The Global Semiconductor Industry Teaching Note [PDF]

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Andrew Inkpen



The Global Semiconductor Industry Teaching Note Case Summary Semiconductors are the brains of modern electronics. They are used in medical devices, communications, computing, defense, transportation, energy, and technologies of the future such as artificial intelligence, data science, and advanced wireless networks. This case examines the global semiconductor industry and its structure. The case raises several important questions: Is Intel falling behind competitors in the race to make ever-morepowerful processors? Apple, Amazon, Facebook, and other tech firms are designing their own chips—how will this impact the industry? Is the fabless model based on contract manufacturing superior to Intel’s model of designing and making its own branded products? Will Chinese companies close the technology gap with firms like TSMC, Samsung, and Intel? Disciplines: General management, industry and competitive strategy, leadership Keywords: Global strategy, semiconductor industry, global competition, international business



Teaching Objective The objective of this case is to help students understand: • • • •



The nature of global industries The structure and basis for competitive advantage in the semiconductor industry The global interconnectedness of the industry value chain Key competitive and geopolitical questions and issues associated with semiconductors



Assignment Questions 1. 2. 3. 4.



Describe the semiconductor industry. Why is it a global industry? What is the basis for competitive advantage in the semiconductor industry? Why have Intel, TSMC, and NVIDIA become leaders in the industry? Will the United States be able to maintain its technological leadership? Will Chinese companies close the technology gap with firms like TSMC and Intel? 5. What will this industry look like in five years? Ten years?



Readings • Meeting the China Challenge: A New American Strategy for Technology Competition https://asiasociety.org/center-us-china-relations/meeting-china-challenge-new-american-strategytechnology-competition • Maintaining China’s Dependence on Democracies for Advanced Computer Chips, by Saif M. Khan and Carrick Flynn https://www.brookings.edu/research/maintaining-chinas-dependence-on-democracies-for-advancedcomputer-chips/ Copyright © 2021 Thunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise. All rights reserved. This teaching note was prepared by Professor Andrew Inkpen for the sole purpose of aiding instructors in the classroom use of the case “The Global Semiconductor Industry.” It should not be used in any way that would prejudice future use of this case.



Teaching Plan This case was written for a Global Strategy course. The semiconductor industry is one of the most global industries. Semiconductors are found in products like mobile phones, cars, and medical equipment that are used in every country. The value chain from upstream R&D and design to downstream sales spans the globe. This industry can be used to explore the meaning of a global industry and a global value chain. The case also provides plenty of scope for a discussion on industry structure, the basis for advantage, and the geopolitics of technology. I suggest beginning with an overview of semiconductors—what they are, how they are used, and why they are so important to the global economy. For a Global Strategy class, I would draw a value chain and link the various countries and companies to the major value chain activities. This will drive home the global structure of the industry and generate some discussion about why certain countries dominate specific activities. Depending on how the case is used, the instructor may want to do a mini-lecture on global industries and the global characteristics of the industry. I then focus on a few questions: What is the basis for advantage in the industry? Which is better—fab or fabless, and does Intel have the right strategy? Why are Apple and other big tech firms designing their own chips? I then shift to the geopolitics with a focus on China’s position in the industry. Will China be able to match the leading companies in technology? Will the United States continue to impose trade restrictions on Chinese companies? I finish with some thoughts and forecasting about the future of the industry and the main competitors.



Analysis 1. Describe the semiconductor industry. Global Industry Is this a global industry? Two broad characteristics of global industries: • An industry in which firms must compete in all major world markets in order to become leading competitors and to prosper. • An industry in which firms can achieve economies of scale (EOS) or economies of scope across geographic markets. What makes some firms more global than others? • Homogenized product needs across markets • High R&D expenditures require more than one market to recover development costs • There are many economies of scale in production, international logistics, or marketing The semiconductor industry has all three characteristics. A multi-domestic industry is one in which firms produce products and services tailored to individual countries. Industries such as home construction, much of retail, and many small business services are multi-domestic. What makes some firms less global and more like multi-domestic industries? • • • • •



Customized products are required in some countries National competitors are common Countries have unique distribution channels, regulations, supply chains There are no or few economies of scale Local/national firms have some inherent advantages in the host country over global competitors



The case lists the reasons why the semiconductor industry is so global: • The comparative advantages of the various countries involved in the value chain. For example, assembly and testing is more labor-intensive than design and can be in countries with lower labor costs. 2 C03-21-0005



• Trade facilitating conditions such as low transportation costs for semiconductors and their components. • Increasing demand for electronic products in emerging markets and, in particular, in Asia. • The high value to weight ratio of semiconductors allows low-cost transportation during the various stages of production. Given (a) the high value-to-weight ratio for chips, and (b) the reality that no single firm can perform all of the necessary value chain activities, it makes sense that the products move around the world during their production. And, when the chips are incorporated in a final product like a phone, they keep moving to hundreds of countries. A question worth pursuing in an IB class is why countries have developed specialties, such as Taiwan in foundries and assembly, testing, and packaging. The instructor may want to discuss industry clusters. Industry clusters develop in places where several semiconductor companies, or related businesses, have established a strong presence. For example, in the United States, manufacturing and equipment clusters exist in Silicon Valley, Phoenix, upstate New York, and Austin. Other manufacturing clusters can be found in in China, Germany, Japan, Singapore, South Korea, and Taiwan. Manufacturing clusters usually include one or more world-class manufacturers, a nearby research institute or university, a talent pool, and a support network. The support network includes small-to-medium enterprises, an ecosystem to support research and manufacturing, and professional services firms like lawyers, accountants, and consultants. Barriers to Entry in the Semiconductor Industry The barriers to entry in the manufacturing sector are very high—the major barriers are capital, IP, supply chain connections, reputation, and scale. Fabs cost $billions, and only a few firms can afford to build them. After a multi-billion fab is built, it can take five years or more to break even if they are operated at capacity. If the capacity drops, the breakeven period grows longer—up to 10 years at 55% capacity.1 For the fabless sector, the barriers to entry are less about capital and more about technological capabilities in the design area. Firms like Apple, Amazon, Facebook, Google, and Qualcomm have enormous numbers of skilled people and deep financial resources. Few other firms can compete at the same level in chip design. Apple believes it can innovate faster than Intel, so it ended its 15-year relationship. By designing its own chips, Apple gains control over critical IP and ensures that its chips are made with the latest manufacturing technology. Controlling its own technologies also helps Apple integrate all of its products.  The barriers to entry were highest for the IDM sector-integrated firms like Intel and Samsung. However, the case mentions that Intel was falling behind in the technology race and was forced to outsource some of its products. So, perhaps integration is not the ideal strategic choice (discussed in more detail below). 2. What is the basis for competitive advantage in the industry? Competitive advantage depends on the type of firm. For Intel, advantage is based on differentiation achieved through technology leadership and branding. For a foundry, advantage is based on technology leadership, customer service, and cost management. For a fabless designer like NVIDIA, advantage is based on differentiation through design skills, which are strongly tied to technology leadership. The semiconductor industry’s record of steady technological improvement has created a winner-takeall dynamic that makes leading-edge capabilities vital within several segments. If a company’s product or service is even slightly better than a competitor’s, it typically captures an outsize portion—or even the vast majority—of industry revenue. This phenomenon is apparent along the entire value chain, from equipment production to chip manufacture. Companies that want to challenge the winner may find it difficult to catch up, since the leading players are often several years ahead in technology development. From 2015-2019, the average combined profits of Apple, Intel, Qualcomm, TSMC, and Samsung were higher than the other 249 semiconductor companies.2 https://www.mckinsey.com/industries/advanced-electronics/our-insights/semiconductor-design-and-manufacturingachieving-leading-edge-capabilities. 2 https://www.mckinsey.com/industries/advanced-electronics/our-insights/semiconductor-design-and-manufacturingachieving-leading-edge-capabilities. 1



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Intel is an example of a firm that has enjoyed a winner-take-all position for several decades with its dominance in the PC sector. “Intel Inside” still has tremendous brand value but it has weakened as AMD has increased market share and with Apple no longer using Intel chips in its computers. The instructor may also want to discuss semiconductors as a B2B product. Although Intel has created strong consumer awareness, Intel must still sell its products to companies like Dell and HP. Since semiconductors are sold as B2B products, the semiconductor firms must rely on the OEMs to drive demand. If the PC market slows down or crashes, there is little Intel can do to stimulate demand. What this means is that winner-takeall for Intel or Apple with iPhones can end once end-product demand drops. The foundries do not have this problem since they are contract manufacturers. They will not capture the high margins enjoyed by Intel but they also should have a less-cyclical business. 3. Why have Intel, TSMC, and NVIDIA become leaders in the industry? Fab or Fabless? For many years, Intel was the most valuable semiconductor company. Over the past few years, that has changed. Intel continues to have the highest sales, but it has fallen behind TSMC and NVIDIA in market capitalization. The equipment firm ASML has also passed Intel in market cap. Intel, NVIDIA, and TSMC represent three different types of firms. Intel is an integrated device manufacturer (IDM). It has the capability of designing and manufacturing chips. NVIDIA is a chip designer, and TSMC is a chip manufacturer. Intel and Samsung were the most prominent IDMs. There was a large set of smaller IDMs, such as Texas Instruments and On Semiconductor. There have been many debates about Intel and whether the integrated strategy still makes sense. There is a piece in the case from Intel arguing in support of the strategy. The argument against the strategy involves the classic arguments against vertical integration: • Difficult to be uniquely competitive across the value chain • Loss of flexibility because of captive suppliers or customers. Intel’s manufacturing division has a guaranteed customer: its design division. • Lack of innovation by suppliers (why innovate when I have a guaranteed customer?) • Complexity and bureaucracy in managing the various different activities • Loss of flexibility in the event of a change in industry structure and/or nature of competition Intel has already been forced to outsource some of its design because it has fallen behind TSMC and Samsung in manufacturing capability. Should the company be broken into two? Or should Intel pursue foundry business? It is unlikely that Intel would go the foundry route, but this industry is fast-moving and unpredictable, so anything could happen. AMD was once an IDM, but it divested its foundry business and created Global Foundries. Here is an argument in favor of keeping Intel intact:3 Intel gets great advantage by having the ability to fine-tune designs and process together when they release products. You don’t get that with a commodity chip maker. As long as Intel can keep their fab full, there really isn’t any downside to having their own fab. It’s very expensive to run a fab, but having one also gives you the ability to manage your production needs ahead of anyone else in the production line. It also allows you to make investments as needed and not rely on others to do so. Finally, it allows you to easily differentiate in designs and not just nodes like 7nm but also in transistor design, interconnect, packaging, and more. Capex An article in Forbes4 looked at the capital investment (capex) of foundries and IDMs versus fabless firms. The article found that NVIDIA creates its market cap with 25 times less capex than Intel. The author says, “Which would you rather own? The company that can take your investment dollar and generate 75 cents of https://www.fierceelectronics.com/electronics/intel-at-crossroads-should-it-split-into-two-companies. https://www.forbes.com/sites/georgecalhoun/2020/08/02/intel-NVIDIA-et-al-and-american-semiconductorhegemony/?sh=3157120dc298. 3 4



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sales, or the company that can take that same dollar and generate $8 of sales? The market sees and respects this difference.” In my view, this is a simplistic argument because the stock market is primarily interested in future earnings. The market must see earning growth opportunities in TSMC and NVIDIA that it does not see in Intel. The demand for gaming and AI is a key reason why NVIDIA has pulled ahead of Intel, which is still closely tied to the slow-growing PC industry. Intel’s depressed value is more about a perceived lack of growth and manufacturing problems than its IDM strategy. The Forbes article goes on to say: The fabless segment is where the market sees the real value in semiconductors, and the market is not wrong; the foundry business is a commodity-type business, favoring consolidation and scale; heavy investments in rapidly depreciating plant and equipment do not inspire investors; the Fabless business model is where the value-creating innovation we associate with the digital economy is concentrated. China’s only Fabless entry is Hi-Silicon, which is a captive subsidiary of its one main customers; they have yet to prove they can compete in the global market. In short, the U.S. controls the semiconductor world, and controls the direction of technological innovation. China is starting at the bottom, and it will be a tough hill to climb. In the 21st century economy, value accrues to companies that control the “intangible” assets like design, brand, human capital (talent), loyal customers, and intellectual property. Traditional 19th century-style “assets” like factories, machinery, inventories, accounts receivable, and even excess accumulations of cash begin to seem more like, well, liabilities.



4. Will the United States be able to maintain its technological leadership? Will Chinese companies be able to close the technology gap with firms like TSMC and Intel? It is clear that China wants to become self-sufficient in semiconductors and reduce its reliance on U.S. and European firms. The Chinese government has said this publicly, and it is a key objective of Chinese industrial policy. What happens if the U.S.-China trade war continues? A report on the United States-China trade relationship identified two scenarios for the semiconductor industry:5 • Controls on exports of U.S. technology to Chinese companies that are currently subject to U.S. restrictions will remain in place, perpetuating the status quo. • A further escalation results in a complete halt in bilateral technology trade, effectively decoupling the U.S. and Chinese technology industries. According to the BCG report, both scenarios could lead to dire consequences for the U.S. industry that include: • Over the next three to five years, U.S. semiconductor companies could lose eight percentage points of global share and 16% of their revenues if the U.S. maintains the restrictions that are already in force on access to products containing U.S. technology by Chinese companies included on the current Entity List. • U.S. companies could lose 18 percentage points of global share and 37% of their revenues over the same period if the U.S. completely bans semiconductor companies from selling to Chinese customers, effectively causing a technology decoupling from China. • These drops in revenue would inevitably lead U.S. semiconductor companies to make severe cuts in R&D and capital expenditures, resulting in the loss of 15,000 to 40,000 highly skilled direct jobs in the U.S. semiconductor industry. • South Korea would likely overtake the U.S. as world semiconductor leader in a few years; China could attain leadership in the long term. The report recommends that the United States and China seek a new balance that leads to a good outcome for both countries.



5



Boston Consulting Group, “How Trade Restrictions with China Could End US Leadership in Semiconductors,” 2020.



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5. What will the industry look like in a decade? Will Intel, NVIDIA, TSMC, and Samsung still be leading companies? Semiconductors will continue to play a vital role in the global economy. Technology will continue to advance, just as Moore’s Law predicted decades ago. The leading firms of today will most likely remain strong players because of the enormous barriers to entry in the industry. However, if Chinese firms are able to increase their technological capabilities to the same level as TSMC and others, there could be some profound shifts in industry structure. With regard to the United States industry: A strong semiconductor industry is critical to U.S. global economic competitiveness and national security in an era of digital transformation and artificial intelligence. The U.S has long been the semiconductor leader, with a 45% to 50% market share. U.S. leadership is grounded in a virtuous innovation cycle that relies on access to global markets to achieve the scale needed to fund very large R&D investments that consistently advance U.S. technology ahead of global competitors… Once the U.S. loses its global leadership position, the industry’s virtuous innovation cycle reverses direction, throwing U.S. companies into a downward spiral.6



Updates In January 2021, Intel announced that its CEO would be replaced. An activist, Third Point, pushed for the change: “Third Point argued that Intel’s problems could force the United States to rely more heavily ‘on a geopolitically unstable East Asia’ to power vital technology ranging from personal computers to data center hardware.”7 Also in January 2021, the Wall Street Journal reported:8 Semiconductor companies are asking their customers for patience as the industry works through a sharp increase in demand from makers of everything from cars to consumer electronics. The chip shortage has caused prices to rise for certain semiconductors, delays in filling orders, and auto makers to idle factories. If the problems persist, consumers may see delays in getting new cars and some electronic devices, and possibly higher prices. There is no quick fix to the situation, either. Adding new chip-making machinery can be expensive and slow, and some of the deepest supply problems are taking place with older production lines that are less lucrative for manufacturers. “In the whole semiconductor industry there is very little [spare] capacity right now—everything is doing well,” said Risto Puhakka, president of VLSIresearch, an industry-analysis firm. “We’re coming off a record investment year, and the demand continues to grow.”



https://www.bcg.com/en-us/publications/2020/restricting-trade-with-china-could-end-united-states-semiconductorleadership. 7 https://www.nytimes.com/2021/01/13/technology/intel-ceo-swan-gelsinger.html. 8 https://www.wsj.com/articles/chips-are-in-hot-demandand-thats-a-problem-11610630859?mod=itp_wsj&ru=yahoo. 6



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