Future of Semiconductor Business and Innovation (April, 2012).pdf

© Rohan Hubli Page 0

April, 2012

© Rohan Hubli

THE FUTURE OF SEMICONDUCTOR BUSINESS &
INNOVATION


CONTENTS
Semiconductor Value Chain and State of the Industry ..................................................................................................
3
Revenue Drivers
.............................................................................................................................................................
4
SemiconduCtor Companies Profitability Analysis Based on Business Models ..............................................................
6
Cost & Value Migration .................................................................................................................................................
7
The Economics of Chip Design .......................................................................................................................................
8
Startup Exit Valuation: ..............................................................................................................................................
9
Implications for Product Innovation ............................................................................................................................
11
The Road Ahead
...........................................................................................................................................................
13
Appendix I: Fabless Semiconductor Chip Startup Business Plan .................................................................................
15
Appendix‐II: World Wide Shipments of Select Devices: ..............................................................................................
16
Appendix‐III: Industry Growth Prospects.....................................................................................................................
17
References ...................................................................................................................................................................
18


Abstract: The Life Cycle theory on industry evolution suggests that the rate of knowledge
obsolescence tends to diminish over time. In effect it deters new entrants from entering the
industry; the ensuing shakeout forces industry consolidation and concentration. The fallout;
operational efficiency, product proliferation and price discipline take center stage.
In the semiconductor industry the very presence of technological knowledge obsolescence
has prevented industry shakeout and consolidation up until now. However, with escalating
costs and the fundamental limits on device physics reaching a climax are the curtains
descending on the semiconductor industry. If so, what are the ramifications for the industry
and its ecosystem?

First a brief look at the semiconductor industry dynamics:

1. Semiconductor fabrication plants exhibit exponential cost dynamics. Rock’s Law, named after
the visionary venture capitalist Arthur Rock, predicts that the cost of a semiconductor fab will
double every four years.
2. Semiconductor Industry is characterized as having very high fixed cost, and low variable costs.
3. A cutting edge semiconductor fab has an active life cycle that lasts anywhere between three
and five years. The cyclical nature of the industry results in periods of high capital expenditure
interspersed with bursts of revenue streams.
4. Moore’s Law, named after the visionary cofounder Gordon More of Intel, predicts that the size
of a semiconductor chip will shrink by half every two years (everything else remaining the
same).
5. Semiconductor chips although very design intensive benefit heavily from division of labor.
6. Semiconductor design exhibits compelling scope economies due to cumulative experience and
design knowledge.
7. Semiconductor design is susceptible to significant knowledge obsolescence within domains.
8. Process and Product Innovation both happen at the same time. Firms either acting alone or
together orchestrate process innovations that the entire industry draws upon. Product
innovations on the other hand are firm specific.
9. The industry is highly competitive with low barriers to entry. However tacit knowledge and
market reputation favor both scope and scale economies.


SEMICONDUCTOR VALUE CHAIN AND STATE OF THE INDUSTRY
As of 2011, worldwide semiconductor sales attributed to IC’s and components reached
$299.5 Billion. The market is fragmented across all sectors except in the area of
microprocessors were a duopoly exists. The worldwide pure play semiconductor foundry
market totaled $29.8 billion in 2011. The top five foundry players accounted for almost 80
percent of the foundry market share.
Electronic Design Automation (EDA) vendors accounted for revenues of $4.19 Billion in
2011. Semiconductor chip design, verification and implementation tools accounted for
almost 90% of this market, with the rest owned by PCB design tools.
The market for semiconductor IP registered sales of $1.58 Billion. Design Services made up
another $350 Million in revenue for 2011. IC Packaging and Assembly generated revenues
of $13.9 Billion and the embedded software market registered sales of $1.2 Billion.
Semiconductor FAB’s demonstrated revenues of $29.8 Billion in 2011.
Across the value chain semiconductor chip companies and semiconductor FABs account for
the lion share of the revenue. The former exploits economies of scope and the latter
economies of scale.


REVENUE DRIVERS


SEMICONDUCTOR COMPANIES PROFITABILITY ANALYSIS BASED ON BUSINESS MODELS
100% 55%
20%
15%
10%
5%
15%
Revenue COGS R&D SG&A EBIT Depr/Amt EBITDA
Fabless Semiconductor Companies
100% 60%
15%
15%
10%
10%
20%
IDM Semiconductor IC Companies
100% 75%
10%
7%
8%
25%
33%
Semiconductor Foundries


COST & VALUE MIGRATION
An amalgamation of processor cores, feature rich IP and fab for hire have pushed the value
frontier to a new normal. Aided by quantum jumps in feature size and design productivity,
SOCs redefined products and markets.
The first generation of SOC’s saw processor, peripherals, interfaces and memory integrated.
The second generation of SOC’s built on the previous by harnessing multiple cores, RF and
power management functions. The third generation of SOC’s will bring together photonics,
high density memory and MEMS into the main stream.
Cost Performance Ratio, SOC’s - The New Normal
On the value frontier, a leading edge System-on-Chip (SOC) offers cost-performance ratio
that rivals the elite microprocessors of today. The new players with vastly different business
models are increasingly threatening the old guard. However both have seen semiconductor
design costs reach epic proportions.
With increasing levels of integration and multicore processors becoming the norm, hardware
and software costs have exploded. Verification engineers and software developers now
covet over half of the development team. As geometries shrink, tooling efforts to account
for increasing variability of parameters and DFM (Design for Manufacturing) requirements
have further exacerbated the problem.


THE ECONOMICS OF CHIP DESIGN
A typical semiconductor company spends anywhere from 20% to 25% of its revenue on
R&D with COGS accounting for another 40%-45% and SG&A in the region of 10% –
15%.
With these assumptions and using the Semiconductor Chip Design Cost Model the numbers
that emerge tend to favor products that can be milked over relatively large periods of time
or in markets with large demand side economics of scale.
To put things in perspective, the annual shipments of microprocessors (all segments) in
2011 stood at 350 Million units. High-end smartphone shipments reached 60 Million units
in 2011. The returns necessary to justify investment on a new chip requires double
digit market share.

$48
$112
$239
$510
12M
28M
52M
102M
$0
$100
$200
$300
$400
$500
$600
65nm 45nm 32nm 28/22nm
Millions
SOC Development Cost/Chip Volumes
SOC Costs
Unit Volumes


FABLESS SEMICONDUCTOR STARTUP:
The picture is no different for emerging startups wanting to unleash the next biggest idea or
invention. Although startups rely on VC money to fuel R&D in the initial stages the return
necessary to justify venture investment are increasingly out of reach for many. A
semiconductor startup pursuing an opportunity in a fast growing market needs to capture
more than 10% market share and demonstrate higher probability of success. To deliver
both, the odds are as good as winning the lottery. (Addendum: Chip Startup Business Plan)
Fabless semiconductor chip startup business plan

$25
$50 $50
($28)
($53)
($37)
$27
$42
-$220
-$170
-$120
-$70
-$20
$30
$80
$130
2012 2013 2014 2015 2016
Millions
Economics of Chip Startup
VC Funding
Expenses
Cash Balance
Net Income


STARTUP EXIT VALUATION:

Note: Startup is funded, based and operates solely out of USA

Net Icome in Year-5 (After Taxes )
Comparable P/E Multiple
Startup Exit Value
VC Target Returns
Seed
Investor
Round-A
Investor
Round-B
Ivestor
Probability of Successful Exit
VC Target Returns per Year 59% 73% 97%
VC Returns $254,053,762 $447,872,521 $382,268,650
VC Target Returns
Seed
Investor
Round-A
Investor
Round-B
Ivestor
Probability of Successful Exit
VC Target Returns per Year 32% 37% 45%
VC Returns $100,186,606 $176,137,681 $320,486,703
Exit Value Necessary
for VC Funding
$1,084,194,932
$41,805,276
Startup Exit Valuation
© Rohan Hubli
Exit Value Necessary
for VC Funding
50%
Scenario-2: 50% Probability of Success
$596,810,990
16
$668,884,410
25%
Scenario-1: 25% Probability of Success


IMPLICATIONS FOR PRODUCT INNOVATION
It is imperative for designers to leverage legacy designs, in die form, surround them with
abundant memory and unleash rich software to create value. New alternatives in 2.5D
packaging (side-by-side die on an interposer) or 3D packaging (Through-silicon-Vias) will
aid this effort. Many low to medium volume applications will make this transition. OEM’s in
commodity markets will increasingly adopt COTS and rely on ODMs/EMS to bring solutions.
Software will be the basis for differentiation.
For high volume applications the next wave of innovation will require products that can
integrate wider range of heterogeneous functions (mobility, sensing, intelligence,
adaptability and connectivity).

The market will essentially evolve to provide one or all of the following functions-
Intelligence, Connectivity, Stimuli and Gratification in varying degrees. A chip that can
integrate all of the above functions and satisfy the needs (price/performance) of the market
will unleash major realignment and shakeout within the industry.


Imagine a TV in the not so distant future that morphs into a Gaming Console, a PC, a Web-
TV or an entertainment hub based on the need. Embedded Hardware Virtualization will
make this happen and enter mainstream market in a big way.
Intelligent Devices constitutes another market area with a potential volume larger than PCs,
Mobile Phones, Servers, and Tablets combined. With a 2020 vision of 25 Billion devices the
market requires Sensing, LBS, Augmented Reality, Analytics, Security and Self-Monitoring
to be prevalent in most nodes. A platform centric vision for intelligent nodes can unleash
innovation and propel existing players to new heights.
We are entering a realm of devices capable of features analogous to what we humans are
born with. Ironically most humans share the same feature set. It is the DNA that confers
uniqueness and character. For chips, with similar features, software will emerge as the key
differentiator and enabler that can morph into something unique depending on the
context.


THE ROAD AHEAD
Globally the aging population (65+) will grow to 2 Billion by 2050. The world’s emerging
middle class will reach 4.9 Billion by 2030. Developed and emerging economies share of the
middle class will reverse from the current 50% to 22%. A slow-cycle market characterizes
one and a fast-cycle market exemplifies the other. The challenge lies in managing both at
the same time and within the same organization.
1. Industry Concentration: The minimum efficient scale (MES) for a semiconductor fab
is nearing $10 Billion. For a fabless chip company the ratio of minimum sales volume
(MSV) to market size has reached double digits (~15%). As platform products and
services, with winner-take-all dynamics, become more prevalent, the industry will
consolidate. Firms either need to pursue broad line differentiation or risk being caught in
the middle where the future is anything but certain. Each market vertical will converge
to the “Rule of Three” with an uptick in M&A based on horizontal product line reach.
2. New Business Models: The new winners will be those who can enrich customer
captivity (combination of switching and search costs) and combine it with supply side
economies of scope. The industry will favor fast-followers and late adopters over
innovators. An asset lite model supplemented by just-in-time design methodology and
standardized hardware platform with software differentiation will redefine competition.
3. Vertical Integration: OEM’s will be forced to ensure that their semiconductor suppliers
remain viable and continue to create value. Some form of vertical integration either in
the form of minority stake, multi-year supplier partnership or outright purchase will
become a necessity. Pure play foundries and EDA specialists will integrate forward to
offer one stop R&D solutions by assembling a portfolio of IP’s and engineering resources.
At the technology level high density Memory (3D), MEMS, Interconnects,
Photonics and Embedded Software are prime targets for M&A.
4. Operational Efficiency: Ultimately all firms needs to generate returns that cover the
cost of capital. The less efficient companies will struggle merely to remain afloat.
Efficiency governs all activities from engineering, production, marketing, sales, to
operations. The organizational power structure, long the bastion of engineering, will
cede control to marketing and finance. ROIC the new mantra.


5. R&D: Escalating costs, will force many chip companies to offshore R&D. In the next five
years leading edge designs, the stronghold of Silicon Valley will move overseas as
markets there become large. Many companies will transform their model to one of an IP
provider. Foundries, the current gateway for all semiconductor chips will move up the
value chain to offer one stop solutions as will EDA companies. Development of process
technology for new nodes will require pooling of industry resources together.
6. Value Migration: For firms to generate economic profit it is imperative to adopt a
software centric vision for the products as value migrates from hardware to software.
Firms that can package and deliver hardware-software together will remain immune to
commoditization and reap the benefits of lock-in and network effects. If you are
somehow not plugged into one of the platforms, competition will force you out.
Closing Remarks:
As the economics of semiconductor business undergoes fundamental shift, changes in the
value chain and ecosystem is inevitable. To sustain economic profits exploiting economies of
scope in R&D resources will become critical and challenging. One business model that could
disrupt the industry is “Just in Time Design” harnessing elements from Dell’s supply chain
model and Toyota’s production management system. When transaction and search costs
associated with semiconductor Intellectual Property and Engineering Talent intersect on an
EBay like trading platform the vision will become a reality.


APPENDIX I: FABLESS SEMICONDUCTOR CHIP STARTUP BUSINESS PLAN

Fabless Semiconductor Chip
Startup Business Plan
2012 2013 2014 2015 2016
Seed Funding $25,000,000
Round A $50,000,000
Round B $50,000,000
Total VC Funding Raised $25,000,000 $75,000,000 $125,000,000 $125,000,000 $125,000,000
Startup Cash Balance 2012 2013 2014 2015 2016
Beginning Balance $25,000,000 $47,354,209 $44,018,651 $7,455,075 $34,755,499
Ending Balance -$2,645,791 -$5,981,349 $7,455,075 $34,755,499 $76,560,775
Income Statement 2012 2013 2014 2015 2016
Sales
W/W High End Smart Phone Market
(TAM), CAGR: 10%
66,000,000 72,600,000 79,860,000 87,846,000 96,630,600
- Target Market Share 0% 1% 4% 7%
- Unit Sales 0 0 798,600 3,074,610 6,764,142
- ASP $25 $25 $25 $25
Smart Phone Market Revenue $0 $19,965,000 $76,865,250 $169,103,550
W/W Tablet Market (TAM), CAGR: 8% 54,000,000 58,320,000 62,985,600 68,024,448 73,466,404
- Target Market Share 0% 1% 3% 6%
- Unit Sales 0 629,856 2,040,733 4,407,984
- ASP $20 $20 $20 $20
Tablet PC Market Revenue $0 $12,597,120 $40,814,669 $88,159,685
Unit Sales (Combined) 0 1,428,456 5,115,343 11,172,126
Net Sales $0 $0 $32,562,120 $117,679,919 $257,263,235
Expenses
- R&D Investments $25,608,265 $51,216,530 $51,216,530 $10,955,311 $51,452,647
- SG&A $2,037,526 $2,119,027 $3,256,212 $11,767,992 $25,726,323
- COGS $0 $0 $14,652,954 $52,955,963 $115,768,456
Total Expenses $27,645,791 $53,335,558 $69,125,696 $75,679,266 $192,947,426
Net Income (After Taxes) ($27,645,791) ($53,335,558) ($36,563,576) 27,300,424
$ 41,805,276
$
Last Update: April, 2012
© Rohan Hubli


APPENDIX‐II: WORLD WIDE SHIPMENTS OF SELECT DEVICES:

2011 Worldwide Shipments Units
Touch Controller IC Shipments 1,224,000,000
LCD TV 250,000,000
Plasma TV 17,200,000
3D TV 24,000,000
Wi‐Fi Capable Devices 1,000,000,000
Bluetooth Capable Devices Shipped 1,600,000,000
Tablet PC Shipments 60,017,000
EBook Reader Sales 22,820,000
PC Server Shipments 9,523,171
PC Shipments 352,806,984
Microprocessor Shipments 352,800,000
Mobile Processor Shipments 859,980,000
Smartphone Shipments 472,750,000
  ‐ Android 219450000
  ‐ iOS 89270000
  ‐ Symbian 88410000
  ‐ RIM 51530000
  ‐ Microsoft 9840000
  ‐ Others 14250000
Image Sensor Shipments 2,100,000,000
  ‐ CCD Sensor 108,300,000
  ‐ CMOS Sensor 1,991,700,000
Personal Navigation Devices 30,000,000

References: Gartner, IC Insight, Display Search, Berg Insight.


APPENDIX‐III: INDUSTRY GROWTH PROSPECTS

Semiconductor Growth Prospects CAGR
Semiconductor IC Market1
6% (2012 – 2015)
Semiconductor IP Market2
14 % (2012 – 2017)
Semiconductor IC Packaging Market3
7.5% (2012 – 2015)
Embedded Software Market4
15% (2012-2014)

1
Global Semiconductor Alliance, March 2012
2
EDA Consortium, Quarterly Marketing Statistics (2011).  Market Research Reports
3
  ChipSTAT Annual Review, April 2012
4
NASSCOM, Opportunities in Embedded Software (2010)


REFERENCES
1. Semiconductor Annual Revenue Data sourced from WSTS, April 2012
2. EDA Annual Revenue Data sourced from EDA Consortium MSS Newsletter, Q1-Q4 2011
3. Semiconductor Foundry Market Data sourced from Gartner, March 2012
4. Processor Market Shipments by Industry and Architecture, IDC, February 2012
5. Semiconductor Industry Profitability Analysis based on financials from 2007 – 2011 of
Top 10 players in each category excluding outliers. Data compiled from Annual reports,
Morningstar, Bloomberg and SEC filings.
6. 2011 PC Shipment Data, Gartner, January 2012
7. 2011 High End Smartphone Shipment Data, Berg Insight, February 2012
8. Intelligent Systems, The Next Big Opportunity, IDC, August 2011
9. World Population Aging, United Nations
10. World’s Emerging Middle Class, sourced from Dr. Homi Kharas, The Brookings
Institution,

Future of Semiconductor Business and Innovation (April, 2012).pdf

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