Insight July 6, 2010, 3:20PM EST

Global Chip Industry Has Room to Improve

Semiconductor makers are growing out of recession faster than in previous cycles but must embrace new management tools, says Accenture

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Not many industries are as consistently volatile as semiconductors. Year -in and year-out, working and investing in the chip industry has been akin to regularly climbing aboard a furiously fast roller-coaster ride.

During the past decade, semiconductors have suffered wild ups and downs in supply and demand. In the months leading up to the Sept. 11 terrorist attacks, chip inventories were overflowing because of widespread anticipation that demand would be strong. After the attacks, many chipmakers dramatically scaled back production. It was a tough time to survive. Predicting demand has been one of the industry's thorniest problems for decades. Chipmakers consistently build too much inventory, or not enough—often at the worst times.

As in 2001, inventory concerns in 2008 topped the industry's agenda as signs emerged of an impending global recession. This time the industry—in quite a desperate state—was so cautious about not getting burned by excess inventory that it cut production quicker and more deeply than usual. Some companies cut output by as much as 50 percent. Overall capacity utilization fell to just 50 percent, well below historic averages of 80 percent. With good reason, companies were cutting back swiftly in anticipation of a recession they suspected could last years. There were signs globally that this would be the case not only in semiconductors but in the overall economy.

Slamming on the brakes turned out to be one of this industry's finest moves ever. Learning from past mistakes, chipmakers were able to reduce production and inventory costs. By slowing manufacturing they not only saved money, but set themselves up for an unexpectedly swift, if unforeseen, market turnaround.

China helped fuel fast revival

The semiconductor industry's worst nightmare, in which the market crashed and stayed at ocean-floor depths for several years, didn't happen. The market rebounded sooner and more strongly than in perhaps any previous cycle in the industry's history. Better-than-expected consumer demand returned by the second quarter of 2009. The market is now expected to grow during the next few years. The industry has traveled a long way in a short period of time.

Why did the market come back so fast? There are several reasons.

1. Economic stimulus from the U.S. and Chinese governments played a role. More money in the economy spurred consumer purchases. With the investment by China to sustain internal growth, small luxury items (laptops, media devices, and smartphones) continued to attain unexpected growth there, with a ripple effect in North America. Thanks in part to this "small luxury item" trend, the semiconductor industry experienced sustained growth in the communications and consumer-electronics end markets.

2. Regardless of the global economic recession, China's growing demand, especially for mobile handsets—each of which houses numerous semiconductor chips—remained relatively robust. In fact, according to a recent Accenture (ACN) survey of Internet-enabled consumers, 63 percent of Chinese consumers occasionally watch videos on mobile devices. Some 59 percent use Web-enabled mobile handsets, which is more than in any other country surveyed.

3. Demand for analog chips used in consumer electronics and communications equipment remained relatively strong. Thanks to the rise of smartphones, sales of analog radio-frequency and power management chips used for Global Positioning System (GPS), Wi-Fi, and Bluetooth posted consistent sales growth. State-of-the-art power management chips allow smartphone battery charges to last several hours longer than before. Likewise, the location and navigation capabilities provided by GPS technology let smartphones address the intensifying need to improve the customer experience. Analog chips also are used in other relatively hot consumer electronics products such as Blu-ray players, set-top boxes, HDTVs, and digital video recorders.

4. A growing number of corporate IT organizations are again starting to buy and upgrade communications equipment. And PC sales have held up relatively well, despite tough economic conditions.