Innovation, for most technology companies, is something that takes place in the research lab. But Bob Bailey, chairman, president, and CEO of PMC-Sierra, defines the term more broadly.

Bailey counts his company's business model as one of its most important innovations. That model--designing highly profitable but relatively low-volume networking chips--has made the fabless chip maker, based in Burnaby, British Columbia, one of the chip industry's most profitable and fastest growing companies.

Most semiconductor companies have to sell millions of chips to justify the high costs of design and fabrication. But PMC's specialized products, like the chips it recently introduced for leading-edge terabit router switches, target lower-volume niches.

'We had to come up with a financial model that gave us sustainability and enabled us to profit and fold those profits back into R&D,' Bailey recalls.

PMC chose to concentrate on high-end products. But to justify the premium prices, the company had to anticipate and satisfy customers' needs faster than the customers could do so themselves. Toward that end, PMC spends an astounding 25 percent of its revenue on R&D. To make that investment possible, PMC uses outside foundries to manufacture its chips, saving it the huge cost of fabrication.

Bailey concedes that PMC pockets hefty profits on some of its chips, which can sell for more than $1000 apiece. But they're worth it, he insists, if they give customers a competitive advantage. 'They're taking these solutions and getting their products out to market in half the time frame, at one-tenth the R&D expense and with much less risk,' he says.

Thanks to its fabless, high-margin strategy, PMC has become one of the chip industry's most profitable companies, with gross profit margins (sales, minus the cost of sales) of 80 percent. And while PMC's $262 million in 1999 sales still ranks far below the industry's leaders, its $20 billion market capitalization is on par with far bigger companies, thanks to a share price that has soared more than five-fold in the past year. Moreover, the company's sales are growing at a remarkable pace, up 62 percent last year and on track for similar growth in 2000.

PMC's customer list is a virtual who's who of the telecom and networking industry, including notables like Nortel Networks, Lucent Technologies, and Cisco Systems. Jeff Lipton, communications research analyst with Chase Hambrecht & Quist, says PMC offers more than 70 products, many of which are relatively new and will produce revenues for years to come. 'They're introducing a lot of new products, and their rate of innovation is very high,' Lipton says.

PMC is the leading supplier of ATM (asynchronous transfer mode) chips, used in network switching equipment. The company also has been increasing its presence in the fast-growing markets for SONET (synchronous optical network) chips, used for fiber-optic data transmission, and remote-access chips, such as its 'FREEDM' family of high-density packet processors.

Flush with its increased stock value, PMC has made a string of acquisitions to broaden its technology arsenal. Last August, PMC paid $400 million for Abrizio, a Stanford University spinoff that had developed a new high-performance networking architecture. This April, the deal bore fruit in the form of the Tiny Tera 1 chip set, which should allow customers like Cisco Systems to significantly improve the performance of their routers.

PMC continued its shopping spree by acquiring Toucan Technology, a small Irish chip designer, for $26 million in January. Then it paid $890 million in March for San Jose-based AANetcom and $415 million in April for Extreme Packet Devices of Kanata, Ontario. Company officials say more acquisitions are likely.

Steve Perna, vice president and general manager of PMC's Optical Networking Division, describes the recent deals as 'gap-filling acquisitions' that will help PMC put together complex network architectures.

'All they do is communications,' says Chase H&Q's Lipton. 'And they really understand the subtleties and nuances and details, in my view, better than any other company.'

Bailey concedes PMC faces growing competition, but says no one targeting the communications sector--not even an industry giant like Intel--can match his company's expertise. 'We're a dominant supplier in broadband infrastructure,' he says, 'which is the largest man-made system in the world and, I think, will be the sweet spot in the semiconductor industry going forward.'