Semi photo

Advanced Micro Devices, maker of the Ryzen chip shown here, has found success under CEO Lisa Su and is threatening Intel's lead in the semiconductor vendor space.

Slowdowns in global trade and business investment crippled chipmakers in 2020 as the pandemic spread, but the industry has proved resilient. 

The VanEck Vectors Semiconductor exchange-traded fund (NASDAQ:SMH) charged 54.1% higher in 2020 after plunging as much as 37% from mid-February highs, and there’s reason to believe more gains are ahead in 2021 and beyond.

This comprehensive research report introduces the semiconductor industry and breaks down its structure, firm conduct, performance and trends to watch going forward.


Industry introduction

A semiconductor is a material that transfers electricity between conductors like metals and insulators like glass or ceramics, allowing an electrical current to easily flow in one direction. 

There are several types of semiconductors, including memory chips used to store short-term and long-term data; logic chips used to perform specific operations like a computer’s central processing unit; microprocessors, which have multipurpose circuits that execute processes based on memory; and power semiconductors, which are used as switches in electronics.

Semiconductor chips are the irreplaceable backbone of modern electronic technology at the heart of integrated circuits of devices like computers, phones, radios and medical devices as well as telecommunications and internet services. The chips also power artificial intelligence (AI) and the Internet of Things (IoT), which includes internet-connected devices of all kinds. 

The semiconductor production process is intricate but not known to be as capital intensive as other manufacturing processes. Integrated circuits that make up semiconductors are created on wafers, which are thin, circular slices of silicon. The manufacturing process takes six to 18 weeks from start to shipment.

Innovations in semiconductors make electronic devices smaller, faster, more reliable and more efficient, so manufacturers compete to make chips as small as possible. Today’s advanced chips are as small as 5 nanometers; it takes 10 million nanometers to equal one centimeter. 

The standard semiconductor size has steadily shrunk about 18% per year, from 22 nm in 2012 to 5 nm in 2020. Experts expect the standard semiconductor size to be about 3 nm in 2022 and 2 nm after 2023— roughly in line with the 18% rate of annual progress observed since 2012.

It’s widely accepted that chip progress follows Moore’s Law, a theory from engineer and Intel co-founder Gordon Moore in 1965 that the number of transistors on a silicon microchip is expected to double every 18 to 24 months, even as computer costs fall by half. 

But as chips get smaller and more advanced, it becomes increasingly difficult and expensive for manufacturers to progress at the historical rate indefinitely. Industry experts believe Moore’s Law may no longer hold true as early as 2020 or 2022, according to Scientific American.

Industry structure

The semiconductor supply chain consists of first-tier suppliers that provide aluminum, minerals and metals for the process; second-tier suppliers that provide semiconductor machinery; vendors and manufacturers who design, make and sell semiconductor chips; first-tier buyers who get chips for computers, appliances and consumer electronics; and second-tier buyers like wireless telecommunication carriers and cable providers.

The supplier and vendor sectors are best classified as tight oligopolies, and concentration is also tight among manufacturers and customers. Manufacturers include Taiwan Semiconductor Manufacturing Company, Applied Materials, Tokyo Electron, Lam Research and KLA Tencor. Notable final customers include phone and computer makers like Apple, Samsung Electronics, Huawei and Dell.

Suppliers

Leading suppliers based on 2018 market share data from IHS Markit include Samsung Electronics (27.5%), Intel (25.7%), SK Hynix (13.4%), Micron Technology (10.9%), Broadcom Limited (6.5%), Qualcomm (6.1%) and Texas Instruments (5.7%). 

Total sales among suppliers climbed to $271.5 billion in 2018 from $170 billion in 2012. Likewise, concentration among suppliers increased notably since 2012, as measured by four-firm concentration and sum of squared market shares. Market share of the four leading semiconductor suppliers was between 55.5% and 57.5% from 2012-15 before climbing to 61.4% in 2016, 68.9% in 2017 and 77.6% in 2018. 

Semi suppliers

This graph shows four-firm concentration based on market share of semiconductor suppliers.

The sum of squared market shares, which increases as concentration does, drastically leaped to 7,808 in 2018 from 1,452 in 2012, including a spike to 7,314 in 2016 from 1,286 in 2015. Numbers equivalents, which move inversely to the sum of squared market shares, fell to 1.28 from 6.89 in that span, showing a stark increase in firm concentration.

Vendors

Top vendors based on 2019 market share data from Gartner include Intel (15.7%), Samsung Electronics (12.5%), SK Hynix (5.4%), Micron Technology (4.8%), Broadcom (3.7%), Qualcomm (3.2%) and Texas Instruments (3.2%). 

Concentration among vendors remained steady overall from 2012 to 2019, especially at the top, but decreased by some measures, unlike the trend with suppliers. 

Market share of the four top semiconductor vendors increased to 38.4% in 2019 from 31.2% in 2012 after peaking at 43.4% in 2018, implying an increase in concentration. However, the sum of squared market shares fell to 2,546 in 2019 from 2,815 in 2012 after dipping to 2,273 in 2018, showing lower concentration. 

Semi vendors

This graph shows four-firm concentration based on market share of semiconductor vendors.

The increase in four-firm concentration coupled with a decrease in overall concentration can be explained by the growth of Samsung Electronics, SK Hynix and Micron Technology, which all cut into Intel’s market share. Intel maintained its lead among vendors in the eight-year span, even as its market share slipped to 15.7% in 2019 from 16.4% in 2012, bottoming at 13.8% in 2017.

Four-firm concentration managed to grow as competition did, in part because Samsung Electronics remained the second-leading vendor, gaining an industry-high 3% market share in that span and growing sales to $52.4 billion in 2019 from $28.5 billion in 2012. 

Competition is growing among vendors, even as four-firm concentration rose slightly from 2012 to 2019. Intel and Samsung Electronics are combatting this pressure by vertically integrating, with the former acting as the second-largest supplier and largest vendor while the latter is the largest supplier and the second-largest vendor. This strategy has kept Intel entrenched at the top as competitors have gained ground and fueled Samsung’s rise as a supplier and vendor.

Vendor sales grew to $419.6 billion in 2019 from $299.9 billion in 2012, according to Gartner. Most of the industry’s 2019 sales occurred in the Chinese market (34.8%), followed by the rest of the Asia-Pacific region (27.6%), the Americas (19.1%), Europe (9.7%) and Japan (8.8%). U.S. firms made up 47% of 2019 sales, followed by firms in South Korea (19%), Japan (10%), the European Union (10%), Taiwan (~6%), China (~5%) and others (~3%), according to Statista.

Industry conduct

The semiconductor supplier market type is best described as a non-cooperative, tight oligopoly that’s competitive but largely controlled by the top four firms — Samsung Electronics, Intel, SK Hynix and Micron Technology. Those four suppliers controlled 77.6% of the market in 2018 and accounted for $210.5 billion of the industry’s $271 billion total sales in that year.

The semiconductor vendor market type is best described as a non-cooperative, loose oligopoly that’s competitive and contestable, as evidenced by the decrease in sum of squared market shares from 2012 to 2019 and the growth of Samsung Electronics, SK Hynix, Micron Technology and NXP while Intel, the leader in the space, saw its market share fall. The four-firm concentration of 38.4% in 2019 is substantial but far lower than that of semiconductor suppliers.

Firm conduct is largely free of cooperative and collusive behavior, evidenced by an overall decline in average unit selling prices that has limited top-line industry revenue growth for vendors, according to IBIS World. 

Theoretically, firms could collude to raise prices because of the relatively inelastic demand for semiconductors, so constant price declines for semiconductors and electronic components in the past decade is remarkable and suggests there is little to no cooperation or collusion among firms. If there was collusion, we would expect to see industry prices rising as firms agree to collectively limit output or raise prices above competitive levels, as is the custom in a cartel.

Mergers happen regularly as firms try to stay ahead of peers and benefit from scale in a competitive market. Recent mergers include mobile computing chip giant Nvidia’s $40 billion acquisition of British semiconductor firm Arm Holdings in mid-September 2020 as well as Advanced Micro Devices’ $35 billion acquisition of Xilinx in October 2020, which helped the Santa Clara, California-based company expand its surging data center business.

These moves helped Nvidia and AMD build upon their strengths, generate cost savings from logistical synergies and gain market power as concentration shrunk. Firms’ efforts to achieve cost advantages through scale suggest industry competition is intense and collusion is difficult.

Industry analysis

The semiconductor industry is marked by middling firm concentration, moderate regulation, high barriers to entry, a mature product life cycle, average revenue volatility and high revenue per employee, according to IBIS World, which are tailwinds for incumbents.

The threat of entry from challengers is ever-present, given the relatively low capital intensity of the chip fabrication process, though leading firms are buffeted by increasingly high barriers to entry from expensive startup costs that deter new entrants.

Headwinds include a surplus of imports from stiff competition, low profit margins and high concentration of suppliers and customers, meaning vendors have less leverage and pricing power. Incumbents face steadily rising competition, industry globalization and a feverish rate of technological change, driven by the quest for ever-shrinking chips, according to IBIS World.

Global demand for semiconductors has driven fierce competition between vendors to capitalize on the massive market. Electronic devices using semiconductors often have short life cycles, which leads to regular upgrades and steady demand. However, the rate of growth in the smartphone market has stalled since 2016, according to Statista, though experts believe the advent of fifth-generation (5G) cellular networks will catalyze upgrades in the coming years.

Structural aspects beyond concentration include the extent of product differentiation, rate of technological advance, cyclicality of orders, elasticity of demand and degree of advertising. 

Product differentiation is primarily through chip size, as vendors compete to make chips smaller while increasing efficiency and power. The rate of technological advance is very high, as Moore’s Law would suggest, though some believe the growth rate will inevitably slow as chips get increasingly smaller.

Semiconductor sales are volatile, cyclical and seasonal, meaning demand — as measured by order sizes — is larger later in the year during the holiday season and is economically sensitive, as demand for electronics dips during downturns. However, demand is relatively inelastic, according to IBIS World, meaning price changes don’t crush demand, given the ubiquity and ever-present demand of electronic devices running on semiconductors.

Sign up for the Madison Business Review Email

Advertising is far less important in the semiconductor industry than other consumer-facing sectors, though leaders like Intel still advertise on the internet, TV and partner with sports teams to generate brand awareness. For the vast majority of chip suppliers and vendors, free cash flow is much better spent on research and development used to directly drive innovation.

Industry performance

The semiconductor industry has grown steadily since 1987 with notable dips in 1996, 1998, 2001, 2009 and 2019, suggesting that performance is sensitive to broader economic conditions. Monthly global sales have increased steadily since 2012, according to Statista, and tend to be seasonally weaker in February, March, April and May and higher in September, October, November and December. 

Worldwide shipments have also increased steadily since 2000 before slipping in 2019 as trade tensions increased between the U.S. and China, weighing heavily on the industry. Capital expenditure has grown overall since 2000 but is very cyclical, reflected by drops of up to 37% from 2001-03, 40% from 2008-09, 12% from 2012-13 and expected drops of 7.6% in 2019 and 3.6% in 2020, according to Statista.

Meanwhile, the semiconductor assembly equipment market grew from 2013-18 despite a drop in 2019 and is expected to rebound to 2017 levels by 2023, according to Statista. Similarly, new semiconductor equipment spending grew steadily from 2014-18, fell slightly in 2019 and is expected to reach 2018 levels again in 2021.

Innovation

Differentiation in the semiconductor industry comes through making chips smaller, which improves performance and efficiency in the electronics they help power. Innovation comes as firms invest in research and development (R&D) to make chips smaller, drive demand and stay ahead of competitors. 

Intel maintained its lead among vendors by lapping peers in R&D spending — investing about four times the amount of its next closest competitor, Qualcomm, in 2017, to make up about one-third of the roughly $35 billion on R&D spending by peers in that year, according to Statista. 

Higher operating costs are a necessary evil for market leaders, as they hurt bottom-line profits but expand top-line sales. Patents, trade secrets and licensing agreements are vital for firms to build and maintain leads, which is why R&D spending in the semiconductor industry is higher than most other industries in the U.S., according to IBIS World.

Specialization

Besides innovation, vendors differentiate their products and carve out a niche by creating chips designed for specific products. Chip specialization and customization create a high barrier to entry that insulates competitors and allows for a high contract renewal rate, according to IBIS World, meaning customers are generally loyal, or “sticky,” in business terms. 

For example, firms like Intel primarily make chips for computers while Qualcomm focuses on phones. As mentioned earlier, AI and IoT are massive opportunities for vendors as those nascent spaces continue to grow at a rapid pace. Third-party manufacturing agreements between manufacturers and vendors help the latter focus on designing, innovating and marketing while manufacturers make the chips in metal-casting factories called foundries.

Pricing

Prices of semiconductors and electronic components typically bend to global supply and demand patterns as well as the costs of inputs, which have risen in 2020 to shrink average profit margins. Fiery price competition and supply increases have led to relatively weak and volatile industry performance as average unit selling prices have fallen, according to IBIS World.

Technological progress and increased production efficiency have improved firms’ bottom-line margins, but stiff competition forces firms to pass these savings onto consumers to avoid being undercut by cheaper foreign substitutes.

Final prices that customers like Apple and HP pay for semiconductors are impacted greatly by input costs, stemming from first-tier suppliers at the start of the supply chain that sell metals like copper and silver used in chip fabrication. Precious metals have swung wildly in value historically and dropped prior to the pandemic, bottoming in mid-March 2020 before rallying remarkably into December. Wages paid to workers throughout the supply chain also sway prices, and outsourced manufacturing to labor-intensive countries helps lower costs.

Profitability

Profitability data available from 2016-19 for three leading vendors — Intel, SK Hynix and Micron Technology — shows an improved net profit margin for Intel and falling net profit margins for SK Hynix and Micron Technology. 

Intel grew its revenue to $71.9 billion in 2019 from $59.4 billion in 2016 while its net income expanded to $21.0 billion from $10.3 billion in that span. The leading chip vendor’s net profit margin grew to 29.2% in 2019 from 17.3% in 2016. Its market share declined slightly to 15.7% in 2019 from 15.9% in 2016, which suggests a growing market, given Intel’s revenue growth.

Semi profits

This graph shows the total revenue, net income and net profit margin of three leading semiconductor vendors: Intel, SK Hynix and Micron Technology.

Meanwhile, SK Hynix and Micron Technology saw revenue jump to $26.9 billion from $17.2 billion and to $21.4 billion from $20.3 billion, respectively, in that same span. SK Hynix’s net income fell to $2.0 billion in 2019 from $2.9 billion in 2016, and its net profit margin was sliced in half to 7.5% in 2019 from 17.2% in 2016, dimming a 56.9% jump in revenue. 

However, SK Hynix managed to expand its market share to 5.4% from 4.2% in that span, meaning it increased expenses and prioritized growing revenue over profits. Micron Technology barely managed to grow revenue from 2016 and saw its net income fall to $2.7 billion in 2019 from $5.1 billion in 2016. Its net profit margin in that span fell roughly in half to 12.5% from 25.0%. But like SK Hynix, Micron Technology increased its market share by roughly one-third, to 4.8% in 2019 from 3.7% in 2016 as it sacrificed profits for growth.

Industry trends

Going forward, the manufacturing sector of the semiconductor industry is expected to hit $47.5 billion at a profit margin of 5.1% in 2020, according to IBIS World. The research firm estimates the industry contracted 1.3% from 2015-20 but will rebound to grow 2.4% through 2025.

Automation and 3D printing are relatively new manufacturing processes that are quickly gaining steam and transforming the chip production process by enhancing capacity, according to IBIS World. These technologies often lower costs by replacing human workers, but those employed can command high salaries due to their technical expertise, according to IBIS World. 

However, the overall labor trend is one of declining employment in the U.S. because of production outsourcing to countries with an abundance of cheap labor. Though the industry has grown in the past five years, the number of firms in the industry will decline by 2.7% per year as the number of industry employees falls by 1.1% annually, according to IBIS World.

Opportunities

Future opportunities for the industry outlined by IBIS World include an end to the U.S.-China trade war, better trade relations from the U.S. under President-elect Joe Biden, an expected rebound in technology investment and an expected decline of the trade-weighted index in the next five years as the U.S. dollar depreciates, which would make U.S. goods relatively cheaper for foreigners and boost exports and sales for U.S. firms.

Revenue growth is expected to grow steadily through 2025, according to IBIS World, thanks to product innovations and the development of next-generation semiconductors as well as healthy demand from the technology and communications sectors. Growth in sectors like cloud computing, AI, IoT and blockchain — which serves as the basis for cryptocurrencies — is likely to outpace the decline in the traditional PC market, according to IBIS World. 

Capital expenditure in electronics, computers and software by firms catalyzes chip growth, as the two are complementary products. While consumer demand for electronics fell sharply as the pandemic spread worldwide in early 2020 and remained lower for much of the year, an expected rebound in consumer demand alongside the economy should lift the industry with it.

Threats

Future weaknesses for firms in the industry noted by IBIS World include continually improving international competition driven in part by foreign governments, the potential spike in the dollar and potential revenue growth disappointment, given low revenue growth in the past 15 years.

Foreign competition for U.S. firms is growing more formidable, thanks to initiatives like Made in China 2025, a plan unveiled in 2015 to bolster the nation’s manufacturing capabilities and shift from making cheap goods toward more complex, high-value goods and services. China plans to produce 70% of all core materials it uses — including semiconductors — by 2025 by bolstering firms like Semiconductor Manufacturing International Corporation (SMIC).

Considering the sheer size of China’s market, as roughly 35% of semiconductor sales occurred there in 2019, according to Statista, the Made in China 2025 initiative appears to be a serious headwind for U.S.-based semiconductor firms, though it should strengthen Chinese firms’ ability to compete abroad.

Aggressive import penetration by foreign firms has been fueled in part by a historically strong dollar, which rose as global investors rushed to safe assets like U.S. Treasuries as the coronavirus pandemic spread. Though the dollar has slipped considerably recently as investors prepare for a global economic rebound, the potential remains for a surge in the dollar if there are further COVID-19 outbreaks or safety, efficacy or distribution concerns with a vaccine.

Emerging markets, including those in East Asia, have made serious moves into the industry on the supply, vendor and manufacturing sides by competing with policy, tax incentives and cheap labor, according to IBIS World. These firms benefitted as the dollar appreciated, which made their goods relatively cheaper and thus more attractive to buyers. 

The industry has seen relatively low revenue growth since 2005 because of price reductions spurred by higher competition as cheap imports saturate the market. This slow growth could continue in the next five years if the pandemic lingers into 2022, even if the dollar depreciates as expected. 

Global economic growth and international trade, which dropped precipitously in 2020, are vital to the semiconductor industry, and a slower-than-expected rebound would result in lower downstream demand by firms and consumers and a hit to both revenue and profits for suppliers, vendors and manufacturers. 

Economic expansion leads to demand by consumers and businesses for new electronics, which spurs semiconductor sales, and international trade helps allocate resources efficiently, keeping costs down with cheaper labor while allowing vendors to reach more customers. The slowdown in international trade may hurt manufacturing revenue by 13.1%, according to IBIS World. 

An end to the coronavirus pandemic will be celebrated by individuals and businesses around the globe, and the semiconductor industry is no exception.

Conclusion

The semiconductor industry is poised for growth in the next five years as the coronavirus pandemic gets under control, global economic growth rebounds, firms invest more in technology, international trade revives as U.S.-China trade relations improve, vendors develop innovative new chips and manufacturing efficiency increases with automation and 3D printing.

However, rising R&D costs and increased imports stiffening Chinese competition may put a damper on profits of U.S. firms.

James Faris is a senior media arts and design major. Contact James at breezembr@gmail.com.

Disclaimer: I’m a long-term investor in Advanced Micro Devices. I wrote this article myself, and it expresses my own opinions. I’m not receiving compensation for it, and I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Investors are always reminded that before making any investment, they should do their own research on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information and shouldn’t be relied on as a formal investment recommendation.