The challenge facing the front-end semiconductor equipment industry
The semiconductor equipment industry, which has been experiencing tough sledding since 2007, failed to cope with the last two cyclical downturns and is not well positioned to face uncertain economic conditions. Editor’s note: This article is part one of a two-part analysis on the state of the front-end capital equipment industry and its future prospects.
The semiconductor equipment industry has been battling a significant industry cyclical downturn since the end of 2007. Vapital spending by customers in the industry has declined significantly from the boom times in the 2000 period. In 2010, the industry is seeing signs of a cyclical rebound—albeit perhaps short-lived as the world copes with a sluggish recovery from the deep recession. I believe the industry has failed to cope with the last two cyclical downturns and is not well positioned to face uncertain economic conditions.
Lack of product innovation
Insignificant product innovation from all of the major equipment companies has led customers to restrain investment in R&D type of equipment and capital. Product development by the equipment companies in the past three to five years has only offered incremental improvement, which the customers refuse to pay premiums for, thereby reducing the profitability of the equipment companies. Unit volumes for new products have not grown due to the lack of innovation, demand interruption caused by the cyclical downturn and the customers’ ability to reuse equipment.
Fundamental business model change
There has been a fundamental change in the business model of the semiconductor capital equipment company caused by the lack of product innovation. Product innovation is defined as products that are disruptive to the current installed product set that demonstrates a significant value through productivity improvement and process capability that enables customers to shorten their product development cycles.
In the 1990s, Applied Materials developed the physical vapor deposition system (Endura) which dramatically improved the capability of the customer and had an average selling price that was nearly 3X the price of its nearest competitor. The value proposition was so compelling that the customers willingly paid the prices since the tool improved the customers’ capability significantly.
The current lack of innovation has the impact of commoditizing the tool set, which results in price erosion, consequently lower gross margins and therefore pressure on operating expenses which starts the cycle all over again. The equipment companies have had to reduce capacity and cost and spend less money on R&D and process development. Applied Materials’ workforce is actually fewer today than it was in 2003. They have also shed employees and other valuable employees have left the industry completely moving to alternative energy or the biotech industries.
The major factors for this value migration is the impact of the lack of product innovation AND the impact of the 300-mm production implementation by the customers. There has been a resultant “brain drain” from the semiconductor equipment industry to other industries where process engineering skills are critical to growth. Venture-backed investment in equipment company startups has been virtually non-existent, with no single new company emerging as a major player in the industry.
300-mm production generation
The 300-mm product life cycle has been devastating to the equipment industry. The fundamental business model was changed as pricing of 300-mm equipment was significantly less than 200-mm without the attendant cost reductions, thereby compressing margins of the semiconductor equipment company.
The equipment industry believed that unit volume would stay flat or grow a bit due to increasing product complexity evidenced by the number of process steps in future product generations. The customers slowed their migration to increasing complexity and the impact on the equipment industry was reduced unit volume.
The customers achieved significant cost benefits through the significant increase in die per wafer (more than 225 percent over 200-mm equivalents) without having to pay enough for those cost benefits.
Gross margins for the equipment industry of more than 50 percent have been reduced by as much as 10-15 points, making it difficult if not impossible to invest in R&D at traditional model levels of 15-20 percent of sales. Operating margins are contracted, forcing the value migration to the semiconductor manufacturer.
The major companies in the pursuit of Moore’s Law—Intel, Samsung and TSMC—have been successful in their supply chain practices reducing equipment company margins. Equipment companies tried in turn to leverage their supply chain without much success, as their leverage over their supply chain is minimal.
Many suppliers to the semiconductor equipment industry abandoned the business entirely rather than succumb to continued pricing pressure. This business phenomenon forced equipment companies to reduce their research and development spending and, while the chip companies reap the benefit of enhanced production of 300-mm tools, the lack of profitability and returns for the equipment industry actually constrains the growth of the entire industry since innovation and new applications cannot be pursued economically.
In addition, venture capital for the entire industry has been impacted by this situation. As growth rates and applications decline there is no reason for entrepreneurs to develop new ideas for the space. The equipment companies did little strategically to combat the behavior of their customers such as:
Used equipment— the equipment industry did not develop an adequate used tool strategy to maximize revenue, instead the customers learning the techniques of “equipment reuse” which should have been the bastion of the equipment company’s expertise.
Services—the equipment company’s failed to add value added service offerings such as process development, equipment maintenance cost savings, parts offerings etc. to buttress the loss of capital equipment spending. Other companies filled this vacuum.
Sematech-the consortia abandoned their approach to improved productivity as focus by member companies turned to photolithography requirements for advanced technology nodes and significantly reduced the size of Sematech’s budget. The State of New York lured Sematech and its member companies through strong subsidies abandoning manufacturing capability initiatives based in Austin, Texas.
The upshot is that the supply chain to the semiconductor equipment industry has become disheveled and weak and not capable of response. Many companies went bankrupt during the downturn and other stronger entities moved on to other industries and refused to grant the cost reduction demands of the equipment industry executives.