'Free engineering' era nears end

The time of free engineering is over; Bob Bailey advises that OEMs partner with the best technology companies and establish stable supply lines now, before the whole industry goes into panic.

Bob Bailey is the president and chief executive officer of PMC-Sierra.

As the engineering glut peaked and the acquisition binge subsided, companies became frantic to keep their engineers busy. Private fabless chip companies would do any chip to enhance their salability, even to the point of doing work free of charge and even at negative margins.

As a result, engineering became a virtually free commodity. This is clearly unsustainable. But there are signs that the phenomenon is coming to an end.

Since the end of 2000, the IC design community has shrunk like a block of ice in the sun. Now we are seeing wafer capacity consumed. This means there will be a shortage of both engineering services and wafer capacity, especially in 90nm technologies. That will lead to price stability and possibly, even price increases in some parts of the electronics food chain.

So why should you as an OEM care? Because eventually, your supplier may not be able to address your future design or wafer needs. ASIC companies that have seen ASIC starts reduced by two-thirds (according to Dataquest) have priced new chips at a marginal cost basis to fill their empty fabs. That will end shortly, if it hasn't already. It is a simple issue of math. To make any money in the chip industry, vendors have to garner at least a 40 percent gross margin. ASIC quotes for volume deals have averaged 30 percent and have been as low as 15 percent, according to anecdotal data.

Meanwhile, some of the larger chip companies are going fabless for the first time, which will further squeeze the supplies of the merchant fabs. Some OEM vendors have based their business plans on this market condition - a shortsighted approach. Why? Because recently, wafer capacity utilization has approached normal levels (90 percent plus) within the merchant market wafer fabs.

Lead times at substrate-packaging vendors have stretched; several vendors have exited the business. OEM and contract manufacturer inventories are at a seven-year low. Add it all up, and you have a volatile mix that smells like allocation in 2004.

The era of free engineering is over. Collaborating with the best technology partners and establishing stable supply lines now, before we are in a panic, is the prudent move.

- Bob Bailey

President and CEO

PMC-Sierra Inc.