Raking In the Chips

By John Greenwald

U.S. semiconductor makers are out of a slump and into their biggest boom

Semiconductor chips are the soul of modern machines. In little more than a decade these tiny electronic marvels have become vital parts of everything from autos and television sets to missiles and battleships. So when U.S. chipmakers stumbled in recent years and lost ground to the Japanese, fears were raised that a glamorous new industry might be going the same uncompetitive way as American cars and steel. Instead, semiconductor makers embarked on a dazzling boom. Worldwide sales of U.S.-made chips jumped fully 20%, to $9.6 billion in 1983, and are expected to show a spectacular 50% increase this year.

The importance of a vibrant semiconductor industry was underscored by Congress last week. In an extraordinary 363-to-0 vote, the House of Representatives passed a bill that would let chipmakers copyright their designs as if they were novels or plays. The measure, approved by the Senate two weeks ago and expected to be signed soon by President Reagan, is meant to safeguard the years of research and the tens of millions of dollars that it takes to create a chip that can pack several hundred thousand electronic circuits onto a silicon sliver smaller than a fingernail. One target of the legislation: the Japanese, who have become the world's No. 2 chipmakers after the U.S., partly by duplicating American designs.

The industry's latest profit reports reveal the extent to which semiconductor makers have been raking in the chips. Last week Intel Corp., a major Santa Clara, Calif., producer of logic and memory circuits, said its third-quarter earnings more than doubled to $70 million, vs. $32.1 million last year. Advanced Micro Devices had an even bigger gain. The Sunnyvale, Calif., chipmaker made $42.1 million in its latest quarter, against $12.2 million for the same period a year ago.

Those glowing income statements reflect both the strength of the U.S. economy and the ever growing pervasiveness of chips. "Semiconductors are here and people now recognize that," says Stephen Zelencik, a senior vice president of Advanced Micro Devices. "They are everywhere, for every reason, in everything." Chips have long since become the most popular components of watches. In cars they monitor antipollution systems and adjust idle speeds. In factories they control robots and automated assembly lines. They are embedded in virtually every major weapons system, where they perform such crucial tasks as aiming guns and navigating flights.

Semiconductor makers are also benefiting from some painful past mistakes. When sales dipped sharply in the 1970s, U.S. chip producers responded by slashing payrolls, halting research and canceling expansion plans. Their cutbacks proved a boon to Japanese companies; they kept building plants and developing products, and thus were ready to grab new markets when business picked up. That lesson did not go unnoticed. During the depths of the 1981-82 recession, U.S. companies continued to invest. "We maintained our level of research-and-development spending," recalls Norman Neureiter, a vice president of Texas Instruments, one of the world's largest manufacturers of memory chips.

Despite their sophisticated design and awesome powers, semiconductors are not hard to understand. There are basically two kinds: memory chips, which hold information, and logic chips (sometimes called microprocessors or "computers-on-a-chip"), which use the data to control what a machine does. In a personal computer, for example, memory chips store programs for everything from Pac-Man to tax forms, while logic devices put the programs through their paces. U.S. companies dominate the market for logic semiconductors. Japan, however, still holds a commanding lead in memory chips.

The current boom has shattered some myths that once clung to the semiconductor industry like barnacles to a ship. Many experts had assumed that the high cost of developing chips would force all but giants like Texas Instruments and Japan's Hitachi out of the business. In fact, new small firms are thriving. At least 51 chipmakers sprang up between 1977 and 1983, including a record 16 last year.

Backed by aggressive venture-capital firms and bank loans, the new companies are moving into niches opened up by the explosive growth of the industry. Says Wilfred Corrigan, president of LSI Logic: "The market for semiconductors is getting so huge that it's starting to be impossible for the major companies to be all things to all people." Instead of mass-producing chips that work in every type of machine, many newcomers are zeroing in on customers with special needs. Others are perfecting a fast-evolving technology called CMOS (complementary metal oxide semiconductor) to produce chips that run on less power and could come to dominate the industry within a few years.

A clear standout among the young companies has been LSI Logic. Since it was founded in 1981, the Silicon Valley firm has become a key supplier of customized logic chips to major computer makers, telecommunications companies and the aerospace industry. LSI President Corrigan, former chairman of Fairchild Camera and Instrument, boasts that his engineers apply "more brains per square inch" to the task of designing chips. Investors seem to agree. LSI Logic was able to raise $152 million by selling stock to an eager public in May 1983.

Micron Technology of Boise, Idaho, is another near instant success. Founded by Twin Brothers Ward and Joseph Parkinson, the company started in 1981 with a cash infusion from an investment group headed by J.R. Simplot, one of the nation's largest potato processors. The following January Micron began shipping a memory chip that was smaller and more efficient than those produced by other U.S. firms. Sales took off, and the company went public with its stock last summer. Initially offered for $14 each, Micron shares rose as high as $40 1/2 and are now trading for about $26.

Perhaps the most remarkable semiconductor success story of recent years involves Advanced Micro Devices. The brainchild of W.J. Sanders III, 48, a silver-haired ex-salesman with a penchant for sharply tailored suits and expensive cars, the 15-year-old company has outperformed the rest of the U.S. chip industry. It offers a broad range of specialized logic products that have been snapped up by makers of items ranging from personal computers to military gear. Predicted Sanders at his company's annual meeting: "I expect Advanced Micro Devices this fiscal year to become the first major semiconductor maker to put two 60%-plus growth years back to back."

Such triumphs notwithstanding, American chipmakers have scarcely overcome all their problems. A delicate one surfaced earlier this year as a result of a federal probe into the possibility that some firms had inadequately tested millions of chips used in defense hardware. National Semiconductor paid $1.8 million in fines in March after pleading guilty to 40 counts of defrauding the Government. Texas Instruments last month disclosed that an internal inquiry had found that at least 4,700 different versions of chips used in military applications may not have been properly tested. The Pentagon is continuing its investigation of TI's procedures.

The U.S. industry also remains under siege from its Japanese rivals, who hold some 30% of the worldwide chip market, vs. 44% for American manufacturers. The Japanese firms' mastery of efficient and low-cost manufacturing techniques has helped them win an overpowering 50%-to-60% share of sales of the most popular memory chip. Known in the industry as the 64K RAM (for random access memory), the semiconductor holds 65,536 bits of information. Such companies as Hitachi, Fujitsu and NEC have opened an even larger lead in the fledgling market for the equally tiny but four-times more powerful 256K RAM. Says an NEC spokesman: "We can already produce 1 million a month."

To get closer to U.S. customers, Japanese companies have been setting up shop in Silicon Valley. Hitachi and Fujitsu both have design centers in California, and Taiwanese and Korean firms have been moving in as well. Texas Instruments, meanwhile, has gone the other way by opening three semiconductor plants in Japan. Says TI Vice President Neureiter: "The overall discipline and challenge of working in that market has served us well worldwide."

What most worries U.S. firms about their Japanese rivals is signs that they plan to move more aggressively into logic chips, a traditional American stronghold. While Japan's manufacturers were once thought to have difficulty in creating innovative and highly successful logic circuits, that view is now changing. Hitachi last week unveiled a new logic semiconductor that is among the first to combine the features of high-speed and low-energy use. Says Frederick Zieber, senior vice president of Dataquest, a San Jose, Calif., research outfit: "Technical dominance is no longer the preserve of the U.S. companies."

American firms are also noticing a dip in business as the economy starts to slow. Domestic orders for U.S. semiconductors topped $1 billion a month in the first half of 1984, but last week the Semiconductor Industry Association said they fell to $843 million in September. Nonetheless, the industry remains optimistic. Says Zieber: "We are entering a period of adjustment from the very strong market of the past six quarters into something less robust. But we don't expect things to fall apart, because we don't expect the economy to fall apart." Indeed, with the rebound still full of vigor, semiconductor makers are happy to let the chips fall where they may.

-By John Greenwald. Reported by Michael Moritz/San Francisco

With reporting by Michael Moritz