Chapter 15

Managerial
Economics in
Action: The
Managerial Case of
Economics:
Economic Tools for
the Semiconductor
Today’s Decision
Makers, 5/e By Paul
Industry
Keat and Philip Young
 Managerial Economics
in Action

• Industry Background
• Industry Analysis
• Managerial Decision Making in Action

2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young

 Learning Objectives
• Describe the market structure of the semiconductor
industry.
• Cite the main factors that affect the degree of
competitiveness in this industry.
• List two or three specific ways that the activities in the
industry illustrate the major economic concepts
presented in this text.
• Explain how the strategy adopted by Standard
Microsystems Corporation was an effective way for
firm to address the “changing economics” of their
industry.
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Background
• 17% annual compound growth rate since
1960’s. Concern is that this will soon drop to
single-digit growth.
• Highly cyclical with roughly four-year cycles.
Most recent downturn has lasted 2.5 years.
• Sources of Cyclicality
• Macroeconomic conditions
• Capital intensity
• Long lead times in production
• Lack of market power
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Background
• Elements of Production
• Research and development
• Design
• Manufacturing
• Wafer and die manufacturing
• “Front end”
• Most capital intensive
• Packaging and distribution
• “Back end”
• Labor intensive
• Located in lower-wage countries

2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young

 Industry Background
• Technology plays a critical role in this industry.
• Moore’s Law: the number of transistors on a
chip will double every 18 months.
• Profitability factors
• Competition
• Technology
• Customers
• Regulation
• Semiconductors is a B2B industry, not B2C
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Analysis
• Industry continued to move ahead at a fast
pace in the first half of 2004.
• Economic boom in China and the Pacific
Rim continued in the absence of serious
troubles such as SARS.
• U.S. and Europe joined in the economic
expansion.

2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young

 Industry Analysis
• Estimates for industry growth were raised.
• SIA forecast 19.4% growth, then raised that forecast to
28.6%.
• VLSI Research forecast 26.2% growth.
• iSuppli forecast 24.4%.
• Gartner: 25%
• Semico Research: 27%
• In-Stat/MDR: 29%
• Micrel Semiconductor: 30%
• Some think growth rates will last into 2006, others
think they will end in 2005.
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Analysis
• Cycles typically last 4 years, with a bust year, a
recovery year, and 2 strong growth years.
• 2000 boom: 36.8% growth
• 2001 bust: 32.0% decline
• 2002 recovery: 1.3% growth
• 2003 boom: 18.3%
• Expectation of 20+% growth over next two
years (until mid-2005).
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Analysis
• Water fabrication plant capacity utilization rose
above 90% in Q4 2003 and even higher in Q1
2004.
• Utilization above 90% usually stimulates plant
expansions and capital purchases.
• Book-to-bill ratio (measurement of expansion) rose
above 1.0 in October 2003 and hit 1.23 in December
2003.
• Lead times had not yet stretched to lengths that
signal a downturn.
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Analysis
• Growth in all areas of semiconductors
• PC sales
• Wireless phones
• Recordable DVD players
• Digital cameras
• Motorola spin-off (Freescale
Semiconductor) prepared for IPO in 2004.

2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young

 Industry Analysis
• FASB prepared to institute rule change that
stock-based incentives must be expensed.
• This would raise Cost of Goods Sold.
• Reported earnings would fall.
• Earnings performance ratios would be affected.
• Cash flow would stay the same.
• Argument that reducing stock-based incentive would
reduce employees’ desire to improve company
performance.
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Industry Analysis
• Expectation that capital spending will rise.
• Forecast at 53% increase.
• Seventeen companies are expected to spend
more than $1billion on capital projects in 2004.
• U.S. and Europe imposed duties on Hynix
Semiconductor DRAMs of up to 44.71% and
34.8%. Japan is considering the same.
• Hynix receives government subsidies, which give it
an unfair pricing advantage.

2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young

 Managerial Decision Making
in Action
• Semiconductor Industry
• SMSC competes in semiconductor industry
• Intense competition
• Rapid technological change
• Cyclical market patterns
• Price erosion
• Periods of mismatched supply and demand
• Many competitors are larger and have significantly
greater financial and other resources
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Managerial Decision Making
in Action

• Personal Computer Industry

• Sales of many SMSC products depend on
sales of PCs and peripherals.
• SMSC may experience greater demand
fluctuation than PC makers.
• Some products are used in PCs sold in
consumer market, which can be more volatile
yet.
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Managerial Decision Making
in Action

• Worldwide Economic Environment

• Slower economic activity
• Decreased consumer confidence
• Reduced corporate profits and capital
spending
• Liquidity concerns
• International conflicts and terrorist and
military activity
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Managerial Decision Making
in Action
• Product Development and Technological
Change
• Success is dependent on development and timely
introduction of new products at competitive prices
and performance levels, with acceptable margins
• Success of new products depends on:
• Timely completion of product development programs
• Market acceptance of manufacturing of wafers
• Achieving acceptable water fabrication yields by
independent foundries
2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young
 Managerial Decision Making
in Action
• Reliance on Subcontract Manufacturing
• Vast majority of products manufactured by
independent foundries and subcontract
manufacturers
• Involves risks
• Potential lack of manufacturing availability
• Reduced control over delivery schedules
• Availability of advanced process schedules
• Change in manufacturing yields
• Potential cost fluctuations

2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young