Chipmakers' Problems Are Speeding Up

By Steve Hamm Typically, companies are reluctant to publicly blame a partner when something goes wrong. But when Apple Computer (AAPL) reported second-quarter earnings on July 14, it didn't hold back. It blamed IBM's (IBM) failure to deliver enough microprocessors for Apple's inability to satisfy demand for its popular Power Mac G5s. Said Chief Financial Officer Peter Oppenheimer: "We're extremely unhappy with these events."

IBM isn't the only company having problems making chips these days. Intel's (INTC) delivery of Prescott, its most recent Pentium processor, was delayed by more than six months, until February, while it worked out design problems. And leading chipmaker-for-hire Taiwan Semiconductor Manufacturing (TSM) has experienced delays as well.

Indeed, the troubles are industrywide, as chipmakers run into limits in their constant quest to pack more power and performance into semiconductors. Although it was always clear that one day they would start to hit a wall, that day appears to be arriving earlier than expected.

THE PRICE OF POWER. Because of the challenges posed by a major shift to more densely packed chips, many companies, including chipmaker Advanced Micro Devices (AMD), have been slow to switch. "These are the biggest technology challenges the industry has faced since the 1960s," says Dan Hutcheson, chief executive of market researcher VLSI Research.

The effects could be far-reaching. For businesses and consumers, ever-more powerful chips will be a little slower in coming, and prices won't drop as quickly as in the past. For the industry, it means the cost of building a chip-fabrication plant, which averages $2.5 billion today, will get more expensive, as will operating costs. Companies with the most advanced design and manufacturing technologies -- including Intel and IBM -- could get even stronger.

These challenges are emerging at a time when analysts are concerned about a slowdown in chip demand in the second half of the year. On July 12, Merrill Lynch (MER) lowered its revenue- growth forecast for the global chip industry in 2005 to 6%, from 16%. Likewise, on July 14, Intel disappointed investors with news that its inventories had risen 15%, depressing profit margins.

"A SEMINAL SHIFT." While most analysts see the recent slowdown as cyclical, the technical problems increasingly bedeviling chipmakers presage a significant long-term challenge. As semiconductor parts get ever thinner, the chips are burning hotter. That's happening as manufacturers shift from components that are 130 nanometers wide to 90 nanometers -- just a few atoms. The situation is expected to worsen over the next few years with the move to 65-nanometer technologies.

For the industry to keep its usual pace of doubling the amount of transistors it puts on a chip every 18 months to 24 months, it had to do a lot of innovating with chip design as well as new materials and manufacturing processes. However, when manufacturers resort to all sorts of tricks to boost chip performance while preventing them from literally burning up, those modifications give rise to design and production problems. "We're in a seminal shift in the industry," says Bernard S. Meyerson, IBM's chief technology officer. "Conventional wisdom doesn't necessarily apply anymore. You have to rely on invention."

IBM is a chip-technology pioneer, so its struggles with Apple's processor are doubly embarrassing. It took IBM more than six months to fix glitches at its East Fishkill (N.Y.) plant that kept yields -- the number of usable chips on a 12-inch wafer -- unacceptably low. Big Blue seems to have ironed out the glitches: Output doubled last quarter and is expected to double again this quarter, and Apple says it will stick with IBM.

"The whole industry has struggled with this transition. But because of our aggressive technology and designs, we tend to hit the bleeding-edge problems before our competition," says John E. Kelly III, senior vice-president in IBM's Systems & Technology Group.

ZIPPIER ELECTRONS. Intel has avoided the yield issues plaguing IBM and other companies that make chips to order, but it has had problems of its own during this switchover. Even after production delays, the Prescott chip hasn't performed as well as expected. Intel more recently canceled two other products and announced that it will make changes in the way it designs chips to help deal with the heat and performance issues.

To deal with these challenges, companies will have to employ a host of engineering improvements -- and come up with new breakthroughs every couple of years. IBM, for example, has developed a technology called silicon-on-insulator, which reduces power consumption and heat. It was also the first company to introduce so-called dual-core microprocessors, chips with two processors on a single piece of silicon that share tasks and eliminate the need to run at the high speeds that cause excessive heat.

Intel expects to deliver dual-processor chips next year -- and it, too, has been innovating. It's switching to a technology called strained silicon, similar to one being used by IBM, which makes electrons move faster. At the same time, Intel is also moving to a new chip-coating technique that will help reduce power consumption while increasing chip speed.

SQUASHING BUGS. Longer term, chip companies are looking at all sorts of exotic solutions, including more use of nanotechnology. Within the next decade, engineers envision using tiny carbon nanotubes as a partial replacement for silicon to cut down on chip overheating. Further out, scientists anticipate being able to make tiny transistors with single-atom switches, requiring infinitesimal amounts of energy to run.

For now, though, simply solving today's problems will require plenty of scientific breakthroughs. IBM has more than 50 research scientists at the East Fishkill plant to get the new manufacturing processes working properly. Until they're sure they can get the job done, they'll have to keep their heads out of the clouds. With Cliff Edwards in San Mateo, Calif., and Andy Reinhardt in Paris

Hamm is a BusinessWeek senior writer in New York

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