FEATURE - Chip industry a case study in deflation effects
02:02 a.m. Jul 03, 1998 Eastern
By Richard Melville
NEW YORK, July 3 (Reuters) - Years of sliding prices in the
semiconductor industry offer a case study of the dramatic changes
deflation force on business.
Semiconductors, particularly memory chips, represent the closest
equivalent to a commodity the technology industry has to offer. As with
many other commodities, pricing trends over recent years have pointed
steadily, often steeply, downward.
Some positive contributors to the phenomenon include technological
advances and increased manufacturing efficiencies.
Sluggish personal computer sales, serious economic problems in Asia and
years of over supply have also contributed to the falling price picture.
The news has been great for customers who reap obvious benefits from
lower costs. In some cases, firms have realigned, modified purchasing
plans and dropped the practice of stockpiling components to extract even
more gains from the price environment.
But for the chip producers, the impact has been low or non-existent
profits despite rapid efficiency and productivity gains and a
consolidation that has squeezed out the weak.
Several analysts believe the worst is yet to come.
''In our view, the steepest part of the semiconductor slow down has
begun and is trending downward,'' said Thomas Kurlak, an influential
analyst at Merrill Lynch in a report on Tuesday. ''End demand is slower
in Asia and the U.S. and is beginning to slow in Europe.''
MAJOR COMPANIES BOW OUT
Texas Instruments in June arranged its own exit from the dynamic random
access memory (DRAM) business, selling its money-losing unit to Micron
Technology. In the United States, only Micron and International Business
Machines Corp remain major producers of DRAM.
The Texas Instruments-Micron deal worried analysts in Japan, given the
potential for Micron to boost production after it assumed control of
TI's plan capacity, despite the fact that more production would
exacerbate an already abysmal market.
While producers in countries like South Korea may cut production,
''Micron will step in and fill the void,'' said Yoshiharu Izumi of SBC
Warburg Japan after news of the Micron deal. ''The hoped-for recovery in
1999 is jeopardised.''
Japanese electronics maker Fujitsu Ltd said last month that it may
consider withdrawing completely Acer Inc from making DRAM chips for
computers and Taiwan's has also shown signs of moving in that direction.
Hitachi Ltd and Toshiba Corp have seen DRAM losses slash their overall
group profits.
CUSTOMERS CHANGING PURCHASING AND INVENTORY BEHAVIOUR
While the news been nearly all bad for chip makers, the climate has
meant profound change for companies that purchase and use semiconductors
like personal computer makers.
For those companies, the downward spiral in prices for memory chips --
and some other components such as hard disk drives -- has prompted a
feverish push to pare down parts inventories and delay purchases.
''You definitely have seen a behaviour change in those who use chips,''
said Pierre Ellis, managing director and senior international economist
at Primark Decision Economics. ''Rather than buy now, you can wait and
perhaps buy cheaper and maker more money later.''
That behaviour tends to feed back on itself, as slower purchasing
exacerbates over supply until production tapers.
But economists do not view the narrow kind of price deflation occurring
in the chip industry as a threat to economic growth. Rather, most see it
as the natural outgrowth of years of over production.
''This is not the kind of deflation the Fed, for example, is worried
about,'' Ellis said.
PRICE DECLINES SEEN CONTINUING, ACCELERATING
Far from abating, internal figures supplied by one PC maker show memory
prices are actually expected to continue their slide for the rest of the
year, as much of Asia works through a severe economic downturn.
The data, which were supplied on condition that the company not be
identified, call for prices of 32 megabyte DIMMs (a commonly-used
configuration for DRAM, the letters stand for dual inline memory module)
to fall by 18 percent in the second quarter from the first quarter.
The decline is expected to accelerate in the second half of the year,
with declines of more than 20 percent in both the third and fourth
quarter, according to the company outlook.
Prices of 64 megabyte versions -- somewhat scarcer because they have
been available for a relatively short period of time -- are expected to
fall even faster, closing a price gap that exists for now with 32
megabyte products.
The deflationary phenomenon rewards companies that have built their
business around last-minute parts purchases and system assemblies, a
method raised to an art form by direct marketer Dell Computer Corp.
Other companies have fought furiously to alter their manufacturing
processes to win the same kind of pricing benefits, including IBM,
Compaq Computer Corp and Hewlett-Packard Co.
Some have argued that such models do not account for the possibility
that prices will eventually, inevitably, reverse course.
Even so, Dell Computer chairman Michael Dell has said he would not
abandon the company's model of sales and assembly even in an
inflationary environment, arguing that the savings from a nearly
inventory-free business model would continue to make sense even in a
climate of rising prices.
The falling chip prices have not proved a cure for earnings at PC
makers, many of which are suffering a round of something like deflation
of their own.
Compaq has managed only marginal profits this year, while IBM's PC
business is widely believed to be losing money. Dell has continued to
post strong profit gains, however.
((-- Wall Street desk, 212-859-1730))
Copyright 1998 Reuters Limited. |
