Fearing R&D's Flight

Semiconductor Decline

But it's the potential loss of the semiconductor industry, an industry critical to maintaining America's manufacturing and military strength, that has become the rallying point for those concerned about U.S. manufacturing.

In fact, for 15 years, some people have been sounding alarms about the future of the U.S. semiconductor industry. For example, in 1989, Robert B. Reich, then a professor at Harvard University's Kennedy School of Government, warned that the U.S. semiconductor industry was losing its competitiveness in the world market. In a "Scientific American" article, he stated that between 1984 and 1988, the U.S. share had fallen to 37% from 50%, while Japan's share had risen to more than 45%. Things have become markedly worse since Reich's warning. This past May a National Academy of Science (NAS) report estimated U.S. share of global semiconductor production at 20% to 25% -- and contended the decline was continuing.

Two basic challenges confront U.S. semiconductor producers, says industry trade expert Thomas Howell, a partner at Dewey Ballantine LLP, Washington, D.C., and a contributor to the NAS report on the semiconductor industry.

"The first is the rapidly rising cost of manufacturing semiconductors as feature size shrinks. Line width is becoming smaller and smaller and is now reaching metrics that are nearing molecular and atomic levels. That constitutes a technological 'brick wall' for silicon technologies. Adding functions can no longer be done through the conventional processes of miniaturization." Unfortunately R&D on a scale necessary to find a replacement is not being funded in the U.S., he says.

"The second challenge is that the actual cost of producing these devices keeps growing exponentially," says Howell. "The cost of a state-of-the-art fab is now several billion dollars, [an amount] many companies are reluctant to spend -- especially since the generation life of a device is only a few years."

Another challenge is the semiconductor sector's declining revenue growth rate, asserts Randy Isaac, vice president of strategic alliances for IBM Corp.'s Technology Group, Somers, N.Y. "The rate has dropped from double-digit ranges to single digits in the last few years while the costs of manufacturing and the cost of development are growing rapidly."

Howell says the challenges have led to the semiconductor business model that disconnects device design from manufacturing. "Semiconductor facilities are opening as contract manufacturers -- often with a [foreign] government's backing. "With this business model, first seen in Taiwan, semiconductor designers can outsource manufacturing and avoid investments in semiconductor equipment."

Howell estimates that Taiwan has already captured two-thirds to three-quarters of the world's entire foundry work. He notes that China is rapidly emulating that success with expertise from Taiwan, with the development of special government-funded industrial parks, the low costs of building construction in China as compared with the U.S., and less onerous environmental regulation. Says Howell, "Expect China to be a major semiconductor competitor [of the U.S.] within 10 years."

IBM's Isaac wonders if the U.S. survivors can successfully concentrate on R&D and outsource manufacturing. He observes that the coupling between R&D and manufacturing is growing tighter as the technology progresses. "Feedback from manufacturing experience is vital to R&D, while new innovation needs to be implemented in manufacturing very quickly."

Howell says the question everyone is asking is how long will it take for these contract foundries to also capture the semiconductor R&D. He also sees the move to off-shore contract foundries cascading into a powerful draw for engineering and research professionals. Already multinational companies, such as General Electric Co. and Microsoft Corp., employ scientists and engineers in research labs in several foreign countries, including low-cost China and India. According to one report, over a third of Microsoft's 180 programmers in its Beijing research lab have Ph.D.s from U.S. universities. Indeed, China is aggressively pursuing such individuals by offering incentives such as tax benefits, world-class housing and extensive stock options.

At the very least, these developments will substantially reshape the global semiconductor industry. Isaac sees the U.S. industry responding by aggressively seeking lower-cost manufacturing, more efficient manufacturing processes and by creating alliances with other companies. "Some countries offer attractive incentives to encourage semiconductor manufacturing to be located in their geography," adds Isaac. The trouble with that is, according to a National Institute of Standards and Technology report: "If domestic R&D resources are not available, U.S. companies do not hesitate to form research partnerships with foreign companies, outsource R&D overseas or directly invest in foreign research facilities. These research relationships often lead to follow-on foreign manufacturing relationships. Thus, the maintenance of an effective domestic R&D network is essential for attracting domestic and foreign R&D funds and subsequent manufacturing."

Sen. Joseph Lieberman (D, Conn.), drawing upon a letter from the Semiconductor Industry Association to U.S. Trade Representative Robert Zoellick late last year, points out that China is using "direct and indirect subsidies" to attract next-generation semiconductor fabs, including offering "a substantial rebate on the value-added tax (VAT) charged on Chinese-made chips."

The question of whether or not semiconductor leadership will migrate to other parts of the world has spawned several efforts by governmental organizations to research the issue on behalf of the semiconductor as well as other high-tech manufacturing industries.

Another danger of relying on off-shore manufacturing is the possibility that other countries will capture tech know-how by taking it from the U.S. firms' production facility. It's no secret that China, like other developing countries before it, allows foreign joint ventures into the country in part to gain technology transfer. It's also generally agreed that the country's enforcement of intellectual property protection is woefully inadequate, though it has made progress, enacting better laws and pledging better enforcement. Still, others wonder if China's trade officials aren't stalling and turning a blind eye toward offenders.