U.S.: Solid Growth Is in the Forecast

By John Dodge and Ed Sperling -- Movers & Shakers, 6/22/2006

Barring inventory oversupply or disasters of the man-made or naturalsort, the next 12 to 18 months for the U.S. semiconductor industry will build on the momentum of 2005.

That's the consensus from top industry executives and market analysts, all of whom harbor vivid memories of the industry's worst years, early in the decade. Estimates of how much the market will actually grow varies from one analyst to another and from one executive to another. But all of these market watchers predict at least some growth if none of the variables run amok.

Worldwide, semiconductor sales are expected to grow 7.9 percent this year, to $245 billion, up from $227.5 billion in 2005, according to the Semiconductor Industry Association (SIA). And it may get better—much better, in fact. iSuppli is forecasting 7.4 percent growth this year and a whopping 12 percent in 2007. And Gartner is predicting growth well into the high single digits this year, with a flatter 2007 and up to 14 percent growth in 2008.

In the United States, overall electronics production for 2005 was just under $276 billion, according to the Yearbook of World Electronic Data (published by Reed Electronics Research, a sister organization to the division that publishes Movers and Shakers). All told, the U.S. still accounts for about 45 percent of all semiconductors consumed worldwide, which makes it the single largest market. But with Asia's appetite for consumer electronics showing sustained growth and manufacturing and design now parceled out to several different geographies, actual numbers are becoming much harder to define by region.

At present, there is growth in every region. The U.S. GDP is projected to grow 3.3 percent in 2006—down from 3.5 percent in 2005, largely as a result of increases in energy prices. The U.S. consumer price index, meanwhile, will be 2.8 in 2006, down from 3.1 in 2005. If that sounds somewhat negative, consider that Semico predicts the U.S. semiconductor market will grow 13 percent this year. Although overall economic growth is down, electronics is growing.

So, is the electronics industry entering another era of irrational exuberance? The very notion sends chills down the spines of electronics executives who survived the earlier part of this decade. U.S. electronics output in 2005 increased about $5.5 billion over 2004, which is roughly equal to how much electronics production dipped from 2002 to 2003.

Cautious optimism would seem to be the prevailing sentiment. "You need to do more with fewer resources," says Altera's vice president of product and corporate marketing, Danny Biran. More with less, of course, is a central theme in Altera's programmable logic pitch, but you'd have a hard time finding an American semiconductor executive who doesn't agree with this thought.

Electronics industry optimism is as high as it's been in the United States in seven years. "The U.S. market is very strong," says Biran, adding that heightened spending in telecommunications and military electronics is driving much of Altera's growth.

High-performance analog IC supplier Linear Technology sees a bright outlook both in the United States and worldwide, driven by new expanding markets such as hybrid automobiles and solar panels, according to Linear's president, Dave Bell. Indeed, the fastest growing vertical market worldwide will be automotive, which iSuppli forecasts will average 10.5 percent growth each year between 2004 and 2009.

"The change toward higher performance is positive for us. One new area is energy efficiency. We have $100 of our parts in one hybrid vehicle model," Bell says, without revealing which one. "Every market is becoming higher performance. Five years ago, you would have said I was crazy if I'd said that high-performance analog ICs went in TVs, but that's changing with LCD and plasma TVs."

Unlike the heads of many U.S.-based but far-flung semiconductor companies, Bell also still sees the United States as the locus for design and development. After Linear opened a Munich design center in April this year, nine out of 10 of its design centers were still based in the United States. Fully half of its demand creation still originates on American soil.

"Five years ago, that dropped into the low 40 percent range, but it's back at 50 percent," says Bell, adding that by demand creation, he means design of end products by a company's customers. "With the Apple iPod, we attribute the demand creation to Cupertino, where the iPods are designed."

One concern that faces analog suppliers such as Linear, Analog Devices and Texas Instruments is a perpetual shortage of analog designers. The prevailing belief a few years ago was that electronics was going digital—lock, stock and barrel. Indeed, the opposite happened. The analog category is not only flourishing but it's forecast by iSuppli to become the second-fastest-growing semiconductor category between 2004 and 2009, at 9.6 percent growth in revenue a year. (The No. 1 growth market is sensors and actuators, at 9.8 percent annually.)

From a management perspective, keeping two factors under control will keep the industry on track, says George Scalise, president of the SIA, the primary lobbying group for U.S semiconductor companies. Those factors are accurately matching component inventories with demand and making sure the industry does not overspend on manufacturing capacity.

"The cautionary areas are inventory and capacity control. We have to maintain control in those two areas," he says. These dynamics worry Scalise more than the threat of terrorism, sky-high energy prices, supply shortages and competitive threats from China. "I don't see how they would affect us any more than anyone else. Everyone pays the price on terrorism and high energy prices," he says.

As for China, Scalise is unconcerned about the world's most populous nation's posing any imminent threat to American supremacy in semiconductor design or even in manufacturing. "I don't see anything from China in the next five years that would put it in a challenging—let alone leadership—position. If it's going to happen, you have to look out five to seven years before those issues emerge as significant."

The major U.S. vulnerability relates to semiconductor consumption, says iSuppli's Gary Grandbois, principal analyst. Chip consumption in 2006 rose a meager 2.5 percent domestically, compared to 15 percent in China. "There is some growth, but not at the pace of other markets. The bulk of the growth is somewhere else."

So far, energy shortages and high oil prices have not affected the U.S. electronics industry, but they will eventually catch up to sales, according to Grandbois. "They should have a dampening effect. We've been worrying about it, but it has not shown an impact yet. After gasoline prices spiked, they came back down. Invariably, shortages and high prices will have an impact, but there seems to be a time lag. They are not affecting our 2006-07 forecasts."

Another way of measuring the market is by looking at the capital equipment used in manufacturing semiconductors. Normally, capital expenditures on manufacturing equipment run years behind increases in production. Not this year. Dean Freeman, principal analyst for semiconductor manufacturing at Gartner, says there is plenty of available space inside fabs for new equipment. That means the equipment can be bought, installed and turned on for production relatively quickly—something measured in weeks rather than years.

The growth in the market for capital equipment alone is expected to run well into the high single digits, starting at about 9.5 percent for the first two quarters of 2006, according to Gartner, and wafting down slowly—largely as a result of Microsoft delays in shipping its Vista operating system.

Freeman says capital equipment sales were expected to be flat in the first part of 2006 but rose unexpectedly as companies invested heavily in equipment to make DRAM and flash memory. Although most of that is being driven by the consumer market, at least some of the sales were in anticipation of PC sales that will be delayed until at least early next year.

"Semiconductors will rise 9.5 percent in 2006 over 2005," he says. "Our numbers are coming down a little, but growth will still be in the high single digits."

Gartner expects sales to slow down in 2007, although remaining positive, with a potential boom year in 2008. That depends, of course, on several factors, ranging from interest rates to fuel costs.

What will drive the next boom is largely a matter of conjecture. Gartner says that historically there is a direct correlation between the Summer Olympics and the sales of home entertainment equipment. But unlike in the past, it may not be any single factor.

Jim Feldhan, president of Semico, is placing bets on five separate areas, which will materialize in different phases. The first is digital broadcasting, which will fuel the market for digital televisions and high-definition DVD players. He says the market will grow when digital broadcasting becomes the standard, in 2008.

The second growth area revolves around microfuel cells for consumer devices. "If you can get an MP3 player that runs 60 hours on 20 milliliters of alcohol, there will be a market for it," says Feldhan. "That type of performance for a cell phone and notebook computer will drive a huge upgrade cycle. The communications industry has been in the doldrums since 2000. In the next couple of years, we'll begin to see a rebound. Fuel cells will be part of that. One of the key decisions was a positive ruling from the U.S. Federal Aviation Administration, which says they're safe for use on planes. You can have them on commercial aircraft starting in the second half of 2007."

A third growth area is storage, which continues to be a lucrative market for both the home and business. Fourth, retinal projection should take off over the next few years, as prices continue to drop and performance improves. Using virtual keyboards and displays also consumes substantially less power than using a 15-inch LCD screen. Fifth is the automotive market, which is growing at a rate of about 8 percent for semiconductors.

"About 2 percent to 3 percent of the growth is attributable to new markets, such as India and China," Feldhan says. "The remainder is increased content for global positioning systems, telematics, wireless, fuel efficiency and safety. Right now, that has only a 2 percent to 3 percent penetration rate."

John Dodge is editor-in-chief for Electronic Business. Ed Sperling is editor-in-chief for Electronic News.