Forecasts call for modest growth in chip sales

07/01/2003

China will the get the lion's share for years to come, experts say

By Mark A. DeSorbo

NEW YORK—As chip and microelectronics industry organizations scale back forecasts for industries already struggling to reduce costs and boost sales, Asia—China specifically—is continually being selected as the land of manufacturing opportunity, much to the chagrin of a U.S. Senator and presidential candidate.

Three organizations are optimistic about low double-digit growth this year, while maturing markets will experience high single-digit growth annually over the next two to three years. But a study conducted by two firms says the bulk of any predicted growth will most likely happen in China, a manufacturing shift that could inflict "long-term damage" to the U.S. economy and the national defense, says presidential hopeful Sen. Joe Lieberman, D-Conn.

In a white paper sent to Defense Secretary Donald Rumsfeld in early June, Lieberman outlined his concerns about the ongoing shift of the manufacturing, research and design sectors of the semiconductor industry to China, saying the long-term national security consequences of this development are "risky." The ranking member on the Senate Armed Services Airland Subcommittee has also asked the Pentagon to submit a detailed plan of action to respond to the problem within three months.

"Our nation is also lagging behind in the critical semiconductor industry," Lieberman recently told students at the University of California in San Diego.

Lieberman's shtick may not be all that far-fetched, for the stage is being set for China's 14 percent of global electronics output by 2005—up from an estimated 8 percent in 2001, according to a study by the International Finance Corp. (IFC; the private sector arm of World Bank Group), and consulting firm Booz Allen Hamilton (McLean, Va.).

That surge in output, the study says, represents a doubling of production activity in emerging markets in the Asia Pacific region, like China, from $65 million in 2001 to $125 million by 2005—accounting for 43 percent of total worldwide manufacturing growth.

"There are some very fundamental economic forces driving this," says Barry Jaruzelski, managing partner of communications and technology practices for Booz Allen Hamilton.

Those factors, he explains, are China's perks: Lower cost production, an economically competitive environment, significantly lower infrastructure costs, and a talented, educated workforce from which to draw.

"If you are making DRAM, the suppliers of those components want to be close to their end customer," Jaruzelski says. "Given the increase in assembly work, it is pulling the supply chain there. More cell phones are sold there than anywhere, and there are also more Internet connections there, putting the United States second to China."

More than three-quarters (77 percent) of the growth in developing countries will be in China, the consulting firm says. The country will also get the lion's share of the growth in world electronics production in coming years, with the size of its output, at $80 billion, surpassing that of Western Europe by 2005.

The Asia Pacific region, the study indicates, already dominates electronics manufacturing in emerging markets. In fact, the study indicates that 83 percent of electronic displays manufactured in emerging markets are produced in the Asia Pacific region, with 44 percent from China.

IFC and Booz Allen Hamilton based its report on 117 interviews with electronics manufacturing firms of varying sizes from all regions of the globe. In addition, extensive secondary research was conducted to quantify the magnitude of the production shift to developing countries.

William McClean, president of IC Insights Corp., a market research firm in Scottsdale, Ariz., believes integrated circuit (IC) production will move to China "in the long run."

"It will be a very slow process," he says. "Many companies, like Intel Corp. and Fairchild Semiconductor, have already established assembly plants there, but for now, IC companies are keeping a lot of the production near their headquarters. But if this trend continues, more IC products will be manufactured [in China]."

IC Insights says the IC market will see a 15 percent growth this year. "If there are problems with severe acute respiratory syndrome (SARS) and the PC upgrade cycle doesn't happen this year, we'll see about 8 to 10 percent growth," McClean adds. "Our viewpoint is that the industry is maturing, and even though the growth rate is still good, it won't be as good as it has been historically."

World Semiconductor Trade Statistics expects global semiconductor sales to increase 11.5 percent this year instead of the 16.6 percent growth the group had predicted in October.

For 2004, WSTS expects growth of 18.4 percent instead of 19.2 percent. The 2005 forecast, however, was revised upward to 7.9 percent from 2.6 percent.

WSTS, in a statement, cited SARS and its impact on the Asia Pacific region as a reason for the reduction. At the time of this report, however, travel restrictions throughout many parts of China were being lifted, indicating that SARS is now under control in several regions.

During a recent Webcast, the Semiconductor Industry Association (SIA; San Jose, Calif.), also pointed to SARS, the war in Iraq and the dampened demand for computers, wireless and consumer products as its reasons for scaling back forecasts.

SIA projected a 10.1 percent growth in 2003 and a 16.8 percent growth for 2004, down from 19.8 percent it predicted in November.

In 2004, SIA says, the growth will be fed by a strong increase in memory, including a 42 percent jump in DRAM and a 25 percent increase in flash, and supported by double-digit growth in other product sectors.

"The recovery is broad-based across consumer and communications applications, as they all continue to be drivers for the industry," says George Scalise, SIA president. "The forecast contemplates a return to higher IT spending levels and the emergence of multifunction products, such as smart phones."

SIA believes the European market will enjoy an 11.8 percent increase to $31.1 billion; 13.6 percent to $35.3 billion in 2004, 4.7 percent to $36.9 billion in 2005 and then shoot up to 8.8 percent in 2006 to $38.24 billion.

The Japanese market will grow 17.5 percent in 2003 to $35.8 billion in 2003, increase to 14.1 percent to $41.9 billion in 2004, 6.5 percent to $43.5 billion in 2005, and 4.9 percent in 2006 to $45.6 billion.

Of all the semiconductor regions, Scalise says the Asia Pacific market will experience the stronger growth over the next few years. SIA believes it will grow 12.1 percent to $57.3 billion in 2003, 20.9 percent to $69.3 billion in 2004 and 9.4 percent to $75.8 billion in 2005. By 2006, the forecast calls for a modest 7.9 percent boost to $81.8 billion.

That growth, Scalise says, is mainly due to the shift in the "geography of consumption"— the migration from the Americas to Asia Pacific, which reflects the "outsourcing of electronic equipment manufacturing, including component sourcing and design services to the region."

For the Americas, SIA says there will be a 2.1 percent drop to $30.6 billion in 2003, but then a 15.7 percent surge to $35.4 billion in 2004. "In 2005, we forecast the market to remain nearly flat with a slight decline of .09 percent to $35.1 billion, and then resume growth of 8.8 percent in 2006," according to SIA's report.

"Since 2000, the U.S. consumption has fallen about 20 percent," says Scalise. "The Asia Pacific market has picked up. It's a very different marketplace over there...outsourcing business is really what's driving it."

Asked if the semiconductor manufacturing base in the United States is being eroded with fabs being mothballed, Scalise says shutting down chip manufacturing operations is all part of the semiconductor process.

"There's nothing unusual about that," he says, adding that SIA believes it's "important to maintain manufacturing in the United States" in order to maintain America's technology strength.

Still, says Jaruzelski, rapid technology obsolescence combined with tepid spending for years to come is reason enough for many companies to move to Asia or China.

"When you start seeing people closing a Mexican operation to move to China, it really crystallizes what's happening," he says, noting the plans of just one of the 117 electronics manufacturing firms interviewed for the study by his firm and IFC.

Jaruzelski adds, "Anecdotally, everyone knew China was becoming a huge force. When you get statistics that it will support all Western Europe, it shows you how dramatically things have shifted."

When asked will if chip production will ever come back, Jaruzelski did not speculate, noting findings that indicate chip production in emerging markets did $3 billion in business in 2001.

"That figure will grow to $11 billion in 2005, with most of the business being done in China," he adds.

Bottom line, Jaruzelski adds, chip or microelectronics manufacturers not doing business in China are or will be "in trouble."

"You have to be there, and even though the biggest concern is intellectual property, it is not preventing other companies from going," he says. "Given the magnitude of the shift, and the incredible ascendancy of China, any company that does not have an explicit strategy of how to support China should be wondering why they don't."