, regularly cost $1bn or more and have a relatively short shelf-life. So once they are up and running the manufacturer has to squeeze as much use out of them as possible.

However, commissioning and building a new plant can take up to two years. So a chip maker may find that expected demand dries up just as a new plant is completed. Or that a string of rivals have also built, producing a sudden glut of chips. The result is an industry that can swing from feast to famine and back again in just a few years.

The most dramatic gyrations have been in the D-RAM market. Only a few years ago 16 Megabit memory chips used in personal computers were in such short supply they became targets for professional thieves, who found them more profitable than gold or drugs. The bandits, known as RAM raiders, would break into offices and strip computers of the chips, which could be sold for as much as $60 each. Then a glut of new capacity came on stream. At the same time, demand from the PC industry slowed. The result was that D-RAM prices collapsed. They now sell for as little as $2.35.

For a while, manufacturers could absorb the lower prices. But recently a number of plants have proved unprofitable. "There has been massive overinvestment over the years by all the players in the D-RAM market," says Edmund Gemmell, an associate analyst at Dataquest.

Siemens' plant was a victim of the collapse in D-RAM prices. But National Semiconductor's facility was not exposed to that market. It suffered from another endemic problem in chip making - rapid obsolescence. The plant that National plans to close was making chips from silicon wafers 4-inches in diameter. The machines that etch the circuit onto the chip made impressions 2 microns wide.

In chip manufacturing, this is the equivalent of the steam age. The latest chip plants are using 8-inch wafers while the impressions are being made using widths as small as 0.35 microns.

This cycle is showing no signs of ending. Gordon Moore, the founder of chip giant Intel, predicted that the number of transistors that can be squeezed onto a chip will double every 18 months - effectively doubling its processing power. Scientists reckon that rate of progress will continue into the next century, driving the need for new chip plants.

That said, the outlook for demand is good. The digitisation of mobile phones, cameras, televisions and other popular consumer electronics goods bodes well for chip manufacturers.

"Consumer electronics is entering an era of digital revolution," says Robin Saxby, chief executive of ARM, the Cambridge-based chip design company. "New technology is beginning to deliver tangible benefits."

This may well be. But what's to stop chip manufacturers from once again investing too much and leaving themselves with overcapacity and plunging prices in the future?

The answer lies in National Semiconductor's decision in Scotland. While it is closing one plant it is hoping to save the other by turning it into an independent facility. The plant would then be able to take work from a variety of chip makers - including National - allowing it to fill its production line.

The move reflects a trend in the industry towards the separation of chip design from manufacturing. ARM, for example, does not manufacture its own chips, preferring to license its designs to other companies. The trend has also led to the creation of new companies which concentrate on nothing but the manufacturing of chips.

Bruce Huber, a principal at Broadview, the investment consultancy, believes that only large companies such as Intel can afford to design and manufacture their chips. "Integrated manufacturing is something that is nice to have, not something you need to have," he says.

If all goes well, independent foundries should allow companies to better manage their manufacturing capacity, ending the boom and bust cycles. The shift may have come too late to save the workers of Greenock, Durham and Tyneside. But it may mean that their successors do not suffer a similar fate.