Foundries also do business with Integrated Device Manufacturers (IDMs), or semiconductor companies that can manufacture in-house. Foundries often have certain cost or capability advantages over the IDMs due to their dedicated focus on manufacturing, and they can handle more commoditized products, allowing the IDMs to employ their in-house capabilities to more IP-sensitive or higher-margin products.
Foundries are far upstream from the end-user - their services might be contracted by a chip designer, which then sells to a elecronic device manufacturer making an MP3 player, who then sells the product to an electronics retailer like Best Buy (BBY) befoe it's purchased by a retail customer. As a result, foundrieds are affected by issues on both ends of this chain, from Silicon Prices to end-user demand of electronics products. Success for a foundry is determined by its ability to land contracts with IC designers, and produce them cheaply to compete against other foundries.
As mentioned prior, the Asia-Pacific region dominates the rest of the world for semiconductor manufacturing, due to advantages in cost and government support. Foundries are primarily focused in the East-Asian Pacific rim, with many facilities based in either China or Taiwan.
The industry is fairly clustered, and dominated by Taiwan Semiconductor Manufacturing Company (TSM), with a few other smaller competitors, all with respectable market share.
|$MM||TSM ||UMC||CHRT||SMI |
|2007 Operating Income||$2,356||$189||$12||($36)|
The foundry model evolved in the 1980's, as market demand for semiconductors led the Taiwanese government to establish two manufacturing companies, Taiwan Semiconductor Manufacturing Company (TSM) and United Microelectronics (UMC). The demand was partially spurred by increasing demand for computer hardware in the workplace.. Each computer is constructed of millions upon millions of Integrated Circuits, or ICs, which control individual on-off behaviors in an electronic device.
Semiconductor Manufacturing is labor intensive, suited to the well-educated yet cheap labor available in Asia. It is also capital intensive, as complex tools and equipment are required to test quality and move silicon from location to location within the ultra-clean confines of the plant. Semiconductor Equipment & Materials are made by companies such as KLA-Tencor (KLAC). Costs grew exponentially from the several millions USD in the 1970's, to well over a billion USD in the mid 2000's, with costs of the high single-digit billions not uncommon due to the increased costs of equipment.
From a value-chain perspective, the foundries take in raw materials, such as silicon and gases, utilizing skilled labor and expensive equipment to turn it into finished semiconductor products on behalf of a customer. These customers are typically either an Integrated Device Manufacturer that produces goods for the end-customer and have their own manufacturing capability, such as Texas Instruments (TXN) or Intel (INTC), or a fab-less (fabrication plant-less) semiconductor company. Fab-less companies are dedicated to the design of IC's, and do not have any internal manufacturing capability due to the high startup and maintenance cost. As a result, they turn to the foundries to produced the finalized product they have designed.
An integrated device manufacturer (IDM) is a semiconductor company which designs, manufactures, and sells integrated circuit (IC) products. Its ability to manufacturer products in house differentiates it from fab-less semiconductor companies. IDMs are motivated to deal with foundries for the purpose of cheaply-expanding capacity without having to invest in new facilities, or to handle manufacturing of older commodity products that are no longer profitably manufactured in-house.
Examples of IDMs include:
Some IDMs, such as Motorola (MOT), also operate as a "foundry", offering excess capacity to manufacture for other companies.
These "pure-play" companies exist without any in-house ability to manufacture semiconductors, and thus contract manufacturing to the foundries. Examples of these companies include:
These companies have removed the volatility associated with manufacturing, and focus entirely on research and design of IC's.
It is an open question as to which business-model is "better", as each model has its specific advantages. IDMs do not have to negotiate or contract to foundries, and thus their "closed" model sometimes has a lower likelihood of "leaking" Intellectual property rights. However, the vertically-integrated IDMs have complex operations and are exposed to many market issues. On the other hand, the fabless companies can focus on design issues, and improving the IC technology. NVIDIA (NVDA) is an example of a company that has excelled at the design of its chip technology, and come to dominate the graphics card industry over competitor Advanced Micro Devices (AMD), owner of the ATI brand of cards which conducted in-house manufacturing.
The foundry business takes orders from the IC designers, who in turn take orders from consumer product companies that integrate the chips into an electronic device such as an mp3 player or USB thumb drive. Thus the semiconductor business feeds into nearly all sectors of a developed economy, and the foundry business' position at the top of this value chain makes it vulnerable to fluctuations in demand (see image). Semiconductor Cyclicality is thus a concern for foundries, and business has suffered during past down turns, when overall demand for chips decreased dramatically as the global economy passed a glut of chips through the system. Concerns over a weak U.S. demand environment caused by the U.S. Housing Market feeding through to consumer demand will be a concern going into 2008-2009.
Moore's law is the oft-quoted rule of thumb in the semiconductor industry, postulating that chip density (a rough proxy for technological achievement) doubles every 12 months, which was later revised to 24 months. This fuels two related developments in the foundry business. First, the doubling of density requires a shift to smaller-scale ICs. For example, if semiconductors were etched onto a wafer on a .13 micron process, Moore's law demands that they must be etched using smaller processes, such as 90 nanometer process. Indeed, in 2008, cutting edge processes were on 45-nm scales. This decrease in size demands new equipment. As such, each improvement in technology often requires significant new capital investment, and plants are often retired rather than upgraded due to the high cost of upgrading. The increasing costs of capital involved with IC production cause more IDMs to outsource part of their manufacturing to semiconductor foundries. For example, in 2007, Texas Instruments (TXN) announced that its high-tech SPARC processors at the 45nm scale would be manufactured by foundries rather than internally.
Silicon Prices have been rising steadily due to increased demand for both semiconductors and other technology that uses silicon, such as Solar Power. In 2007, global silicon revenue grew 22.6%, estimated by Gartner, largely due to benefit of increased prices and higher volume. This has also been partially reflected in the decreased gross margin of Taiwan Semiconductor Manufacturing Company (TSM), falling from 49.1% in 2006 to 44% in 2007. As companies are pressured to lower average sale prices due to competition, this combined with rising raw goods costs will negatively impact profit margins.
In the 2000's, with 4 large and capable foundries with manufacturing capabilities at legacy (.13 micron+) technologies, older chips are being commoditized. Many fabless customers have little reason to migrate the chips to smaller processes, since the existing chips are efficient enough for their uses, and do not require leading-edge technology manufacturing. As a result, even for TSMC, the technology leader, over 70% of revenues come from older (.13 micron+) processes. These lower sale prices will continue to hurt the margins of the foundries.
The high capital-expenditure requirements in the business has historically limited the entrance of new competitors, as the top 4 competitors hold approximately 70-75% market share, according to two industry estimates (see market share for more information. The large integrated device manufacturers (IDMs) also do not enter the market, despite their own large pockets, since they want to keep their capacity open to their own chips. As a result, it is likely that the top 4 will continue to control the market and continue to invest in their business, taking advantage of the economies of scale resulting from the manufacturing business. These economies of scale include negotiating power for procurement, as well as continued relationship with the clients. Since processes have to be designed for each final product, the IC designer and foundry must cooperate to manufacture the product. As such, relationships and cooperative history are greatly beneficial to the Big 4.
|Company||Revenue 2007 ($MM)||2007 Market Share (%)|
|Taiwan Semiconductor Manufacturing Company (TSM)||$10,609||47.0|
|United Microelectronics (UMC)||$2,957||13.1|
|Chartered Semiconductor Manufacturing (CHRT)||$1,743||7.7|
|Semiconductor Manufacturing International (SMI)||$1,354||6.0|
The global semiconductor foundry market revenues is estimated at $22.5B by Gartner Dataquest and $24.5B by IC Insights for the year 2007. The "Top 4" - TSM, UMC, SMI, and CHRT - are estimated to have 72.5% and 68% combined share of the total market by the two data services, respectively.