When the Chips are Down, Ditch Those Assets

A study out today from research firm iSuppli shows that operating margins in the chip industry have declined from the upper teens to the single digits, making the industry more cutthroat than ever. The numbers paint a grim picture for AMD, Freescale and NXP, all of whom are still struggling to get out of the old-boy (and expensive) mentality that only real men have fabs.

That adage, pushed by Jerry Sanders, the founder of AMD, defined chipmaking (and all chipmakers) for years, and saw companies such as IBM and Intel race to build the latest manufacturing plants to churn out ever smaller chips on ever bigger wafers. In the early part of this decade the prevailing wisdom shifted to say that only the top 10 chipmakers should own fabs. We’re about to cut that number again.

A fab can cost up to $4 billion to build and equip, making it a game few can afford to play. In Dallas, for example, a 300mm fab built by Texas Instruments stands empty. Many firms have transitioned to an asset-light model in which they manufacture some semiconductors in their older, existing plants and farm out the newer designs to foundries, which are essentially outsourced fabs.

But some are still making the transition, most notably AMD, which has been struggling for more than a year to define its asset-light strategy. Ever since AMD kicked out CEO Hector Ruiz a few months ago, Wall Street and plenty of AMD employees have been waiting to hear details of the chipmaker’s own plan to cut back on fabs.

The iSuppli report grimly states that the semiconductor industry has lost its “money-making touch,” but I think it’s missing the point. Making chips might be less profitable, but designing and controlling intellectual property around chips is still helping firms such as Qualcomm and MediaTek outperform their peers, according to the report.

So perhaps the better conclusion is that if you don’t want to be stuck with commodity margins, you’ve got to get out making a commodity product (which is what large scale chipmaking is built on). After all, even Intel will one day encounter a fab so pricey it doesn’t justify the cost of building it. That’s the way economics work. The value isn’t always in the manufacturing, but in the design. Ask Apple. Or Dell.

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