Sourcetoday 736 Thinkstockphotos Chip Jpromo 1
Sourcetoday 736 Thinkstockphotos Chip Jpromo 1
Sourcetoday 736 Thinkstockphotos Chip Jpromo 1
Sourcetoday 736 Thinkstockphotos Chip Jpromo 1
Sourcetoday 736 Thinkstockphotos Chip Jpromo 1

Some Buyers See Risk as Foundries Handle More Chip Production

Dec. 16, 2016
Foundries continue to make investments in capacity and process technologies to meet growing demand from semiconductor suppliers.

Outsourcing is nothing new to the electronics industry. In fact, outsourcing the production of printed circuit boards, subsystems, and systems to contract manufacturers has been a critical strategy for many electronics OEMs for more than 25 years.

At the same time, outsourcing has become an important supply chain practice for some semiconductor companies. Some have been fabless since day one, relying on foundries to produce all their products. And some integrated device manufacturers (IDMs) operate their own fabs, but outsource a portion of their chip production to foundries.

Semiconductor suppliers are outsourcing for the same reasons that OEMs outsource equipment manufacturing. They want to reduce manufacturing costs and avoid investment in new facilities and equipment, which today typically costs many billions of dollars.

As a result, the amount of semiconductor production being outsourced to foundries continues to grow. This is causing concern for some semiconductor buyers at OEMs and electronics manufacturing services (EMS) providers. They believe it may increase risk in the supply chain because a handful of foundries handle the bulk of outsourced chip production.

In 2015, the percentage of semiconductors produced by foundries was 17.5%, according to researcher IC Insights. This figure is projected to increase to 19.7% in 2017 and 20.6% in 2020. “On average, it looks like it is growing at a rate of about a half a percentage point per year,” says Brian Matas, vice president of market research for IC Insights.

Some of that growth is due to IDMs outsourcing more production. “We are seeing a little bit more outsourcing to foundries from companies like Texas Instruments that outsources some of its high-end semiconductors,” says Matas. “Freescale and Fairchild were doing a little bit more before being acquired and Japanese companies are doing a bit more as well, which would’ve been unheard of a few years ago.”

Some buyers point out that while foundries are handling more production, a relatively small number of them are responsible for most of the outsourced chip production. The top four foundries—GlobalFoundries, SMIC, TSMC, and UMC—accounted for 85% of foundry sales in 2015, according to IC Insights. Purchasers are concerned that as IDMs outsource more to foundries, it increases risk in the supply chain.

One potential risk is faster component obsolescence, according to a purchasing vice president at a midsized EMS provider, who used “virtual manufacturing” to describe foundries. “With virtual manufacturing, there can be a perceived low barrier to exit for products that are now redundant or underperforming,” he says. Outsourcing chip production may make it easier for a semiconductor supplier to obsolete a part.

Another potential risk is capacity. Since a small number of foundries are handling the bulk of chip production, if those foundries don’t add enough capacity or develop new process technologies to support additional customers, a surge in semiconductor demand could stretch lead times of critical chips.

So far, capacity has not been an issue. “Foundries have made the necessary investments to satisfy all their customer requirements,” says IC Insights’ Matas. “Periodically they get a wee bit behind the curve, but they know it’s really critical to have enough capacity at the very leading edge to be able handle the demand from top clients.”

In fact, foundries have increased capital spending for capacity and new process technologies over the years. While foundries build less than 20% of semiconductors, about a third of all capital spending is being done by foundries, according to IC Insights. However, capital spending by foundries can vary year by year.

For instance, foundry capital expenditures fell from $22 billion in 2014 to $20.5 billion in 2015, but are expected to end 2016 increasing 5% to $21.4 billion, the researcher said. In addition, capital spending as a percent of sales for the top five foundries in 2016 is expected to be 39% compared to 19% for the overall semiconductor industry.

While some buyers may be concerned about the risk of outsourced chip production, only a relatively small amount of IC products are built by foundries. Foundries such as the big four typically focus on application processors, field programmable gate arrays, baseband processors, graphics drivers, and ARM processors, says Matas. Those products are designed by “the QUALCOMMs, Broadcoms, and Xilinxs of the world. Those companies design ICs that require the latest process technology process geometries,” he said.

Other high-volume chips, such as memory ICs and analog chips, are typically not outsourced. “DRAM and NAND flash generally don't get outsourced,” says Matas. “Samsung is making all theirs, Hynix is making their own, and so is Micron.” Most other commodity chips used across various industries are not built by foundries either.

While risk may increase when a semiconductor supplier outsources production of a chip, it also increases when an OEM outsources production of a system. In both cases, the risk has to be managed and mitigated. The threat of risk does not stop OEMs from outsourcing and it won't stop chip suppliers from outsourcing, either. 

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About the Author

James Carbone | Freelance Writer

Jim Carbone is a freelance writer covering the electronics supply chain. A veteran journalist, Jim was a writer and editor for Electronics Purchasing and Purchasing magazines for 21 years. He covered electronics distribution, semiconductors, passive components and connectors for the magazines. He also wrote extensively about the strategic purchasing strategies of electronics OEMs and electronics manufacturing services providers. Before covering the electronics industry, Jim worked as a reporter and editor for United Press International for nine years. He started his career as a newspaper reporter and photographer. Jim is a graduate of the State University of New York at Albany.