A few months ago, when SemIndia decided to locate its semiconductor fabrication plant in Hyderabad, India at a cost of $3 billion, the media went ‘ga ga’ about it saying that it signals India’s entry into the manufacturing league, a stronghold of select few countries such as China, Taiwan and Singapore till recently. Yes. One cannot refute the fact this is the first time India has been considered as manufacturing location for chips. However, this is not the first time a chip company is setting up its operations in India. Companies such as Texas Instruments and Cadence Systems set up their development centers in India as early as 1980s to make the most of talent pool available here. Besides, if the argument truly holds water, Intel, the worlds largest integrated chip manufacturer, would have located its fab (28) at an estimated cost $3.5 billion in India, instead of Israel.
The cost arbitrage
So, what is new this time, one may ask. The apparent reason to locate a fab is India must be the cost arbitrage. This holds good particularly in the wake of appreciation of the Chinese currency, Yuan, by 3.3% since it got pegged to the basket of currencies last year. Hence, importing wafers from fabs is China may not be a viable option for fabless manufacturers such as Freescale, Broadcom, Altera and nVidia, on the long run. This is because, the appreciation in the currency will offset the cost advantage. Consequently, the wafer manufacturers will be forced to keep a mark-up on the product prices. This in turn will have a bearing on the operating margins of the fabless manufacturers.
Secondly, a huge fabrication facility also lowers the time-to-market for pure design firms that operate out of India and enable them to stay ahead in the competition. Thirdly, the technical expertise that India has gained over a period, bridging the perceived gap in technology adoption, also appears to have aided the decision. The other possible reason could be the decision to strike a geo-political balance and diversifying the risk by setting up a base in a market-driven economy instead of purely relying on select China-based large manufacturers such as United Microelectronics (UMC) and Taiwan Semiconductor Manufacturing (TSM).
Driven by volumes
Semiconductors (particularly digital chips) generally have a short product life cycle, rapid technological obsolescence and a steady markdown in selling prices. This calls for large capital expenditures by wafer manufacturers on a regular basis to roll out products in line with market requirements. Hence, economies of scale become the single most critical success factor to cover up all the fixed costs a wafer manufacturer incurs. The question at this point of time is do we have a large domestic market to achieve the economies of scale. The answer is a big no. Nonetheless, according to a leading market research firm, the market for electronic equipments is expected to grow by 35% annually for the next five years driven by a surge in sales of set-top boxes, DVDs, cell phones and other electronic appliances. This in turn is expected to drive the demand for chips.
However, it is pertinent to note that the market for PCs, which account for over 50% of the chip demand globally, is growing at a single digit rate. Adding to the risks, the chip industry has been historically cyclical in nature. For instance, during the downturn in 2001 the top and the bottom line of most of the semiconductors witnessed a nose-dive. Consequently, wafer manufacturers such as UMC and Chartered Semiconductor Manufacturing (CHRT) also reported operating losses during the period. These Industry manage to witness a recovery only in 2004, and post revenues of over $200 billion in 2005, the first time since 2000.
What is in store for SemIndia?
According to SIA, the trade association that represents the U.S. semiconductor industry, the global sales of chips are expected to grow at about 10% annually. This augurs well for all the chips and wafer manufacturers. However, the success of SemIndia will depend on its ability to ward of all these challenges and risks. Further, its strategy should be flexible enough to focus not only on the domestic market, but also on the international markets, if the anticipated growth in the domestic market does not emerge. In such case, SemIndia should also be ready on its toes to take on the biggies such as TSM, UMC and CHRT.
Madhan Gopalan
The author is the Head of Investment Research and Advisory Services of Ness Innovative Business Services (Ness IBS). The views expressed are his own and not that of Ness IBS.
