What recession? Planning SoC strategy in an uncertain economy

It’s easy to get confused about economic indicators these days, and that’s not a good thing for managers who have to makes bets 18 months in advance on an SoC development. A lot depends on what you read.

If you are reading the consumer press, you are hearing that pretty much everyone is out of work, and that most of us are behind on our mortgages or in foreclosure. If you read the business press, you have heard about some unspecified trouble with delinquencies in some parts of the residential mortgage market, but the main issue has been the freezing up of the international credit markets, due to the loss of faith in complex debt instruments no one ever heard of. If you read the electronics industry press, this is looking like a pretty darn good year.

So what is going on, really? Really, nobody knows. But it is possible to make some observations that might be useful in planning an engineering program. The first thing to note is that, more than in any recession I can remember, different sectors of the economy are behaving very differently.

This is not common. Normally at the leading edge of a recession, everyone panics at once, and economic activity across the global industry contracts nearly in lock-step. That is clearly not happening now. The reasons for this might be helpful.

To start with, the housing crisis is real, if not nearly so universal as the evening news would suggest. (Nor is all of California on fire, but that is a different subject.) At a personal level, real means real tragedy for many families who cannot service their mortgages. But in economic, rather than personal terms, it means a significant increase—but still a small overall percentage increase—in defaults on home loans. A similar thing is happening in commercial loans, by the way, but it doesn’t have the heartstrings appeal for the evening news when a business defaults on a loan.

On to the credit markets. The problem here appears to be transparency, not cash flow. The loan defaults will ripple through the credit system, reducing the value of all sorts of securities that are built on or linked to loans, and stressing the stability of the companies that insure these securities. The problem here isn’t so much the magnitude of the losses as the uncertainty. Because much of the activity in complex securities has been all but unregulated, nobody really knows the impact of a given loan default on a given piece of paper. Uncertainty, in bad times, slashes market value. In some cases, such as auction-rate securities, it eliminates the market altogether.

And of course, due to rising demand, global instability, and to no little extent the brilliant policies of the Bush administration, there has been a surge in energy and food prices. These have reduced real disposable income for individuals, and rippled through to increase many sorts of prices.

All of this only concerns the electronics industry because the global economy is full of feedback loops. Rising costs, increased risk, and tight credit all tend to reduce consumers’ spending on non-essentials. There is a significant delay element here, by the way. People don’t cut back at once. On average, they will try to maintain their lifestyle until they begin to fear, then they will cut back substantially. The timing differs from country to country. In the US, evidence seems to suggest that consumers are already cutting back rather sharply. In Europe, they may be just starting. China, now a significant consumer market, is less clear, especially if Chinese households have significant savings, but a cutback there seems inevitable sooner or later.

Reduced consumer spending directly hits consumer electronics companies and the automobile industry. And it ripples back through transportation, industrial equipment and materials. So on different times for each sector of the economy in each region, things slow down. Mostly.

There can be exceptions. For example, if you were a service provider getting ready to support next-generation broadband wireless services, this could be a great time to work on infrastructure, to be ready for the next big surge in consumer spending. If you were an Internet service provider, a recession would give you the breathing room you need to finally let infrastructure build-out catch up with growing rich-media services demand. If you were involved in R/D, this is the perfect time to work harder, because odds are that some of your competitors won’t, or can’t, and so the expected value of your return on investment is significantly higher.

It’s a very complex picture. And there’s no guarantee that this downturn will be another of our normal cyclic recessions—it already looks abnormal, and it could turn into a prolonged period of stagflation, or of the stagnant deflation the Japanese suffered through for so long. But for now, as this model suggests, industrial activity is holding up. Malcolm Penn, chairman and CEO of research firm Future Horizons, observed recently that beneath seasonality the industry fundamentals are still surprisingly strong.

This should change as consumer demand drops away, region by region, and that impact ripples back through the supply chain. But that impact will start out with products for the consumer electronics industry, and ripple back through industrial goods. Certain kinds of infrastructure build-out, especially in Internet, wireless, and energy-related fields, might continue or even grow. There are no certainties at this point, but when you are planning engineering investment right now, it’s worth considering where the end-products are going.