Intel's Continuing Folly: Capacity Expansion That's Too Fast For its Own Good

We have written frequently about the gross overinvestment semiconductor companies have been making, and of the trouble it will likely lead to. DigiTimes says foundries look to be in for a tough quarter:

Foundries are bracing for a weak fourth quarter with inventory issues likely to last through the first quarter of 2007, according to industry sources.

The sources cited CMOS sensor supplier OmniVision’s (OVTI) decreased orders with Taiwan Semiconductor Mfg. Co. (TSM) as an indication of weak demand for the foundry sector. OmniVision’s orders for TSM in August and September decreased significantly compared to July, the sources added.

They are being optimistic by guessing the glut will only last through the first quarter of 2007. In addition to Omnivision, of course, this week saw a disappointing announcement from Marvell (MRVL), which itself was jumping on a growing heap of disappointments. And the excess capacity is only just now starting to get installed.

One of the major contributors to the industry’s declining profitability (as measured by return on investment) is none other than industry leader Intel (INTC). Rather than taking behaving like the responsible industry leaders in every other cyclical industry and taking the lead in reducing supply, Intel clings tenaciously to Moore’s law in hopes that ever-falling costs will continue to lead to ever-more innovation rather than just lower prices.

In their recent developer’s forum, Intel announced plans to spend $9 billion to roll out 45 nanometer (read: smaller than before) factories beginning this year.

Moving along a path of energy-efficient computing, Intel has pledged technology evolution in microprocessors that will improve performance per watt by 300 percent by the end of the decade.

Speaking to attendees at the Intel Developer Forum in San Francisco, Intel president and CEO Paul Otellini said this goal would be achieved through continued evolution of Intel’s semiconductor manufacturing technology.

Today, the company uses 65nm process for microprocessor design and by 2008, it plans to reduce that to a 45nm design process. By the end of 2010, Otellini said, Intel aims to achieve 32nm microprocessor design.

“We’re not going to slow down on Moore’s Law; we have the design and capability to make it happen,” the Intel president said. He was referring to Gordon Moore, co-founder of Intel, who made a popular observation - or forecast - that the number of transistors on integrated circuits doubles every two years.

The problem is, there are no indications that today’s computers aren’t up to the job. Whereas past developments were needed to keep pace with ongoing software developments, all but the most specialized of computing needs can now be handled with a bare-bones setup. And while reducing power consumption is a worthwhile goal, there doesn’t appear to be any particular hurry in doing so.

Advanced Micro Devices (AMD), the rival that has recently been throwing Intel into fits, has no plans to begin producing at 45 nm until 2008. By that time the manufacturing techniques will have been proven and the cost of equipment will have come down thanks to Intel’s relentless push into the technology. And while Intel will have a significant lead to market with the technology, it had a similar lead at 65 nm and managed to lose share anyway. One has to wonder whether the time and expense will be worth the effort or simply help its competitor, which is taking the more rational approach to capacity expansion.

INTC-AMD 1-yr comparison chart:

Comment on this article

Comments

[Sean MacMillan:]

Where does all this negativity towards Intel come from? I say ‘good for them’ for using their $20 billion a year in gross profits to advance technology! Should they wait to make improvements until your D&D game needs the extra processing power… or maybe these advancements they are talking about will be used to do advanced astrophysics and environmental calculations that, yes believe it or not, need more processing power and less power consumption than today’s top of the line processors can provide? The hurry is improving technology to meet actual scientific needs, not whether the graphics look killer on your paladin with that level 10 sword…

2006 Oct 09 11:51 AM

[William Trent_:]

The negativity stems from the fact that adding capacity when there is an inventory glut is a stupid thing to do. I'm not so much interested in whether they advance technology as whether they can earn an adequate return on capital doing so. If the advanced astrophysics and environmental applications are willing to soak up the excess capacity then by all means I am for it. But since they aren't I think Intel should stop making so damn many processors.

2006 Oct 09 12:15 PM

[Sean MacMillan:]

Intel's return on assest (7.61% vs 4.78%) and return on equity (10.27% vs 7.45%) are well still above AMD's as of Q2'06... and you still didn't explain why you think that is bad for the industry other than it is a "stupid thing"... what facts are you basing your postion that the market is flooded? Your only point is that you disagree and as any manager will tell you, that is just bitching unless you propose a solution, but I suggest you explain the problem as well...

2006 Oct 09 12:38 PM

[William Trent_:]

The first link in the post helps describe the problem. Orders for semiconductor manufacturing equipment have been rising by 70% year/year, while end demand for semiconductors is in the high single digits. (Even this is above the 10-year average of 5.8%.)

If you wonder whether the industry is flooded, simply take a look at the inventory balances for Intel, AMD and their channel partners. The rapidly growing inventories tell you there are already too many chips. The 70% growth in semi equipment orders means there are going to be lots and lots more chips made in the very near future.

So there is the problem (which I have detailed extensively for months and was simply sparing those readers who have seen it before.) I also already gave the solution, which is to make fewer chips.

2006 Oct 09 01:15 PM

[Jack Haddad:]

William,

Your assertion and plea that INTC should not be producing processors in light of AMD's competitin so that they may balance capacity is absurd. I respectfully disagree with you.

Jack Haddad, MD, MBA, CMT, DITA
UCSF Medical Center, San Francisco, CA
San Jose Orthopedic Group, San Jose, CA
Merrill Lynch, Santa Clara, CA.
Haddad Capital Management, LLP., San Jose, CA

2006 Nov 18 04:10 PM

[William Trent_:]

Jack,

It is fair enough to argue that Intel doesn't want to lose further share. However, <i>somebody</... is making too many processors and needs to stop. The auto makers bought the share loss argument for too long, and produced vehicles sold into fleets at little profit in order to avoid share loss. The same will happen in semiconductors unless supply and demand return to balance.

So Intel and AMD have a couple of options:
1) they can each produce an amount higher than end demand, hoping that the excess production gives them excess market share. If both companies continue to follow this strategy there will be little or no share shift, only excess supply (and lower prices) plaguing both of them.
2) only one can produce a higher amount than end demand, and gain share. Neither will allow the other to do this.
3) they can both reduce capacity growth to the level of end demand, in which case both can maintain their share and profitability. There could easily be fluctuations cack and forth as one or the other develops a superior generation of chips according to one metric or another.

It is a simple mathematical identity that <i>both</i>... companies cannot gain market share. Right now they are playing a game of chicken to see which one backs off first. While the consequences of being the one to chicken out may be embarassment and a small loss of market share, the consequences of neither chickening out are far worse.

2006 Nov 18 06:51 PM