IBM turns up the heat on Taiwan’s chip makers

The competitive threat to Taiwan’s contract chip makers was supposed to come from Shanghai, not East Fishkill, N.Y.

The rise of Chinese chip makers, like Semiconductor Manufacturing International Corp. (SMIC) and Grace Semiconductor Manufacturing, was expected by some observers to mark the beginning of a shift in the center of contract chip making from Taiwan to China. But that was before IBM began an aggressive expansion of its own contract chip-making business.

Contract chip makers, commonly called foundries, produce chips for companies, such as Via Technologies and Nvidia, among many others, that don’t have their own chip fabrication plants (fabs). The business is dominated today by two Taiwanese companies, Taiwan Semiconductor Manufacturing Co. (TSMC) and United Microelectronics Corp. (UMC), which together are expected to account for 63% of the total foundry market in 2003, according to an estimate by Salomon Smith Barney. TSMC alone will account for 44% of the market, it said.

IBM’s push to expand its foundry business comes as the contract chip-making business is changing. The industry is showing signs of segmenting into two layers: one comprised of companies that produce chips in volume using older chip-making technologies and another consisting of companies able to produce high-end chips using cutting-edge processes and materials.

One reason for the change in the dynamics of the foundry industry is the increasing cost of designing chips for the latest generations of chip-making technology, said Morris Chang, the chairman of TSMC and an executive often credited with developing the foundry business model.

“The number of new customers has drastically decreased in each new generation (of chip-making technology),” Chang said, noting that chip designers want to be confident that the increased investments required to design chips for the latest process technologies will pay off.

“It’s a new game,” he said. “It’s a situation that clearly favors the leaders.”

IBM is one of those leaders, having led the push into many high-end chip production technologies, and will increasingly compete against TSMC for high-end foundry business while Chinese foundries compete for business at the low end of the market, Chang said.

“IBM have always had the best (chip-making) processes,” said Martin Kidgell , the Asia-Pacific managing director of National Semiconductor, which uses TSMC to manufacture digital processors. “They want to come out and play and be a much bigger fish in this pond. I see that as competition for TSMC and UMC.”

IBM has already made inroads into the high-end foundry business, signing a deal with Nvidia to manufacture its next generation of GeForce graphics chips at IBM’s fab in East Fishkill, N.Y. The deal, worth more than $100 million, is a shot across the bows of TSMC, which counts Nvidia among its most important customers.

In addition to Nvidia, IBM has signed deals with Qualcomm and Xilinx, one of UMC’s major customers, to manufacture chips under contract. IBM has also signed an agreement to jointly develop next-generation process technologies with Advanced Micro Devices (AMD). That deal ended a similar agreement between AMD and UMC and has raised questions about whether the two companies would move ahead with plans to build a joint-venture fab in Singapore.

IBM’s stepped-up foundry efforts will put pressure on TSMC and UMC thanks to the company’s manufacturing prowess with advanced chip-making technologies, but Big Blue isn’t likely to threaten their dominance of the foundry business anytime soon.

“It’s not automatic that you would necessarily leap to the lowest available geometry,” Kidgell said, referring to process technologies that are used to make chips. “What we’re all looking for is the most cost-effective manufacturers in the volume sweet spot. I can see that, like in any industry, there will be people leading with the technology but they won’t necessarily be the volume manufacturers.”

Moreover, IBM will have to adopt the shorter manufacturing lead times and increased flexibility that are required of contract chip makers.

“IBM, as a foundry, they’ve never been particularly easy to deal with in terms of the flexibility of the way you could place orders with them,” Kidgell said. “They traditionally tended to have longer lead times and less ability to move around your schedules as the end customers demanded.”

IBM’s push to grow its foundry business isn’t the only challenge that Taiwan’s foundries face. On the low end of the market, the Chinese foundries pose a cost-effective alternative to TSMC and UMC for chips that are sold into the Chinese market. Chinese foundries can reduce manufacturing costs by up to 30%, largely due to value-added tariffs that are placed on chips imported into China, Kidgell said.

Intent on making its presence felt in China, TSMC last year filed an application with the Taiwanese government to build a fab in Shanghai.

The lengthy approval process for TSMC’s application, now in its eighth month, doesn’t mean that the company is sitting on the sidelines while its Chinese rivals carve out an insurmountable lead in China’s foundry market. “You’ve got to build up a few years of experience and trust with these companies because you’re staking your future on them,” Kidgell said.