PRICING POWER: In a Tech Backwater, A Profit Fortress Rises [WSJ]
Maker of Arcane Chips Earns Better Margins Than Google, Microsoft
By GEORGE ANDERS
July 10, 2007; Page A1
MILPITAS, Calif. -- Erik Soule had been waiting 15 months for this moment. The semiconductor engineer was about to launch a new chip, and he needed his pricing approved. In a conference room at Linear Technology Corp., Mr. Soule anxiously explained why his amplifier chip is so advanced that it should sell for $1.68, a third more than its rivals.
His bosses' reaction: Charge even more. The chip is 30 times better than the competition, they asserted, and high-end customers will crave it on any terms. Why not boost the $1.68 list price by 10 cents? Mr. Soule was nervous. "I can live with that," he guardedly replied, "but what does that accomplish?"
[Robert Swanson]
"It's a dime!" declared Linear's chairman and founder, Robert Swanson. "And those dimes add up."
For many U.S. companies, such exuberant pricing power vanished long ago. They now struggle to deliver more at lower prices, amid intense global competition. But Linear has built one of the world's strongest profit fortresses by staying strictly at the fringes, where competition is low and margins are still high.
Away from the semiconductor industry's frenzied center stage, this midsize company makes 7,500 arcane, unglamorous products that solve real-world problems for a long list of customers. Instead of the better-known digital chips that power the brains of the world's computers and bring in 85% of the industry's revenue, Linear makes so-called analog chips that are too cheap for customers to haggle over, but perform chores too important to ignore.
Pick apart a medical ultrasound machine, a hybrid car battery or thousands of other costly devices, and somewhere inside is a Linear chip that helps monitor power consumption or guard against voltage surges. It's a backwater of high tech well-suited to Linear's engineer-driven culture, where quirky developers shop for old part testers at flea markets to keep costs down. Many of Linear's chips cost less than 50 cents to build and sell for three to four times as much, but customers seldom complain about the markup.
Linear made a 39% profit on its $1.1 billion in sales in calendar 2006 -- more than five times the average for U.S. industrial companies. Linear easily outpaced even the tech industry's best-known profit powerhouses, Microsoft Corp. and Google Inc., which earned profits of 26% and 24% of sales for the same period.
Squeezing Margins
Now some bigger chip makers want to muscle in, and Linear may find it harder to keep squeezing huge margins from its offbeat specialties. A big stock buyback has shored up Linear's share price this year, but its sales growth has ebbed amid a general slowdown in microchips. Dallas-based Texas Instruments Inc., more than 10 times Linear's size, says analog chips now account for 40% of its chip sales and its analog operation is growing faster than the rest of TI.
Other rivals such as Richtek Technology Corp. of Taiwan and Freescale Semiconductor Inc. of Austin, Texas, are targeting Linear's specialty of power management. More big chip makers may follow, says Suzie Inouye, research director of Databeans Inc., a Reno, Nev., market-research firm. "They can all see how profitable power management has been," she says.
LINEAR THINKING
[computer chip icon]
Profile of Linear Technology Corp.
How the Company Started: Engineers led by Robert Swanson and Robert Dobkin left National Semiconductor Corp. in 1981 to form Linear.
First New Product: The LT1013 operational amplifier, developed by engineer George Erdi, dubbed 'Mr. Precision' by colleagues. The chip is still being sold.
What Linear Makes Today: Some 7,500 kinds of analog semiconductors, chiefly for power management. They go inside everything from digital cameras to aircraft cockpits.
Average selling price: $1.67 per chip
Heard in the Hallways: Everyday phrases include buck-boost converters, power over Ethernet, and circuit topology. The ultimate macho question engineers ask one another: 'Couldn't you build that with fewer transistors?'
Popular Chips: The DC/DC Micro-Module Regulator provides a power supply for network systems and servers on an ultra-thin chip. The Buck/Boost Synchronous DC/DC Converter helps maximize battery life in media players, digital cameras and cellphones.
Headcount and offices: 3,800 employees; headquarters in Milpitas, Calif.; other sizable operations in multiple U.S., Asian and European cities.
Linear's Mr. Swanson asserts that his company's sprawling product line, without a single blockbuster, makes it a tough target for competitors. In the digital-chip world, a single winning design bought by a few big customers, such as Intel Corp.'s Pentium, can yield huge profits at its peak. But that market is fraught with huge capital costs, rapid obsolescence and brutal competition. Linear has 17,000 customers, none of which represents more than 3% of its sales. "We built this business one brick at a time," the company chairman says. "Anyone who wants to take us on will have to do it one brick at a time, too."
In fact, Mr. Swanson says, he gets nervous if one chip starts selling too well. That invites competition; it also means customers may peer harder at costs. Linear learned that the hard way in the early 1990s, when Ford Motor Co. was its biggest customer. What started out as a lucrative contract selling transmission-system chips turned into a quagmire as Ford kept pressing for discounts. "We got out of that business, and for years afterward, we refused to do anything with automotive," Mr. Swanson says.
Linear would rather see its order book packed with small to midsize orders from companies too busy to bargain over prices. "Shaving the last penny or two off our price quote just isn't a priority for them," says Lothar Maier, Linear's chief executive.
Agilent Technologies Inc. fits that bill. The Santa Clara, Calif., instrument company uses a smattering of Linear chips to keep power systems running smoothly inside oscilloscopes that measure electrical signals and sell for $100,000 or more. "Power management is something we'd really like not to worry about," says Mike Boyers, an oscilloscope product planner at Agilent. "We'd much rather concentrate on our own technological contributions."
Agilent's purchasing managers have noted Linear's fat profit margins as a negotiating point in seeking discounts. But their leverage is limited. About 80% of Agilent's purchasing priorities are based on nonprice factors, such as quality and reliability. Linear gets high marks in those areas, says Mr. Boyers. For the past few years, it has been an Agilent preferred supplier.
In other cases, customers pay Linear's markups in the hope of gaining a competitive edge. In Everett, Wash., Intermec Inc. makes mobile data scanners, including hand-held units that weigh as little as 13 ounces and can operate for a full eight-hour work shift without being recharged. Its devices cost as much as $2,500 apiece. They are used in warehouses by Boeing Co. and others.
Extra Life
Intermec uses Linear chips to coax extra life from its devices' batteries; their total cost is less than 5% of the materials budget. "Linear is a relatively small part of our spending, but it's a vital piece," says Intermec marketing director Dan Bodnar. Performance is crucial in his world; price isn't. "If our product doesn't last as long as customers expect," he explains, "it doesn't matter what it costs."
Traditionally, the dozen or so major analog chip companies have tiptoed around one another's product lines, helping keep profit margins high. Linear, TI and National Semiconductor Corp. have carved up various areas of power management, with overall market shares of 10% to 15% apiece. Analog Devices Inc. has focused on analog-to-digital converters, such as the chips inside Nintendo Corp.'s Wii game machine. Other companies have focused on buffers, sensors or filters.
Each company established its strength decades ago, making it easy to extend existing product families and deepen relations with longtime customers. "We chip away a little at each others' specialties," says Jerald Fishman, chief executive of Analog Devices. "But there isn't a lot of direct competition."
Linear was formed in 1981 by Mr. Swanson, chief technical officer Robert Dobkin and three other engineers, most of whom broke away from National Semiconductor because they felt it was too bureaucratic and wasn't making the most of its analog opportunities at the time.
Right away, Linear created a corporate structure that showcased individual chip designers. Instead of being roped together in big teams, designers took solo command of a new chip. They brainstormed with potential customers, they sketched circuits, and they even participated in advertising meetings. Successful designs were posted on the walls as art.
Designers cherished the autonomy and recognition. Top executives found that designers worked faster and smarter when they felt in command of everything. Linear avoided putting so many people onto a $2 million project that it would risk delays or runaway costs.
Engineer Magnet
Linear became a magnet for gung-ho engineers who had been messing around with circuits since they were children. Often the slyest rascals turned out to be the cleverest designers. As a 12-year-old in the 1960s, Steve Pietkiewicz stored electrical charges in capacitors, then tormented his little sister by leaving them on the kitchen table to shock her when she touched them. At Linear a few years ago, Mr. Pietkiewicz designed some of the first chips that let cellphone batteries create enough juice to trigger a camera flash.
![](http://<br><br>Robert Reay, who joined Linear in 1988, won acclaim for creating "hot swap" chips that made it easy and safe to switch circuit boards while a computer was running. He had more than a casual interest in the problem; as a teenager he had ruined his father's Apple II computer by trying to yank out boards in an effort to install a speech synthesizer.<br><br>At a recent job fair at the University of California, Los Angeles, Linear engineer Atsushi Kawamoto jostled for attention with recruiters from Walt Disney Co. and a big mutual-fund complex. "They had Frisbees and stuffed animals to give away," Mr. Kawamoto recalls. "All I had was the Accuracy Translator" -- a thin strip of gray plastic that helps engineers convert decibels to powers of two, among other things.<br><br>Most visitors scoffed at the Linear booth as too geeky. But one student was enchanted. "He kept saying: 'I didn't know that companies like you existed,' " Mr. Kawamoto recalls. "That's the kind of person we like to hire."<br><br>Linear's quirks include a resolutely low-tech approach to its high-tech mission. Mr. Swanson refused to put in an email system for much of the 1990s, telling people to wander down the hall and talk to colleagues instead. He only reluctantly accepted voicemail and rejects modern "customer relationship" software to manage the business. Instead, sales updates are distributed on old-style green-and-white-striped printouts with rows of holes on each side.<br><br>Meanwhile Linear's bosses have pinched pennies as if the company were teetering on the edge of insolvency. Mr. Swanson uses a scuffed desk chair from the early 1980s and tells subordinates that they can live with worn furniture, too. "They call me the Neanderthal Man," Mr. Swanson says. "But I'm right."<br><br>Mr. Dobkin, the chief technical officer, won't spend much for test equipment. Instead, he encourages chip designers to scour flea markets for used voltmeters, oscilloscopes and the like to test the electrical performance of their chip designs. Aging models that cost $75 or less are ideal, Mr. Dobkin says, and if repairs are needed, engineers can learn by fixing the machines.<br><br>Instead of rebelling, Linear's engineers have turned their lab into a haven for vintage electronics gear. "There's some beautiful design from the 1960s," explains Jim Williams, a Linear engineer who has surrounded himself with tools from the era.<br><br>Such eccentricities sometimes help Linear make money, Mr. Williams says. In the early 1990s, when he was trying to improve battery life and screen lighting for laptop computers without electrical distortion, Mr. Williams says he patterned part of his approach after the design of a 1967 oscilloscope. His laptop project helped Linear become a major supplier for Apple Inc.'s computers.<br><br>Hoping for another déjà vu moment, Mr. Williams spends many Saturdays prowling through Silicon Valley junk shops, looking for interesting electronic parts. He was delighted one recent afternoon to snap up a used electricity meter -- like those bolted to millions of homes -- for $45. "This is a huge market," he told a companion. "I'm going to take it apart. Perhaps there's something we can do to help improve it."<br><br>Linear's thrifty ways carry over to its factories. Digital chip makers such as Intel spend as much as $2 billion to outfit a plant that may last only a few years before new technology makes it obsolete. Not so in the analog world. Chip designs from the 1980s still attract customers, and ancient chip-making tools still suffice for some functions.<br><br>In Linear's newest factory, built in 2001, modern chip-etching machines jostle for space with some old workhorses made by companies that went bust years ago. "We've got great mechanics," explains Robert Barber, Linear's director of process engineering, who says the old equipment hasn't become obsolete. "If our guys took care of your car, you could still be driving a 1965 Mustang."</span></td></tr></form></table><br></tr></td></table><br><!--start of bottom--><table class=) |
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