Semiconductor Market Trends

Date:   Monday , November 17, 2008

Historical Trends
From its inception in the 1950s through the mid 1990s, the semiconductor market grew at an average annual rate of between 15-20 percent. Driven by Moore’s Law new applications for semiconductors evolved as cost per function reduced, which fuelled demand for new types of electronic equipment.

Initially, the semiconductor industry was supported by government and military spending. By the 1970s, corporate spending on electronics was becoming more influential although it was the advent of the so-called “killer applications,” the personal computer (PC) in the early 1980s and the cell phone in the 1990s that really drove semiconductor market size and growth. Heavy investment by businesses in Information Technology (IT) was justified by the productivity gains that computing and communications electronics delivered and the period up to 1995 was hugely profitable for the semiconductor industry.

In the past decade, the corporate PC and cell phone markets have matured and are now replacement markets. Outside of emerging regional markets, sales of PCs and cell phones to new customers are driven by consumer spending, which means that the end market for semiconductors has become more price-sensitive and demand more elastic and this is causing a change in semiconductor market dynamics.

Market Dynamics
Despite its healthy long-term average growth rate through 1995, the semiconductor industry was plagued by market volatility. While demand for semiconductor units increased every year at a long term growth rate of about 10 percent, the nature of semiconductor manufacturing and its associated investment model meant that managing capital spending to match supply to the level of demand was difficult if not impossible. Furthermore, a highly competitive marketplace and attractive growth prospects meant that over-investment in “hot” markets was commonplace, which led to inevitable, periodic market corrections.

2001 was, in fact, a seminal year in the history of the semiconductor market because it was the first and only year so far to see a decline in unit demand. Although this was caused by the bursting of an economic bubble, it is worrying in that it shows the potential effect of demand side weakness, which is something the semiconductor industry seldom suffers.

It is unlikely that a new “killer application” to rival the significance of the PC or the cell phone will emerge and therefore the nature of demand for semiconductors will change. Demand will likely come from a host of different types of electronic equipment whose customers will be consumers looking for devices offering mobility, wireless connectivity and audio / video content storage and playback.

Long-term growth rate
As semiconductor demand becomes more price elastic, the ability of semiconductor vendors to maintain pricing levels is diminished, which has an adverse effect on revenue growth (assuming unit shipment volumes do not increase to compensate enough for lower prices). Since 1995 the long-term growth rate of the semiconductor market has declined toward 10 percent and it looks likely that a single digit long-term growth rate will characterize the market in the future. That is not to say that industry cycles are a thing of the past because supply and demand imbalances will still be a feature of the market but the peaks and troughs in market growth year-to-year may be modulated.

Current market status and forecast
Following growth of 24.6 percent in 2004 when the semiconductor market reached $222 billion, the year 2005 saw slower growth of 5.7 percent and sales of $235 billion. Gartner Dataquest’s forecast for 2006 is for modest growth of 10.9 percent, which would put the market at $260 billion, as shown in Table.

Semiconductor industry capital spending levels continue to be revised upward in 2006 and our current forecast stands at 16.6 percent growth. This level of spending will be enough to relieve the pressure on manufacturing capacity utilization and keep mild downward pressure on ASPs. However, any further increase in capital spending in 2006 would exacerbate oversupply in 2007, which would put greater downward pressure on ASPs and hold back revenue growth.

In the medium term we still expect a cyclical market peak in 2008 due to stronger demand fuelled by a favorable macroeconomic environment. The “wild card” that could affect top line semiconductor growth is the commodity memory market where the DRAM market is expected to continue to receive support from the NAND flash memory market. Major manufacturers are continuing with their strategy of tightly controlling DRAM manufacturing capacity while taking advantage of NAND flash memory market elasticity to ramp output and drive down costs (and prices).

While it is possible that commodity memory manufacturing capacity could be redirected back from NAND flash memory to DRAM during the forecast period, which could push the DRAM market into oversupply, as long as NAND flash memory demand remains highly elastic and margins healthy, this scenario is unlikely.

In the longer term, end market demand for electronic equipment and, by extension, semiconductor devices are expected to remain steady through the forecast period. The ongoing transition in the PC market from the desktop to the mobile platform as well as continued strong growth in the market for Flash Cards and USB flash drives will continue to fuel growth in the Data Processing sector.

More significantly, digital cellular handset unit production will remain healthy throughout the forecast period, which will underpin the semiconductor forecast for the communications segment. In 2008 we expect a peak in consumer spending on electronics because of the Beijing Olympics as well as stimulus in the U.S. economy related to Presidential Elections.

Finally, in Automotive, safety and security applications (airbags and remote keyless entry) and “infotainment” (GPS navigation and car radio) electronics will continue to be the main growth drivers through 2010.

Gartner Dataquest’s updated semiconductor market forecast profile through 2010 reiterates the expectation of a milder industry cycle than has historically been the norm. This outlook reflects our view that the industry is entering a new era of lower long-term growth and that this market maturity is bringing with it more-sensible investment decision-making by semiconductor vendors. It remains to be seen, however, whether capital spending will continue to be controlled in the future in order to maintain a better balance between supply and demand and therefore reduce market volatility.

We are still forecasting that annual revenues will breach the $300 billion level in 2008, which we still expect to be the peak growth year in the current industry cycle. By 2010, we expect revenues to approach $350 billion, giving a five-year CAGR though of 8.3 percent.

richard Gordon is the Managing VP, Semiconductors, Gartner Dataquest Research