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Suggested Citation:"10 Semiconductors." National Research Council. 1999. U.S. Industry in 2000: Studies in Competitive Performance. Washington, DC: The National Academies Press. doi: 10.17226/6313.
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Semiconductors JEFFREY T. MACHER DAVID C. MOWERY DAVID A. HODGES University of California, Berkeley INTRODUCTION Often called the "crude oil of the information age," semiconductors are the basic building blocks of many electronics industries. Declines in the price/per- formance ratio of semiconductor components have propelled their adoption in an ever-expanding array of applications and have supported the rapid diffusion of products utilizing them. Semiconductors have accelerated the development and productivity of industries as diverse as telecommunications, automobiles, and military systems. Semiconductor technology has increased the variety of prod- ucts offered in industries such as consumer electronics, personal communica- tions, and home appliances. Global production of semiconductor components grew from roughly $19 bil- lion to $137 billion (in 1997 dollars) during 1980-1997, an annual growth rate of more than 12 percent (see Figure 1~.2 Nevertheless, the U.S. semiconductor in- dustry, which had pioneered the commercial development of this technology, iThe research on which this paper is based was supported by the Alfred P. Sloan Foundation. We are indebted to our fellow participants in the Berkeley Competitive Semiconductor Manufacturing Research Program and especially to its director, Professor Rob Leachman, for invaluable data, advice, and support. We also appreciate the assistance of Jerry Karls and Howard Dicken of Integrated Circuit Engineering, Inc., Doug Andrey and Lynn Lehsten of the Semiconductor Industry Associa- tion, Dan Hutcheson of VLSI Research, Inc., and Jodi Shelton and Debra Scoggin of the Fabless Semiconductor Association in providing data for this paper. This paper has benefited greatly from the comments of Melissa Appleyard, Rose Marie Ham, and Bill Spencer. The authors are solely responsible for any errors or omissions. 2Market share data presented in this paper represent the dollar amount of billings as reported by member semiconductor firms to World Semiconductor Trade Statistics (WSTS), Inc. 245

246 150 _` o . _ m ~ 100 o ._ ~ 50 $ .F a) U.S. INDUSTRYIN2000 ~ Row 7~ /' O 1 980 1 981 1 982 1 983 1 984 1 985 1 986 1 987 1 988 1 989 1 990 1 991 1 992 1 993 1 994 1 995 1 996 1 997 Year FIGURE 1 Worldwide semiconductor production, 1980-1997. Source: SIA 1997 Annual Databook; ICE Status: A Report on the Integrated Circuit Industry, 1980- 1998. experienced wide swings in its competitive performance, especially relative to that of Japan, during this period. The 1980s opened with an expanding Japanese presence in memory components, products widely viewed as essential "technol- ogy drivers" for advances in semiconductor manufacturing processes. U.S. firms steadily lost market share to Japanese firms in memory components during the 1980s, and Intel, now among the most profitable semiconductor manufacturers in the world, nearly collapsed in the 1984-1985 industry recession. At the end of the decade, the M.I.T. Commission on Industrial Productivity (1989) suggested that: The traditional structure and institutions of the U.S. [semiconductor] industry appear to be inappropriate for meeting the challenge of the much stronger and better-organized Japanese competition.... The technological edge that once en- abled innovative American companies to excel despite their lack of financial and market clout has disappeared, and the Japanese have gained the lead. By 1989, however, this dismal picture had begun to brighten, and the market position and profitability of U.S. firms have since improved, especially relative to that of Japanese firms. Stronger U.S. performance is revealed in gains in global market share that rest in part on improvements in product quality and manufac- turing process yields. Improved performance also reflects the withdrawal by most U.S. firms from the fiercely competitive DRAM segment of the semicon

SEMICONDUCTORS 247 ductor industry. During and after the late 1980s, U.S. firms shifted to logic and microcomponent products,3 where foreign competition was less intense and they could pursue new product opportunities, many of which drew on their proximity to developers of computer software and other complementary products. Japanese firms, facing less progressive domestic computer hardware and software indus- tries, were less successful in product innovation. Other U.S. firms, such as the so-called "fabless" semiconductor firms,4 have entered the industry successfully as specialists in innovative device designs. Meanwhile, the Japanese firms that dominated DRAMs now face a domestic recession and entry by South Korean and Taiwanese firms with low costs and high manufacturing productivity. Entry by non-Japanese semiconductor manufacturers also has expanded export markets for U.S. producers of semiconductor equipment. Although the Asian economic crisis that began in 1997 is likely to depress global demand for semiconductors in the near term and erodes the financial performance of U.S. producers, the relative performance of U.S. semiconductor firms remains strong, as their continuing lead- ership in global market share indicates. Much of the "renaissance" of U.S. competitive advantage in semiconductors thus reflects exploitation by U.S. firms of long-standing strengths in product in- novation. Many of the new opportunities that appeared in the late 1980s for such product innovation reflected developments in other industries such as telecom- munications and computers, in which U.S. firms demonstrated renewed innova- tive and competitive vigor. The repositioning of U.S. semiconductor firms was if anything aided by the U.S. industry's fragmented structure, criticized by the MILT. Commission and others (e.g., Florida and Kenney, 1990~. U.S. semicon- ductor firms' exploitation of new opportunities for product innovation built on an unusual industry structure that distinguishes this industry from its Western Euro- pean, South Korean, and Japanese counterparts. The U.S. semiconductor indus- try is dominated by merchant producers5 rather than by subsidiaries of large, diversified electronics firms. A number of federal government initiatives, ranging from trade policy to financial support for university research and R&D consortia, played a role in the industry's revival, but the specific links between such undertakings as SEMA- TECH6 and improved manufacturing performance are difficult to measure. Col 3Microcomponents include microprocessors, microcontrollers, DSP devices, and microperipheral devices. 4Fabless semiconductor firms design new microelectronic products but subcontract out the manu- facture of these products to firms ("foundries") specialized in their fabrication. 5Merchant semiconductor firms sell most of their production on the open market, in contrast to captive semiconductor firms who produce semiconductor devices principally for internal "parent" systems divisions. 6The SEmiconductor MAnufacturing TECHnology (SEMATECH) consortium was created in 1987 to develop semiconductor manufacturing technology, using a combination of industry and federal government funding.

248 U.S. INDUSTRYIN2000 laboration between equipment and manufacturing firms contributed to improved manufacturing performance, but the size of this contribution as well as the factors that produced higher levels of collaboration in an industry long known for its fierce interfirm competition remain uncertain. Industry managers are virtually unanimous in emphasizing that the crisis of the 1980s forced them to devote much more attention to improving their development and management of manu- facturing process technology. But we do not know how much of the overall improvements reflect this renewed focus by managers, nor do we understand why poor performance was tolerated for so long. In a complex industry such as semiconductors, no single explanation for im- proved U.S. performance is likely to suffice. All of the factors discussed above have contributed to this industry's revival, and it is futile to attempt to assign weights to individual causes. At the same time, the foundation for this com- petitive revival is fragile. U.S. producers' success in repositioning their product lines and developing innovative products does not guarantee enduring domi- nance. The M.I.T. Commission's grim diagnosis of the "structural crisis" of the U.S. semiconductor industry does contain important insights; and at least some of the negative consequences of the U.S. industry's unusual structure have not been addressed. Many of the large corporations that supported much of the ba- sic research that propelled the semiconductor industry's early growth have re- duced the scope of their in-house basic research, and public funding for long- term R&D is more uncertain in the wake of the Cold War. Without a clearer understanding of the factors that gave rise to it, maintaining interfirm collabora- tion may prove difficult. This paper surveys the competitive performance of the U.S. semiconductor industry since 1980. The following gives a description of the industry's decline and revival, focusing on measures of financial and manufacturing performance. In Section III, we discuss the changes in technology management that contributed to this revival. Section IV discusses the non-technological factors that affected the U.S. and global semiconductor industries. A short summary and concluding comments are presented in Section V. INDUSTRY PERFORMANCE, 1980-1997 Our discussion of industry performance begins with a summary of the devel- opment of the global semiconductor industry, highlighting trends in the market shares of U.S. and non-U.S. semiconductor manufacturers and semiconductor equipment suppliers during the 1980-1997 period. Our market-share data are measured in terms of revenues and therefore confound trends in output quantity and the price per unit of that output. This effect is not entirely undesirable; one of the primary factors behind the resurgence of U.S. manufacturers' market share in semiconductors is precisely the higher average selling prices of their output dur- ing the 1990s. But we also wish to discuss trends in manufacturing performance,

SEMICONDUCTORS 249 and therefore present data in subsequent sections on product quality, yield, and productivity that exclude these price effects. Market Share U.S. Dominance Prior to 1985 The first transistors, and subsequently the first integrated circuits (ICs), were developed and manufactured in the United States primarily for U.S. military and space programs. By the mid-1960s, the computer and communication industries surpassed the U.S. military as the predominant markets for semiconductors, and the market for semiconductor components has been dominated by commercial applications ever since (Tilton, 1971; Braun and MacDonald, 1978~. From the invention of the IC in 1959 through 1985, the combined market share of U.S. producers exceeded that of firms from all other nations (see Figure 2~. A combination of unusual circumstances, including abundant venture capi- tal, widespread licensing and cross-licensing of key patents, and the willingness of U.S. military and space agencies to purchase semiconductor devices from rela- tively new firms, produced an industry structure that by the 1960s contrasted with those of the Japanese and Western European semiconductor industries. The lead- ing commercial producers of semiconductors in the U.S. included a number of "merchant" firms that specialized in semiconductor manufacture. Many of these firms were relatively young, having been founded during the 1950s and 1960s with venture capital financing. In contrast, the Japanese and Western European semiconductor industries were and continue to be dominated by subsidiaries of large, diversified firms in the electrical equipment industries. 60% 40% ~ 80% Ct s o o ~o%X ~ ~ ~ ~ ~ ~ ~ ~ ~ 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 Year FIGURE 2 Worldwide IC production market share, 1970-1980. Source: ICE Status: A Report on the Integrated Circuit Industry, 1976-1982. us ~ JAPAN -war - EUROPE

250 Japanese Growth and Dominance, 1985-1990 U.S. INDUSTRYIN2000 The dominant position of U.S. firms was challenged by foreign sem~conduc- tor producers in the late 1970s. Japanese firms had been active in the sem~- conductor industry since the 1950s but lagged behind U.S. firms in product and process technology. But in the m~d-1970s, MITI, NTT (at the time, Japan's state- owned telecommunications firm), and Japanese producers of semiconductor de- vices and manufacturing equipment launched several research programs to im- prove the semiconductor manufacturing capabilities of domestic firms. These initiatives included the well-known VLSI Program overseen by MITI and a paral- lel program for its semiconductor suppliers sponsored by NTT. Paradoxically, the VLSI Program sought to improve Japanese semiconductor capabilities in or- der to strengthen the international competitiveness of Japan's computer industry. These technology development programs focused on memory devices, which were important in computer systems and whose relative design simplicity facili- tated the testing of new process technologies. The market outlook for these de- vices appeared to be favorable, a projection that was amply borne out by subse- quent events. Finally, "Moore's Law"7 provided a clear "roadmap" of the path of future developments in DRAM technology, enabling Japanese firms to focus their efforts to "catch up" in semiconductor technology. In 1977, Japanese sem~con- ductor producers gained a foothold in 16K DRAMs; by 1979, Japanese producers accounted for almost 42 percent of global DRAM sales (ICE Status, 1980~. Japanese producers became the dominant suppliers of memory devices in the industry by the m~d-1980s, and U.S. firms' market share in memory products plummeted from 75 percent in 1980 to less than 20 percent in 1990 (see Figure 3~. U.S.-Japanese competition in DRAM production took on the characteristics of a So% .0 c' ~ 60% 0 ~ tL cn 0 a) , 0%] ~ 0 cat ~ ca oo 0 cat ~ ca oo oo oo oo oo a) a) a) a) a) a) a) a) a) a) a) a) a) Year FIGURE 3 Worldwide memory production market share, 1980-1997. Source: ICE Status: A Report on the Integrated Circuit Industry, 1980-1998. ~ US JAPAN EUROPE X Row 7Moore's Law was articulated in 1965 by Dr. Gordon Moore, one of the founders of Intel, who pointed out that the number of transistors integrated on semiconductor devices tends to double every 18 months.

SEMICONDUCTORS 75% ._ ~ ~ ~ 50% ~ ct Q ~ cn cn .~ 0' 25% ~ ct ~ 0% . ~I I I I I I I I I I I r r I 0 Cal ~oo 0 Cal oo oo oo oo oo Year FIGURE 4 Worldwide semiconductor capital spending share, 1980-1997. Source: ICE Status: A Report on the Integrated Circuit Industry, 1980-1998. 25 + US JAPAN EUROPE X Row "capacity race" firms in each nation invested aggressively in production capac- ity for next-generation products. Aided by their superior access to internal sources of finance, Japanese semiconductor manufacturers were able to dominate this investment competition. The U.S. share of capital spending in the world semi- conductor industry declined from nearly 60 percent in 1980 to roughly 30 percent in 1990 (see Figure 4~. During 1979-1990, Japanese producers were first to mar- ket and increased their overall market share with each new product generation (see Table 1~. The enormous capital requirements of the investment capacity race, combined with fierce price competition in DRAMs and a U.S. industry re- cession, forced many U.S. merchant firms, with the notable exceptions of Texas Instruments and Micron Technology, out of the DRAM market by 1985. By 1990, Japanese firms accounted for 98 percent of sales of 4-megabit DRAMs, then the most advanced memory product. Reflecting their declining fortunes in memory devices, U.S. merchant semi- conductor producers lost considerable market share during this period (see Figure 5~. From a leading share of almost 62 percent in 1980, U.S. chipmakers lost roughly 25 percent of the global market over the next nine years, declining to a TABLE 1 Maximum Market Share by Device Type Device type Volume production Maximum market share (%) U.S. Japan 1K 1971 95 5 4K 1974 83 17 16K 1977 59 41 64K 1979 29 71 256K 1982 8 92 1M 1985 4 96 4M 1990 2 98 Source: Dataquest, cited by Methe (1991) and Langlois and Steinmueller (1998).

252 75% o 0 ~ 50% ~ s ~ Oh 0 ~ ._ oh U.S. INDUSTRYIN2000 0%1 ~ 0 cat ~ ~ oo oo oo oo oo oo Year r I r 0 Cal r I I . . _ . . . Row X EUROPE FIGURE 5 World semiconductor production market share, 1980-1997. Source: SIA 1997 Annual Databook; ICE Status: A Report on the Integrated Circuit Industry, 1980- 1998. low point of 37 percent by 1989. Japanese semiconductor firms by 1989 ac- counted for more than half of global semiconductor revenues. The Japanese semiconductor manufacturing equipment industry also enjoyed rapid growth during the 1980-1990 period (see Figure 6~. Indeed, the trends in Japanese firms' share of overall capital spending and Japanese semiconductor equipment market share parallel one another closely, since many Japanese semi- conductor firms purchased most of their manufacturing equipment from domestic suppliers. Japanese firms held less than 50 percent of the equipment market in Japan in 1980, but their share increased to 84 percent by 1991 and remains near 75 percent in 1997 (VLSI Research, 1998~. Japanese semiconductor equipment manufacturers increased their global market share from less than 20 percent in 1980 to almost 50 percent in 1990, largely at the expense of U.S. equipment firms, whose market share declined from roughly 75 percent to less than 45 per- cent during the same period (VLSI Research, 1998~. The rapid growth of Japa Europe >< Row 0% . , ~7 ~... . ~or o Cal ~(D 0D 0D oo oo oo oo a) a) a) a) a) Year O Cal ~(D a) a) a) a) a) a) a) a) FIGURE 6 Worldwide semiconductor equipment production market share, 1980-1997. Source:VLSI Research Semiconductor Equipment Consumption and Production by Region, 1998.

SEMICONDUCTORS 253 nose equipment firms appears to be attributable to the growth in investment spend- ing by their major customers, rather than MITI initiatives such as the VLSI Pro- gram (Langlois and Steinmueller, 1998~. Equally important, however, was the superior performance and reliability of Japanese equipment. U.S. Revival, 1989-1997 Japanese firms' advances in DRAMs produced widespread concern within the U.S. semiconductor industry and among government policymakers. This dire competitive situation nevertheless began to change in the late 1980s. U.S. pro- ducers reversed their global market share decline in 1990 for the first time since 1975 (ICE Status, 1976-1991~. But this reversal in market share took place in areas other than memory products, where U.S. firms' global market share has grown only slightly since 1990 (see Figure 3~. Much of the improvement in market share resulted from the efforts of U.S. firms to shift their product mix away from low-margin products such as DRAMs in favor of products that enabled them to exploit their strengths in product inno- vation. Having largely exited the DRAM market by 1985, U.S. semiconductor manufacturers in the l990s focused on logic devices and "mixed-signal" and other digital signal processor (DSP) components for the burgeoning market in com- puter networking equipment. Strong demand for these "design-intensive" com- ponents propelled U.S. chipmakers to market share leadership in the global semi- conductor industry by 1993 (see Figure 5~. By 1997, U.S. producers controlled over 50 percent of the global semiconductor market, well above the 29 percent held by Japanese firms. Contradicting the predictions of analysts who argued that DRAM production was an indispensable "technology driver" for semiconductor manufacturing, U.S. firms' enduring market share losses in DRAMs did not pre- vent this revival in their competitive fortunes. New Competition in DRAMS, 1992-1997 The post-l990 decline in Japanese firms' global market share reflected the revival of U.S. firms in new, more profitable product lines, as well as entry by South Korean and Taiwanese firms into the DRAM market. South Korean firms began DRAM production in 1984, and Taiwanese firms had entered large-scale merchant production of DRAMs by 1994. Rather than shifting to logic products, Japanese firms remained in the DRAM business and sought to be technology leaders in introducing next-generation DRAM devices. But a global recession in the early l990s and the subsequent prolonged domestic recession in Japan depressed demand for next-generation memory products. The weakness of the Japanese counterparts of the U.S. indus- tries (e.g., computer networking, Internet applications, and packaged software) that sparked innovation in the U.S. industry also contributed to Japan's misfor

254 75% l ~ c ~ ~ 50% 0 s ~ En id: o: 25% o%d ~ = 1989 1990 1991 1992 ~T T 1993 1994 1995 1996 1997 Year FIGURE 7 Worldwide DRAM production market share, 1989-1997. Source: ICE Status: A Report on the Integrated Circuit Industry, 1980-1998. U.S. INDUSTRYIN2000 JAPAN X Row + EUROPE tunes. The situation was made worse by the appreciation of the yen, which placed Japanese firms' memory chips at a competitive disadvantage vis-a-vis those of other DRAM producers in foreign markets. Japanese firms' market share in DRAM products has declined from roughly 70 percent in 1990 to less than 50 per- cent in 1997 (see Figure 7~. Moreover, more intense price competition has reduced the profitability of DRAMs. Their loss of market share therefore understates the financial damage to Japanese semiconductor firms from their focus on DRAMs. DRAMs now are essentially commodity products, and Japan, Taiwan, and South Korea are engaged in a global battle for market share based on low produc- tion costs and high yields. Japan no longer dominates the memory market as it did in the 1980s, having lost market share to Korean and Taiwanese semiconduc- tor firms. The Korean semiconductor firm Samsung now holds the largest share of the global SRAM and DRAM markets, and Korean semiconductor firms oc- cupy three of the top six spots in DRAM sales (see Table 2~. TABLE 2 Worldwide DRAM Merchant Market Sales (Million Dollars) Company Country 1995 1996 1997 Samsung Korea 6,462 4,805 3,550 NEC Japan 4,740 3,175 2,510 Micron U.S. 2,485 1,575 2,003 Hitachi Japan 4,439 2,805 1,950 Toshiba Japan 3,725 2,235 1,750 Hyundai Korea 3,500 2,300 1,650 LO Semicon Korea 3,005 2,005 1,580 Mitsubishi Japan 2,215 1,400 1,150 Texas Instruments U.S. 3,200 1,600 1,100 Fujitsu Japan 2,065 1,350 1,050 Others 4~999 1~880 1~505 TOTAL 40,835 25,130 19,798 Source: ICE Status: A Report on the Integrated Circuit Industry, 1996-1998.

SEMICONDUCTORS 255 The rapid growth of Japanese firms' market share during the 1980s relied in part on their reputation for high-quality products. Similarly, the revival of U.S. firms' market share in the late 1980s and l990s rested in part on improvements in the quality of their products. Although the data on product quality are reasonably reliable, the causes of these trends are less easily discerned. We discuss both the trends and the available evidence on factors that lay behind them in the following section. The Quality Challenge From Japan Product Quality In the early 1970s, Japanese firms recognized that improved quality in their semiconductor products could aid entry into the U.S. and global markets. These chipmakers targeted global firms such as IBM and Hewlett Packard, who needed high-quality components for their advanced electronic systems products. Draw- ing in many cases on practices they had long followed in their other manufactur- ing businesses, Japanese semiconductor manufacturers incorporated statistical process control (SPC), total quality management (TQM), and total preventive maintenance (TPM) into their semiconductor operations.8 By the mid-1970s, Japanese firms were applying SPC methods to semicon- ductor processes in fabrication and assembly in order to reduce process variance and defects quality control practices that U.S. semiconductor firms did not pur- sue until well into the 1980s. Japanese semiconductor firms implemented TQM concepts through extensive training of line operators and selective automation of manufacturing to improve process control, material handling, and data process- ing and feedback. Japanese firms also improved the reliability of their semicon- ductor equipment through preventive maintenance and strengthened their rela- tionships with systems-level customers, semiconductor equipment manufacturers, and materials vendors. These internal management practices produced significant quality differences between Japanese and U.S. semiconductor products. Users of U.S. and Japanese devices discovered Japanese memory products had defect rates that were one-half to one-third those of comparable U.S. memory products (Barron,1980~. In 1980, leading Japanese memory producers averaged 160 defect parts per million (PPM) while U.S. semiconductor firms averaged 780 PPM for the same devices (Finan, 1993~. Their skills in managing the development and introduction of new process technologies also enabled Japanese semiconductor manufacturers to "ramp" out- put of new products more rapidly than their U.S. counterparts. Faster achieve- ment of high production volumes gave Japanese firms advantages in defining See Finan (1993) for a more extensive discussion.

256 U.S. INDUSTRYIN2000 product standards for leading-edge memory devices, facilitating more rapid mar- ket penetration (Finan, 1993~. U.S. industrial consumers of semiconductor devices publicized these U.S.- Japanese differences in product quality. Hewlett Packard presented data at a 1980 Electronics Industries Association of Japan (EIAJ) conference that showed Japanese memory products had average defect rates that were an order of magni- tude lower than those in U.S. products. A 1989 SEMATECH survey revealed a preference among both U.S. semiconductor manufacturers and U.S. equipment and material suppliers for partnerships with Japanese firms (rather than U.S. firms) because of Japanese firms' commitment to quality and effective manage- ment of their supply chains (Erickson and Kanagal, 1992~. U.S. Semiconductor Firms' Response By the mid-1980s most of the leading U.S. semiconductor firms recognized the strategic importance of quality and had initiated quality improvement pro- grams. Some U.S. semiconductor firms devoted considerable effort to learning from Japanese firms; and those with operations in Japan, particularly TI and Motorola, were among the first to apply Japanese quality management techniques. Confronted with evidence of improvement in the performance of these domestic competitors, other U.S. firms began to emulate their practices. A survey in 1990 by the National Institutes of Standards and Technology (NIST) of 11 U.S. semi- conductor firms' quality assurance investments revealed a doubling of the share of spending related to quality in the previous five years (Finan, 1993~.9 The estimated share of total company outlays directly or indirectly allocated toward achieving higher quality averaged 10-20 percent during 1980-1985 but increased to 20-35 percent by 1990. In addition, industry managers argue that the forma- tion of SEMATECH supported more effective collaboration between U.S. manu- facturers and equipment suppliers on quality and reliability problems. These and other efforts were associated with a reduction in average product defect rates to less than 400 PPM by 1986, according to the Semiconductor In- dustry Association (SIA), the U.S. semiconductor manufacturers' trade group (Finan, 1993~. Defect rates continued to decline through the rest of the decade, and by the early 1990s leading U.S. firms had matched Japanese memory produc- ers' defect levels at less than 100 PPM (see Figure 8~. Other Measures of Manufacturing Performance In addition to improving their product quality, U.S. semiconductor firms strengthened their performance in manufacturing process management. Data from 9Finan measures this increased spending on product quality as a doubling in the share of total firm expenses (operating, R&D, and capital outlays) devoted to quality improvement programs.

SEMICONDUCTORS 400 300 CD 200 100 O 257 I L It'd 1986 1987 1988 1989 Year FIGURE 8 U.S. IC defective PPM, 1986-1992. Source: SIA Quarterly Quality Survey (1992), cited in Finan (1993). 1990 1991 1992 the U.C. Berkeley Competitive Semiconductor Manufacturing (CSM) Programi° suggest that the U.S. firms have improved manufacturing "yield" and direct labor productivity in some product lines since the early 1990s,~i although they still lag behind Japanese and other Asian firms in most of these performance measures. Nevertheless, narrowing this gap in manufacturing performance appears to have been sufficient, in combination with U.S. firms' product innovations and strate- gic repositioning, to improve their overall competitive performance. A key measure of semiconductor manufacturing performance is die yield, the number of usable die per silicon wafer that emerge from the manufacturing process. Die yield is a measure of "process quality" that differs in at least one important respect from the product defect data discussed earlier. The number of defective PPM reported earlier referred to defects among products released to the market. A significant portion of the reductions in defective PPM in U.S. firms' commercial output reflects more intensive inspection of chips after manufacture and before distribution to the market. Our measure of die yield, however, is not directly affected by such inspection procedures. Instead, die yield is sensitive to i°This multi-year research effort is a joint project of the College of Engineering, the Haas School of Business, and the Berkeley Roundtable on the International Economy at U.C. Berkeley. The project has been supported by the Alfred P. Sloan Foundation and semiconductor producers from Asia, Eu- rope, and the United States. Program directors are Dave Hodges and Robert Leachman of U.C. Berkeley's College of Engineering. iiIn a CSM working paper (CSM-40) entitled National Performance in Semiconductor Manufac- turing, Robert and Chien Leachman report fate performance in logic and memory devices for sub- micron CMOS processes using eight different performance metrics. National statistics are tabulated based upon fate location rather than the nationality of the owner firm, but the data reported here contain no "transplants." The next several paragraphs draw on Leachman and Leachman (1997), and the interested reader is referred to it for a more thorough discussion.

258 U.S. INDUSTRYIN2000 the execution of the numerous steps involved in the production of a new compo- nent, and its improvement reflects improved manufacturing methods, in many respects a more difficult achievement. The level of technical sophistication of semiconductor manufacturing pro- cesses typically is defined as the size of the smallest feature on a chip that is manufactured with the technology. "State-of-the-art" manufacturing processes now can produce chips with linewidths as small as 0.18 microns But this tech- nological frontier is continually moving, and comparing manufacturing perfor- mance over even a brief length of time requires a choice of a single linewidth category that has been in use within the U.S. and Japanese industries throughout the period of comparison. Accordingly, our analysis of manufacturing perfor- mance uses data for devices with minimum linewidths of 0.7-0.9 micron for the 1989-1994 period.~3 We present data only for logic products because we lack a sufficient number of observations for U.S.-located, domestically owned memory production capacity to support a comparison of performance in U.S.- and Japa- nese-owned memory production facilities for this period. Japanese defect density data for logic products are available only for 1993, but during this period their defect densities were far lower than U.S. or other firms. Nevertheless, U.S. firms reduced their defect densities from as many as 2.5 fatal defects per square centi- meter in 1991 to levels comparable with the 1993 performance of Japanese fates by 1994 (see Figure 9~.~4 During this period, Taiwanese firms achieved similar improvements in defect density. Along with Finan (1993), Leachman and Leachman (1997) attribute improve- ments in U.S. manufacturing performance to increased use of quality manage- ment techniques. Widespread adoption of SPC methodologies by U.S. firms ap- pears to have lowered defect densities and improved die yields. In addition, U.S. firms improved the speed of collection, the reliability, and the accessibility of data on manufacturing performance, all of which enabled faster identification and diagnosis of problems in manufacturing yields. These steps included the use of "end-of-line" yield analysis that relies on rapid transmission of data from probe tests of wafers to engineers, the increased use of data collection systems that provide statistical correlation of in-line data on process steps and lot characteris- tics with end-of-line yield tests, the increased automation of manufacturing pro i20ne micron is 1/lOOOth of a millimeter. i3Die yield is affected by particulate contamination of the silicon wafer's surface, among other things, and reported die yield therefore is sensitive to the average size of die on a wafer. In order to control for differences in average die size, the measure of die yield that is reported here is "defect density," the number of fatal defects per square centimeter on a wafer. i4The figure reports defect density for "CMOS" logic manufacturing processes, which are the larg- est single category of MOS manufacturing processes. During the period of the sample, CMOS repre- sented more than 90 percent of MOS technology used in all IC manufacturing (ICE Status, 1989- 1994).

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260 U.S. INDUSTRYIN2000 cess information,~5 and the automated collection of equipment performance and control parameters. Other measures of die yield indicate significant improvement in U.S. semi- conductor firms' manufacturing performance by the end of the 1980s. According to the U.S. General Accounting Office (U.S. GAO), U.S. firms had fallen behind Japanese firms in "probe yielded by 1981 (U.S. GAO, July 1992),~7 but U.S. firms' performance in this quality measure improved significantly during the 1986-1991 period. By 1991, U.S. manufacturers had narrowed but had not elimi- nated the gap between their performance and that of Japanese manufacturers (see Table 3~. Although U.S. semiconductor firms have narrowed the gap with Japanese firms in die yield for some devices, they continue to lag in other areas, such as direct labor productivity. Our data support comparisons of U.S. and Japanese productivity performance, measured in terms of the number of wafer layers per operator per day. This measure captures differences in "physical productivity;" the value of output per worker is not captured by this measure. As such, differ- ences in the price per die on wafers produced in different fates may partially or entirely offset much of the financial consequences of differences in this measure of performance. At CMOS logic fates, U.S. firms' direct labor productivity improved during the 1991-1994 period but still lag behind Taiwanese and Japanese firms (see Figure 10~. The importance of scale economies in semiconductor manufacturing means that the smaller average size of U.S. fates, relative to those in Japan, South TABLE 3 Average Probe Yield: U.S. and Japanese Semiconductor Manufacturers (1981-1991) Average probe yield (%) Country 1981 1986 1987 1988 1989 1990 1991 U.S. Japan 45 55 60 75 60 67 74 80 84 79 81 85 89 93 Source: U.S. General Accounting Office (July, 1992). i5Such as "downloading" of recipes for specific device types to operators, helping to reduce errors. i6Probe yield is the percentage of good die on a silicon wafer after the last electrical test for func- tionality before semiconductor devices are cut from the wafer, packaged, and assembled. It is similar to defect density, although it does not control for variation in die size. i7The GAO study cited unpublished data from VLSI Research in this assessment. insignificant differences within the sample in fate organization and relationships with other corpo- rate functions, such as R&D, process development, and the like mean that the amount of "indirect" labor i.e., engineering and management staff is likely to vary among fates in this sample. "Direct" labor productivity should reduce the influence of these differences in the comparison of fate-level productivity.

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262 U.S. INDUSTRYIN2000 Korea, and Taiwan, depresses U.S. firms' performance in this comparison (Leach- man and Leachman,1997~. Nevertheless, as was noted above, the consequences of these differences in physical productivity are mediated by the prices and mar- gins per die in each region's product mix. U.S. firms have specialized in rela- tively high-margin products and therefore are somewhat insulated from the finan- cial consequences of their relatively low physical productivity. But as and if non-U.S. firms strengthen their capabilities in product innovation and shift their output mix to become direct competitors with U.S. firms in these newer, more design-intensive products, the relatively low direct labor productivity of U.S. fates could produce more serious competitive difficulties. During the late 1980s and 1990s, U.S. firms also improved their manage- ment of the development and introduction of new process technologies into high- volume manufacturing.~9 Increases in the design complexity of semiconductor devices during the 1980-1997 period meant that the process technologies neces- sary to produce them became more complex. Greater design complexity made it much more difficult to predict the performance of new process steps and equip- ment through simulation or laboratory-scale experimentation and complicated the "debugging" of new process technologies in the manufacturing environment. At the same time, intensified competition in many product lines meant that rapid expansion of the output of new products was essential to maximize sales in the increasingly brief period prior to entry by competitors. A prolonged period of "learning," during which yields are low and/or product quality is unreliable, re- duces profits. The difficulties associated with new process development and in- troduction thus have grown simultaneously with the competitive and financial penalties of a poorly managed introduction. Evidence from the CSM study and other sources suggests that U.S. firms were slow to respond to these new realities until forced to do so by Japanese competition. There is no single "best practice" for managing the development and intro- duction of new process technologies. Many U.S. firms have expanded their use of "development facilities," which are similar in many respects to pilot process plants in the chemicals industry. These facilities support the development and debugging of new process technologies and equipment in an environment that is insulated from the demands of high-volume manufacturing yet is designed to reproduce as many characteristics of that environment as possible. Intel's inte- grated process development facility in northwest Oregon doubled manufacturing yields from the 1980s to the mid-199Os and accelerated the "ramping" of produc- tion of new device designs (Cole, 1998~. Duplication of the manufacturing environment requires that the development facility duplicate production equipment and materials to the maximum extent, which can be costly and in some instances delays the adoption of the latest pro- duction technologies. Firms also rely on multifunction teams for the develop i9See Hatch and Mowery (1998) and Appleyard et al. (1997) for further discussion of these issues.

SEMICONDUCTORS 263 ment and introduction of new manufacturing processes, and members of the pro- cess development staff participate directly in the introduction and debugging of a new manufacturing process. Improved management of new process development and introduction also requires an integrated approach to product and process de- velopment. Introducing a radically new manufacturing process (for which 75-90 percent of the hundreds of individual steps are new) and attempting to simulta- neously begin large-scale production of a new product design with this process is formidable. Many U.S. firms instead introduce incremental advances in manu- facturing processes and debug these modified processes on new versions of exist- ing product designs for example, a smaller version or "shrink" of an established logic or memory chip. This more incremental approach to new process develop- ment and introduction requires close coordination among product design, process development, and equipment procurement over multiple generations of existing and new products. Other Factors Affecting U.S. Semiconductor Firm Performance By the early 1990s, the global semiconductor industry had coalesced into three broad product categories memory, logic, and microcomponent products. Memory has traditionally been the largest single segment of the semiconductor industry. The logic market includes both application-specific integrated circuits (ASICs) and other general and special-purpose logic devices. ASICs are logic devices produced for a specific customer and not, as the name implies, devices for a specific application. U.S. semiconductor firms' total ASIC market share declined from 1988 to 1991 but has rebounded. U.S. firms controlled almost 50 percent of the worldwide total ASIC market in 1995 and dominate the program- mable-logic, analog array, and standard cell segments (ICE ASIC Outlook,1987- 1988, 1990-1998). The microcomponent market of the semiconductor industry includes micro- processors, microcontrollers, DSPs, and microperipheral devices. Microproces- sors, "computers on a chip," have continuously improved in functionality, com- plexity, and processing speed. Microcontrollers are somewhat simpler and less powerful than microprocessors and have their main applications in automotive, factory and industrial automation, and processing machinery. Digital signal processors are a rapidly expanding segment of the micro- component market because of their applications to the computer networking and communications industries. The global DSP market has expanded from roughly $340 million in 1991 to just under $3.4 billion in 1997 and is dominated by U.S. semiconductor firms who produced more than 90 percent of the DSP products sold in 1997 (ICE ASIC Outlook, 1990-1998~. U.S. semiconductor firms' strength in this segment of the industry reflects their presence in the most dy- namic end-user markets for these applications as well as their ability to exploit their proximity to U.S. systems producers that dominate these end-user markets.

264 ~ 00% a) tin 75% ~ 50% ~ 9 25%4 l U.S. INDUSTRYIN2000 0% ~ OTHER Cal ~(D OD O Cal ~(D OD OD OD OD a) a) a) a) a) a) a) a) a) a) a) a) Year FIGURE 11 Worldwide cumulative IC product market share, 1982-1997. Source: ICE Status: A Report on the Integrated Circuit Industry, 1982-1998. >< Bl POLAR ANALOG LOG IC MEMORY In both Western Europe and Japan, the much slower growth of end-user markets has hampered European and Japanese semiconductor firms' entry into DSPs and related products. Sales of logic, microcomponent, and memory products accounted for over 80 percent of worldwide IC market revenue in 1997 (see Figure 11~. These prod- uct markets have benefited from strong end-use demand, most notably from the computer industry, which consumes almost two-thirds of the memory and micro- component devices output. Memory sales in 1996 amounted to $36 billion, but declined in 1997 to $31 billion and are expected to continue to decline as a result of price competition (ICE Status, 1997-1998~. Sales of microcomponent devices reached almost $40 billion in 1996, exceeding memory product revenues for the first time, and were greater than $50 billion in 1997 (ICE Status, 1997-1998~. Four distinct process technologies are used to manufacture semiconductor devices discrete, bipolar, analog, and metal-oxide semiconductor (MOS). Dur- ing the 1980s, semiconductor producers shifted from discrete and bipolar process technologies to MOS, while analog technologies retained roughly 15 percent of the overall IC market. From just under 55 percent of worldwide sales in 1984, MOS devices have grown to more than 80 percent of the overall IC market by 1997 (see Figure 11~. For much of the 1980s and 1990s, DRAMs pioneered in the development of process technologies. Indeed, concern within the U.S. indus- try and U.S. government over loss of DRAM market share reflected the view that these products "drove" advances in manufacturing methods for many products. In recent years, however, DRAMs have lost their position as the "technology drivers" in MOS products as microprocessor manufacturing technologies have placed even greater demands on process limits and controls. In 1997, for ex- ample, Intel introduced large-scale production of portable Pentium microproces- sors using 0.25-micron process technology, exceeding the then current state-of- the-art production technology of memory components (0.35 micron). At least for the near term, microcomponent devices, where U.S. firms retain a leadership po

SEMICONDUCTORS 265 sition, appear to have assumed a role as "technology dnvers" for manufacturing processes. Since 1985, U.S. semiconductor companies have shifted away from the com- modity memory business, concentrating instead on "design-nch" semiconductor market segments that have more specialized and demanding product design re- quirements than memory devices. U.S. producers such as Intel and AMD now dominate the microcomponent market and have increased the U.S. share of m~crocomponent device production to more than 70 percent in 1997 from 50 percent in 1989 (see Figure 12~. The shift by U.S. firms to the m~crocomponent and logic product market segments has significantly changed the competitive positioning of firms in the semiconductor industry. The industry titans of the 1970s and 1980s National Semiconductor, Motorola, Intel, and TI are still around, but their product portfolios have changed. Whereas memory products were an integral part of their product portfolios in the 1970s and 1980s, logic and m~crocomponent devices now are the single most important source of revenues for all. Another major change in the U.S. industry is the growth of specialized design firms. Dunng the 1980s and l990s, a significant number of U.S. entrants into the semiconductor industry focused exclusively on the design and marketing of semiconductor devices, relying on third-party foundries for the manufacture of these devices (see below). Shifts in the growth of demand and profitability of semiconductor market segments, along with the entry of new producers, have affected regional capital investment trends in the global semiconductor industry. U.S. firms have signifi ~75% s (A ~ 50% 4 o o AL ~25% 0% ~ _ _ - _` - l l l l l l l l 1 988 1 989 1 990 1991 1992 1993 1 994 1 995 1 996 1 997 Year _US JAPAN EUROPE Row FIGURE 12 Worldwide microcomponent production market share, 1988-1997. Source: ICE Status: A Report on the Integrated Circuit Industry, 1988-1998; ICE Microprocessor Outlook, 1997-1998.

266 U.S. INDUSTRYIN2000 cantly increased their capital spending since the early l990s and since 1992 have accounted for the largest single regional share of overall investment in plant and equipment (see Figure 4~. This represents a considerable change from the 1984- 1991 period, during which Japanese semiconductor companies were responsible for nearly half of the capital expenditures made by IC manufacturers. Despite increases in their capital investment since 1993, Japanese producers accounted for only 25 percent of total industry capital and equipment investment in 1997. South Korean and "RoW" ("rest of world," largely Taiwanese, firms) have doubled their share of capital spending since 1991, and since 1996 combined investment in fates and equipment by South Korean and RoW semiconductor firms has exceeded that of Japan (see Figure 4~. These investment trends have contributed to a revival of the U.S. semicon- ductor manufacturing equipment industry, which increased its global market share from roughly 45 percent in 1990 to more than 50 percent in 1997, while Japanese equipment firms have lost market share (see Figure 6~. The market share gains by U.S. semiconductor firms after 1989 aided U.S. equipment suppliers because U.S. equipment suppliers maintain a position in the U.S. market that is only slightly less dominant than that of Japanese equipment firms in the Japanese domestic market. From 1980 to 1997, U.S. semiconductor equipment manufacturers sup- plied at least 75 percent of the equipment demanded by U.S. semiconductor firms in each year (VLSI Research, 1998~. The development of the Taiwanese and Korean foundry industries has also played a part in the U.S. semiconductor equip- ment industry's recovery. These foundries typically manufacture U.S.-designed semiconductor products, which require multiple metal layers and advanced equip- ment for chemical vapor deposition (CVD) and thin-film sputtering, areas in which U.S. semiconductor equipment firms have traditionally excelled. Summary: Factors behind U.S. Decline and Revival The performance of the U.S. semiconductor industry during the 1980-1997 period reflected shifts in both product and process technology management. In contrast with the Japanese firms that during the mid-1980s appeared to pose a serious competitive threat, U.S. firms proved to be relatively agile in reposition- ing their product portfolios to emphasize new products that were relatively design intensive. At the same time, however, U.S. firms improved their manufacturing performance, which enabled them to exploit their long-standing strengths in prod- uct innovation more effectively. From a position of substantial inferiority in the development and management of semiconductor process technologies in the early 1980s, U.S. chipmakers narrowed the gap between U.S. and Japanese manufac- turing capability and productivity in some product lines by the end of the decade. Both repositioning and improved manufacturing performance almost cer- tainly were necessary; neither was sufficient. Improvements in both of these dimensions of performance reflected improved technology management practices,

SEMICONDUCTORS 267 where these practices are defined to include management of process technologies on the shop floor as well as improvements in the development and adoption of new process and product technologies. In addition to these changes in their inter- nal management of innovation and production, U.S. firms expanded collaboration among one another, with equipment firms, and with non-U.S. firms. Finally, the entry of specialized design firms into the U.S. semiconductor industry signaled the development of new approaches to the organization of the innovation process that involved greater reliance on specialization and arms-length arrangements. Although U.S. semiconductor firms' performance during the 1993-1997 pe- riod has been impressive, it has been aided in part by Japanese and South Korean semiconductor firms' failure to shift their product portfolios away from DRAMs to design-intensive components. The 1998 industry downturn caused by the con- tinued economic problems in Asia and excess capacity in DRAMs, may bring new competitors to semiconductor markets that have traditionally been domi- nated by U.S. producers. Indeed, some Taiwanese DRAM producers have re- cently entered product markets led by U.S. semiconductor firms, such as flash memory (Takahashi,1998~. Drawing on their experience in operating "foundry" production facilities, other Taiwanese firms now are able to switch from memory to advanced logic components, depending on market conditions. The flexibility gives them an advantage over South Korean and Japanese semiconductor firms and may foreshadow the development of a formidable competitor in the years to come. U.S. firms will be challenged by foreign firms for the foreseeable future, placing a premium on their ability to innovate and shift to profitable new activi- ties and products. CHANGING TECHNOLOGY STRATEGIES In this industry, like other U.S. high-technology industries, perhaps the great- est single change in the innovation process since 1980 has been the increased reliance by U.S. firms on collaborative strategies. Collaboration has been both "vertical," linking suppliers of equipment with semiconductor manufacturers, and "horizontal," linking semiconductor manufacturers with one another. Collabora- tion has also been both domestic and international; it has been supported by pub- lic and by private funds, and in a number of cases it has been associated with increased specialization by firms in different phases of the development and manufacturing process. A central reason for collaboration is the higher costs and risks of new prod- uct development and the spiraling costs of new production capacity. Electronic system suppliers are demanding specialized chips that incorporate more features and provide more functionality, but these semiconductor components require chip facilities that cost more than $1 billion per plant (see Table 4~. Many semicon- ductor firms have found it impossible to invest in new products or manufacturing capacity without some arrangements for risk-sharing.

268 TABLE 4 Fabrication Facility Production Costs U.S. INDUSTRYIN2000 YearCapital cost (million dollars) Linewidth (micron) Early 1970s$ 20 3.00 Early 1980s100 1.00 Early l990s300 0.70 Late l990s1,200 0.35 Late 2000s12,000 0.10 Sources: Cost Effective IC Manufacturing (1998-1999, 1997); National Technology Roadmap for Semiconductors: Technology Needs (1997). Producer Designer Collaboration One strategy to reduce financial risks that has been adopted by recent entrants into the U.S. semiconductor industry is specialization in design. By the late 1980s, the rapidly escalating costs of manufacturing facilities, along with burgeoning opportunities in less capital-intensive sectors for venture capitalists, had reduced the flow of venture-capital financing for new firms in semiconductor manufactur- ing. The declining opportunities for entry into semiconductor manufacturing, however, created other possibilities and financing for specialized design firms. These so-called "fabless" semiconductor firms design semiconductor components but rely on specialized "foundries" for the production of their designs. Access by fabless firms to foundry capacity was aided by the rise to domi- nance within the semiconductor industry of MOS manufacturing processes, which effectively standardized manufacturing technologies for commercial semiconduc- tor devices. The diffusion of MOS production technology facilitated the division of labor between device designers in fabless firms, who were able to operate within relatively stable rules and constraints, and foundries, who were able to incrementally improve their process technologies to accommodate a succession of new device designs. The fabless firm is largely a North American phenom- enon; more than 300 of the worldwide population of 500 fabless firms were lo- cated in North America in 1998.2° By contrast, most state-of-the-art foundries are located in Asia.2i 20The estimate of North American fabless firms was provided by the Fabless Semiconductor Asso- ciation (FSA) and Integrated Circuit Engineering (ICE) Inc. The estimate of the worldwide popula- tion of fabless firms was provided by the FSA through personal communication on August 1, 1998. 2iMajor "pure-play foundries" include TSMC and UMC (both Taiwan), Chartered Semiconductor (Singapore), and Tower Semiconductor (Israel). New pure-play foundries include Anam (a Korean startup) and WSMC (a Taiwanese startup). The prevalence of Southeast Asian pure-play foundries is subsiding as merchant semiconductor producers from all nations are converting older facilities or dedicating entirely new facilities to provide foundry services to this industry. IBM Microelectronics (U.S.), LG Semicon (Korea), Samsung (Korea), Winbond (Taiwan), and VLSI (U.S.) are notable examples.

SEMICONDUCTORS 269 Outsourcing of manufacturing is not new to the semiconductor industry; many producers of electronic systems have relied on third-party manufacturing of custom components for in-house designs. But the fabless business model in- volves outsourcing of production to specialized third parties and relies on skills that differ from those exploited by the traditional merchant semiconductor firms. Fabless firms concentrate on design R&D, utilizing design tools and architectures that must be compatible with the process requirements of the foundry in order for the designs to be manufacturable. The foundries that work with the fabless firms must be able to manage small production runs, support and modify their process technologies for a diversity of products, and provide short prototyping and good cycle times. Although the manufacturing capabilities of most advanced found- nes lag behind those of merchant semiconductor firms, this gap is expected to close in 1998 (see Figure 13~. Fabless firms serve a variety of fast-growing industnes, especially personal computers and telecommunications, and seek to dominate their markets by offer- ing more innovative designs and shorter delivery times than merchant firms. Constant-dollar industry revenues have grown at an average annual rate of 32 percent since 1991, almost twice the average for the global semiconductor indus- try as a whole (see Figure 14~. The fabless industry's trade association estimates 1997 fabless industry revenues at $7.8 billion (FSA, 1997), and Dataquest fore- casts fabless industry revenues will grow to $11.7 billion in 2000 and 40 percent of the world's chip production by 2010 (Semiconductor Business News, 1998~. 1 0.9 0 8 0 7 0 6 0 5 0.4 0.3 0.2 0 1 o Aug-87 Dec-88 May-90 Sep-91 Jan-93 | Industry Leading Technology I .\\\\ l Jun-94 Oct-95 Mar-97 Jul-98 Dec-99 Pure-Play Foundries FIGURE 13 Trends in process technology migration, 1987-1999. Source: FSA State of the Fabless Business Model (Sept. 1997), UBS.

270 20000 ~1 5000 Al -- 10000 us at u) a, ~ _ Q U.S. INDUSTRYIN2000 ---a Fabless ~ Overall ' 5000 O my/ _ _ I_ . 1 1 NJ cn _ ~ 1 1 1 1 mar ~1 1 rid co ~ cn cat ~ cn Year (1997-2000 Estimated) to g - 300000 at - 400000 a 0 1 00000 .o An - 200000 ~ - o - FIGURE 14 Fabless and total semiconductor revenue, 1991-2000E. Source: FSA State of the Fabless Business Model (Sept. 1997); ICE Status: A Report on the Inte- grated Circuit Industry, 1990-1998. International Collaboration U.S., Japanese, and European multinational manufacturers have increased offshore R&D spending since 1980 but all still perform the vast majority of firm- financed R&D in their home regions. Examples of departures from this pattern by U.S. firms are long-established, relatively small R&D organizations operated by TI in Bedford, England, by IBM in Zurich and Tokyo, by Motorola in Hong Kong, and by Intel in Israel. These U.S.-based firms seek access to overseas talent, better understanding of competition and of foreign market needs, and im- proved access to local and regional markets. Overall, however, there is no evi- dence of major growth in offshore R&D by U.S. semiconductor firms. During the past 20 years, several non-U.S. firms have established R&D fa- cilities in the United States and other developed nations outside their home re- gion.22 These foreign R&D investments are motivated by the same factors that drive U.S. offshore R&D investment, although many foreign firms are especially interested in tracking new semiconductor product and process developments in the U.S. market. This desire to monitor technological change also has led a num- ber of European and Japanese firms to support U.S. university research and edu- cation in the semiconductor field. Although U.S. semiconductor firms have not significantly expanded their foreign R&D operations, alliances among U.S. and non-U.S. semiconductor firms have grown rapidly since 1980. Many alliances focus on specific product or process development projects and often involve some exchange by U.S. firms of product technology for foreign, usually Japanese, expertise in process technol 22Philips, Siemens, NEC Hitachi, and Fujitsu are examples.

SEMICONDUCTORS 271 ogy. Such partnerships also facilitate access to international markets that are otherwise impeded by tariffs or political mechanisms. Manufacturing partner- ships are driven by the same considerations as R&D partnerships, along with the escalating costs of new production facilities. Many of these international col- laborative agreements focus on a single product area, such as nonvolatile memory or microprocessors, and many involve no U.S. partners. Coming from a "catch- up" position in semiconductor design and manufacturing technology, firms based in Taiwan, Korea, and Singapore have actively sought relationships with more advanced firms in Japan, Europe, and the United States. Domestic Collaboration International collaboration in the semiconductor industry has been paralleled by expanding domestic collaboration, some of which is supported with public funds. Japanese firms' growing domination of the global market for semiconductor memory chips in the late 1980s reflected concern within both the U.S. industry and the U.S. government over the future viability of an industry that supplied critical components for defense applications.23 This possibility led to an unusual initiative, spearheaded by the Defense Department, to strengthen U.S. semiconductor firms' commercial- device manufacturing capabilities.24 SEMATECH was formed in 1987 by 14 U.S. semiconductor manufacturing firms that together accounted for more than 80 per- cent of U.S. semiconductor manufacturing capacity25 and was financed jointly by member firms and the federal government.26 SEMATECH's defense-related fund- ing and sponsorship, along with broader political concerns, led to the decision to exclude non-U.S. firms from membership. In addition to paying dues totaling $100 million per year matched by $100 million from federal sources the member firms contributed roughly two-thirds of SEMATECH' s 300-member research staff through temporary, usually two-year, rotation of "assignees" at the consortium. Concur- rently with the foundation of SEMATECH, U.S. semiconductor materials and equip- ment (SME) suppliers formed SEMI/SEMATECH to facilitate linkages between U.S. SME suppliers and SEMATECH. SEMI/SEMATECH has more than 100 members who account for more than 85 percent of U.S. SME sales. 23This discussion of SEMATECH draws on Grindley et al. (1994). 24Concerned by the implications for national defense of U.S. dependence on foreign semiconduc- tors, the Defense Science Board (an advisory committee within the Department of Defense) devel- oped a competing proposal that recommended creation of a manufacturing facility jointly owned by government and industry to produce semiconductor components (McLoughlin, 1992). 25SEMATECH's founders included the following firms: Advanced Micro Devices, AT&T, Digital Equipment Corporation, Harris Corporation, Hewlett Packard Company, Intel Corporation, IBM, LSI Logic, Micron Technology, Motorola, National Semiconductor, NCR, Rockwell International, and Texas Instruments. Three of the founding members of SEMATECH (Harris Semiconductor, LSI Logic, and Micron) left the consortium in 1991. 26SEMATECH's federal funding ceased in 1996.

272 U.S. INDUSTRYIN2000 SEMATECH's original objectives improving member firms' semiconductor manufacturing process technology underpinned its decision to build a large-scale fabrication facility in Austin. But SEMATECH had difficulty developing a research agenda that could exploit this research facility and eventually altered its research agenda to one that sought to improve the technological capabilities of U.S. sup- pliers of semiconductor manufacturing equipment through "vertical" cooperation between U.S. suppliers and U.S. users of semiconductor process equipment (Katz and Ordover, 1990; U.S. Congressional Budget Office, 1990~. This research focus could benefit all members without threatening their proprietary capabilities. In the words of William Spencer, former SEMATECH CEO, "We can't develop specific products or processes. That's the job of the member companies. SEMATECH can enable members to cooperate or compete as they see fit" (Burrows, 1992~. In many respects, SEMATECH now resembles an industry association, dif- fusing information and best-practice techniques, setting standards, and coordinat- ing generic research. Like many Japanese cooperative research projects, SEMA- TECH is concerned as much with technology diffusion as with the advancement of the technological frontier. SEMATECH also has focused on medium-term, rather than long-term research, with the typical time horizon for R&D invest- ments targeted at three to five years. SEMATECH's formation and operations coincide with improvements in U.S. semiconductor manufacturing performance and increased market shares for U.S. semiconductor equipment suppliers. It is difficult if not impossible, however, to find direct cause-and-effect links between SEMATECH's activities and these developments. In the case of semiconductor manufacturing equipment, for ex- ample, a significant portion of the improved market share of U.S. suppliers re- flects the decline in Japanese manufacturing firms' capital investments, which has depressed the growth of equipment demand in a market that was long domi- nated by Japanese equipment firms. U.S. equipment producers have not increased their share of the Japanese market significantly during the 1990s but have ben- efited from the rapid growth in the South Korean and Taiwanese markets, which were far easier to penetrate. Nevertheless, SEMATECH member firms have con- tinued to support and participate in SEMATECH since the cessation of federal support, a strong signal that industry managers believe that the consortium has produced important benefits. Indeed, this continued support suggests that a smaller amount or shorter period of federal support might have sufficed to launch and sustain this consortium. Even if its specific contributions to improved industry performance cannot be isolated definitively, the survival and evolution of SEMATECH suggest some important lessons for future consortium design. Industry leadership in the design and establishment of the research agenda, joint industry and public funding, staff- ing the consortium by employees of member firms, flexibility and adaptiveness in the research agenda, and the consortium's focus on "vertical" rather than "hori- zontal" collaboration all have contributed to its success. At the same time, how

SEMICONDUCTORS 273 ever, the exclusion of non-U.S. firms from membership in the consortium did not prevent foreign firms from benefiting from its activities. Many member firms developed collaborative relationships with non-U.S. firms in related manufactur- ing areas, and the original restrictions on equipment firms' export of products embodying SEMATECH research results have been relaxed. Indeed, non-Japa- nese foreign firms now are active in a recent SEMATECH initiative that seeks to define equipment and performance standards for 300-mm wafer processing. Another collaborative research initiative that predates the formation of SEMATECH is the Semiconductor Research Corporation (SRC), supported by industry firms, the Defense Department, and more recently, by SEMATECH. The SRC supports university research in order to bolster an important portion of the U.S. research infrastructure, attract faculty and students to work on problems of relevance to industry, and attract high-quality students to seek employment opportunities in the U.S. semiconductor industry. State-level programs, such as the California MICRO program, pursue similar objectives through a combination of public and industry support. Finally, the Microelectronics Advanced Research Corporation (MARCO) is a new industry-financed collaborative research initia- tive that will support long-range, university research on silicon IC technology. The academic R&D focus of MARCO is intended to complement the efforts of the SRC and SEMATECH. Fabless semiconductor firms also are pursuing collaborative R&D in two consortia sponsored by FSA. The first is a 0.35-micron wafer level reliability project that seeks to standardize test structures and test methodologies and evalu- ate their usefulness. Dozens of fabless firms and foundries are participating in this endeavor. The second project, which involves five foundries, is developing a standard test chip that will improve manufacturing efficiency in 0.25-micron, five-level metal MOS processes and develop standards for process performance. Publicly and privately funded R&D collaboration has expanded significantly within the U.S. semiconductor industry since 1980. Domestic collaborative ven- tures focus primarily on near-term or mid-term R&D rather than joint manufac- turing or long-term basic research. Most ventures also are quite young, and their ultimate effects on U.S. industry performance are difficult to predict. In view of the limited experience of U.S. managers with such undertakings, both failures and successes are likely, and the essential point is to try to capture sufficient knowledge from each to improve performance. Collaboration is not a panacea, but it may offer some solutions to the competitive weaknesses associated with the fragmented industry structure cited by the M.I.T. Commission. Who Will Fund and Perform Basic Research? However useful, collaborative R&D in the U.S. semiconductor industry thus far has supported little long-term research. The large U.S. corporate laboratories of the 1950s and 1960s, most notably those of AT&T, GE, and IBM, performed

274 U.S. INDUSTRYIN2000 much of the fundamental research that underlies today's mainstream semicon- ductor technology. Those laboratories now focus on near-term corporate goals and applied research, and no U.S. organization has emerged to fund the basic research needed for the future. Federally funded R&D in the U.S. semiconductor industry, mostly in defense-related applications, has declined from nearly 25 per- cent of total R&D spending in the industry (imperfectly defined in this case as SIC 367, "electronic components") in 1980 to slightly less than 7 percent in 1992 (National Science Foundation, 1996~. Defense-related R&D funding is likely to continue to decline in the aftermath of the Cold War. Although the leading U.S. merchant semiconductor firms, such as Intel, TI, Micron, and AMD, spend 10-15 percent of revenues on R&D, the bulk of these expenditures focus on new product development. Intel has announced its intention to expand its long-term research program, but few other semiconductor manufac- turing firms conduct much R&D beyond development of next-generation products. None of the new leaders in digital communications maintains any internal semi- conductor R&D; instead they focus their efforts on product definition, system design, and marketing of their end products. These smaller firms rarely per- form much fundamental research, instead pursuing product development using sharply targeted technical teams stocked with Ph.D. engineers and scientists, cat- egories of professional staff rarely employed by such small firms in earlier times. By contrast, the major non-U.S. semiconductor manufacturers such as NEC, Hitachi, Toshiba, Philips, and Siemens still conduct considerable long-range R&D. These firms are integrated from materials and components to system-level products, and their varied internal customers for semiconductors allow them to extend the productive life of their semiconductor production facilities. Their other businesses produce generous cash flows that help to offset the heavy R&D and investment costs of the capital-intensive semiconductor business. Despite these apparent advantages over their smaller U.S. merchant and fabless competi- tors, these large, diversified foreign firms thus far have been relatively slow or ineffective in exploiting new opportunities for innovative products. Particularly in Japan, internal R&D has been applied to problems in manufacturing processes, and capital resources have enabled rapid capacity expansion for new generations of products that follow a well-established "trajectory" of technological develop- ment. Nevertheless, non-U.S. firms could re-emerge as formidable competitors in product lines in which the pace of product innovation has slowed or assumed a more incremental and capital-intensive character, as was the case in DRAMs during the 1980s. What institutional mechanisms for supporting long-term research exist within the U.S. economy? U.S. research universities, even if they should receive ex- panded research funding, can fill only part of the gap left behind by the down- sizing of U.S. corporate laboratories. Moreover, efforts by many U.S. research universities to expand their patenting of scientific advances in areas such as bio- technology that formerly were placed in the public domain could, if expanded

SEMICONDUCTORS 275 into research in electronics and software, restrict the dissemination of critical research results to industrial and other practitioners. The large network of public laboratories in the United States also may be of limited use for this purpose, as only Sandia Labs has contributed significantly to the recent advancement of semi- conductor technology. The reconfiguration of the semiconductor industry described above merits detailed study. More public support for research may be needed to ensure U.S. leadership in semiconductor technologies over the long term, but the political rationale and institutional vehicles for such an initiative are uncertain at present. Publicly funded research might rely on partnerships among industry, universities, and government, extending and elaborating recent experiments in collaboration discussed above (Rosenbloom and Spencer, 1996~. But any such arrangements would require change in the historical roles played by all three of the institutional partners in this industry. THE ROLE OF NON-TECHNOLOGICAL FACTORS IN U.S. SEMICONDUCTOR INDUSTRY'S REVIVAL Our discussion of the decline and revival of the U.S. semiconductor industry has emphasized technological factors, such as the improvements in U.S. firms' manufacturing performance and renewed emphasis on product innovation. But these factors cannot be considered in isolation from non-technological factors or the broader economic, institutional, and policy environment. Moreover, a central concern of the Board on Science, Technology, and Economic Policy project on which this book is based is the interaction between these non-technological or external influences and the competitive performance of U.S. industry. At least some of the factors associated with the industry's revival were facilitated by non- technological factors that were hardly exogenous. Indeed, the development by the U.S. semiconductor industry of an influential political voice in the SIA was partially responsible for some significant changes in U.S. government policy. Accordingly, this section considers the influence on the U.S. semiconductor industry's improved performance since 1980 of the environment for capital for- mation, the role of government antitrust policy and trade policy, and the changes in intellectual property protection. Our treatment is necessarily brief, and we conclude that non-technological factors have been helpful and necessary but are by no means sufficient in explaining the industry's revival since 1990. Capital Formation Any discussion of the cost and availability of capital in competitive perfor- mance within the semiconductor industry confronts a paradox. On the one hand, this issue is important in some segments of the industry, where the costs of a single commercial-scale production facility significantly exceed $1 billion. In

276 U.S. INDUSTRYIN2000 deed, we noted earlier that U.S. firms faced significant handicaps in the DRAM "capacity races" that developed in the early 1980s. On the other hand, capital expenditures by U.S. merchant semiconductor producers amounted to more than $14 billion in 1996 and $13 billion in 1997 (ICE Status, 1998~. Investments of this size suggest that constraints on the supply of capital to U.S. firms are scarcely binding. In addition, the recent competitive performance of the large firms active in both the Japanese and South Korean semiconductor industnes, especially those specializing in DRAMs, suggests that one can have too much of a good thing. Low-cost capital has been associated with ovennvestment in manufacturing ca- pacity for commodity products that yield low profits. Histoncally, the U.S. semiconductor industry has faced an abundant supply of venture capital (VC). VC funds have supported the foundation of literally hundreds of semiconductor firms since this industry's inception four decades ago. The data in Figure 15 suggest that this high "birthrate," which has contributed significantly to the industry's technological dynamism, shows few signs of de- clining. Especially interesting is the sharp upsurge in new-firm formation during 1983-1985, a period of severe industry recession. Excluding this penod, an aver- age of eight semiconductor startups appear annually (Figure 15~; the majority (70 percent) of these are fabless firms. The VC community has continued to support new fabless semiconductor endeavors, but has been less generous toward sem~- conductor ventures that include manufactunng. Although there are few reliable estimates of the nsk-adjusted cost of capital in the U.S., Japanese, South Korean, and other semiconductor industnes, U.S. firms may well face a higher cost of capital. Nevertheless, any such differential has not deterred the foundation of new U.S. firms, nor has it deterred large-scale capital investments by U.S. firms that have developed successful competitive strategies that rely on their strengths in product design and innovation. For estab- lishedU.S. semiconductor firms, competitive success appears to lead to abundant 25 20 ~ 15 E z 10 5 o 1980-82 1983-85 1986-88 Year FIGURE 15 U.S. semiconductor start-ups, 1980-1994. Source: FSA Fabless Forum (1995) V.2, n.1. 1 989-91 1 992-94

SEMICONDUCTORS 277 capital for investment in plant and equipment rather than vice versa. A higher cost of capital may contribute to the low level of investment in long-term, basic research by many U.S. semiconductor firms. Nevertheless, given the competitive realities of this industry, especially the short product cycles and high costs of R&D for maintaining near-term competitiveness, the risk-adjusted cost of capital would have to be very low indeed to produce higher levels of such investment. Trade Policy Among the several government initiatives emerging from the semiconductor industry's turmoil of the 1980s was a sector-specific trade agreement, the effects of which continue to be debated. The Semiconductor Trade Agreement of 1986 responded to accusations by U.S. firms that Japanese DRAM producers were "dumping" their products in the U.S. market.27 By preventing the imposition of heavy antidumping duties on U.S. imports of DRAMs, the agreement sought to avoid a policy that would drive up the domestic prices of components that were essential to U.S. manufacturers of electronic systems, creating strong incentives for them to shift production to foreign locations. A system of "fair market value" prices for DRAMs was created under the terms of the agreement that was in- tended to prevent dumping in the U.S. and third-country markets. The agreement also included an "understanding" that foreign-sourced components would achieve a 20 percent share of the Japanese domestic market within five years. An exten- sion of the agreement in 1991 retained the market share language but dropped the price-monitoring system. Although the agreement was negotiated in response to the competitive crisis facing U.S. producers of DRAMs, its effects on these firms' activities in DRAM production were limited. Most of the major U.S. DRAM producers had exited from this product line by 1985, well before the agreement was finalized.28 The agreement' s price floors and the associated implementation by MITI of controls on production and capacity investment by Japanese DRAM producers, however, had several interesting effects, few of which directly benefited U.S. semiconduc- tor manufacturers or were foreseen in 1986.29 Higher prices for DRAMs pro 27Flamm (1996) provides the most objective account of the agreement, and these paragraphs draw on his analysis. 28The agreement's "price floor" nevertheless may have aided the remaining U.S. domestic producer of DRAMs, Micron Corporation. 29The period following the agreement was also associated with severe shortages of 256K DRAMs, then a vital component of personal computer and other electronic systems. U.S. computer producers, among others, blamed the agreement and the informal, MITI-guided domestic production cartel that oversaw the agreement's implementation within Japan for the shortages. Concern over DRAM short- ages and the alleged Japanese cartelization of the DRAM market (a condition to which U.S. policy, in the form of the bilateral trade agreement, arguably had contributed) led to the proposal by a group of U.S. computer manufacturers to jointly fund the creation of a DRAM manufacturing consortium, U.S. Memories. As supplies of DRAMs became more abundant, this proposal was abandoned in early 1990.

278 U.S. INDUSTRYIN2000 vided an opportunity for South Korean firms to expand their production of these devices, sowing the seeds for more intense competition in this product line in the future. Flamm (1996) argues that similar restrictions on production of electroni- cally programmable memory chips (EPROMs) reduced Japanese exports of these devices and enabled U.S. producers of EPROMs to remain in this product line. Although the Semiconductor Trade Agreement may have provided some ben- efits to U.S. EPROM producers, the effects of its pricing provisions seem to have had little effect on the overall U.S. industry. These provisions did not attract U.S. manufacturers back into DRAM production and imposed heavy short-term costs on major U.S. consumers of DRAMs. The market-share provisions of the 1986 and 1991 agreements, however, were eventually followed by a significant in- crease in U.S. semiconductor manufacturers' market share in Japan, and the agreement is viewed as a key factor in expanded Japanese imports of foreign components. In 1992, the foreign share of Japan's domestic consumption of semiconductor components increased beyond 20 percent, and recent data suggest that this share now is at roughly 25 percent (SIA Annual Databook, 1997~. Ac- cording to Flamm (1996), this increase cannot be attributed solely to growth in Japanese consumption of devices (such as microprocessors) in which U.S. firms have a strong competitive advantage but includes significant growth in other prod- uct areas. In other words, U.S. producers increased their Japanese market share in products where they historically had been relatively weak. The agreement's market-share provisions thus contributed to the revival of U.S. semiconductor firms after 1990, but the timing of this revival is such that the lack of such an import target would not have prevented the U.S. industry's recovery, which was well under way by 1990. Antitrust Policy U.S. antitrust policy played an important role in the earliest years of the semiconductor industry, as Bell Laboratories' liberal licensing of the original transistor and related patents was motivated in part by concern over the outcome of the federal government's antitrust suit against the firm that was settled in 1956. The 1956 settlement also led AT&T to manufacture semiconductor devices solely for internal consumption rather than entering the commercial market. These early actions by the technological pioneer in semiconductors powerfully influenced the subsequent development of the U.S. semiconductor industry. The competitive crises of the semiconductor and other U.S. industries con- tributed to a far-reaching shift in U.S. antitrust statutes and enforcement policy in the 1980s. U.S. antitrust policy was widely criticized in the late 1970s for dis- couraging R&D collaboration. The U.S. Justice Department issued guidelines in 1980 that were intended to clarify the antitrust statutes and the Department's enforcement philosophy toward R&D collaboration, in order to remove impedi- ments to such collaborative undertakings. Nevertheless, continuing industry and

SEMICONDUCTORS 279 Congressional dissatisfaction resulted in the 1984 passage of the National Coop- erative Research Act (NCRA). The NCRA has been credited with facilitating the formation of SEMATECH, among other industry-wide collaborations, and R&D collaboration appears to have aided the revival of the U.S. semiconductor indus- try. The act was amended in 1993 to extend its coverage to joint production ventures. An evaluation of the "real" effects of the NCRA and the broader shift in antitrust enforcement policy on the U.S. semiconductor industry's decline and revival is difficult without some clearer specification of the counterfactual situa- tion. Would SEMATECH have been formed without the NCRA? Has R&D collaboration contributed to increased market power and/or poorer industry per- formance? Given the size of the firms that joined together to create SEMATECH and the sustained acquaintance of several of them with the federal antitrust au- thorities, the legislative endorsement of R&D collaboration under the terms of the NCRA almost certainly did aid in the creation of this consortium. The semi- conductor industry's performance suggests that R&D collaboration need not re- sult in cartelization and a weakening of competitive forces, although the large share of the U.S. semiconductor equipment market represented by SEMATECH member firms means that this consortium's vertical relationships deserve contin- ued monitoring. Indeed, collaboration may provide one mechanism for combin- ing the benefits of the U.S. industry's atomized structure and technological dyna- mism with those flowing from closer user-supplier relationships. Nevertheless, very few production joint ventures have been formed since the passage of the 1993 amendments to the NCRA, suggesting that this policy shift thus far has had little effect. Intellectual Property Rights Since 1980, the U.S. semiconductor industry has experienced considerable change in another important aspect of the public policy environment, intellectual property rights. Shifts in U.S. policy toward intellectual property rights began with the 1982 legislation that established the Court of Appeals for the Federal Circuit (CAFC), which strengthened the protection granted to patent holders.30 The U.S. government also pursued stronger international protection for intellec- tual property rights in the Uruguay Round trade negotiations and in bilateral ven- ues. These shifts in federal policy toward intellectual property rights involved both stronger international and domestic enforcement and a somewhat more fa- vorable attitude in the judiciary and antitrust enforcement agencies toward patent 30According to Katz and Ordover (1990), at least 14 Congressional bills passed during the 1980s focused on strengthening domestic and international protection for intellectual property rights. The Court of Appeals for the Federal Circuit created in 1982 has upheld patent rights in roughly 80 percent of the cases argued before it, a considerable increase from the pre-1982 rate of 30 percent for the Federal bench.

280 U.S. INDUSTRYIN2000 holder rights. The shift was particularly significant for the U.S. semiconductor industry, because of the relatively limited economic role historically occupied by formal instruments of intellectual property protection such as patents. As we noted in our summary of the industry's development, the unusual circumstances of the industry's founding years, especially the extensive cross-licensing by Bell Labs and the Defense Department' s requirements for "second-sourcing" of many devices, meant that knowledge flowed relatively freely among firms in the indus- try. Interfirm knowledge flows were further enhanced by high levels of labor mobility, by reverse engineering by firms of one another's chip designs, and by diffusion of advances in process technology through equipment suppliers. In addition to these shifts in federal policy affecting all U.S. industries, the semiconductor industry was the beneficiary of a law designed to strengthen pro- tection of industry-specific intellectual property. The Semiconductor Chip Pro- tection Act (SCPA) of 1984 established protection for the design or "mask work" used in semiconductor manufacturing (Stern, 1986~.3i Passage of the S CPA es- tablished a new form of semiconductor intellectual property a "chip design right," best described as a sui generis mode of protection that combines elements of patent and copyright principles with elements of trade secret law (Brown, 1990~. The SCPA extends protection from copying to the three-dimensional images or patterns formed on or in the layers of the semiconductor component that is, the "topography" of the chip and provides for a reverse engineering clause whereby a competitor may reproduce a mask work for the purpose of analyzing it.32 Although it is an interesting experiment in sui generis protection of new forms of intellectual property, the SCPA's economic significance appears to be limited. Only one case has ever been litigated under its provisions.33 The SCPA's unanticipated insignificance appears to be one result of the increasing complexity of manufacturing process technologies in the semiconductor industry. Copies of a device design and mask work are necessary but by no means sufficient to enable large-scale production of infringing products (Kasch, 1993~. As a result, semi- conductor firms during the 1980s and 1990s continue to rely on trade secrets and patents, the value of which has increased as a result of the policy shifts noted above.34 3iMask works represent the three-dimensional pattern of the layers (the topography) of a semicon- ductor component. 32Mask works may be reproduced for the purpose of teaching, analyzing, or evaluating the concepts or techniques embodied in the circuitry, logic flow, or organization of components. Legitimate re- verse engineering may incorporate the results without infringement into another mask work to be produced and distributed. 33This case, Brooktree Corporation v. Advanced Micro Devices, resulted in the award of $26 mil- lion in damages for AMD's infringement under the SCPA and several patents. 34The registration of mask works under the SCPA provisions has advantages over patent filings, which require the disclosure of proprietary information and a time-consuming search through prior art to assert validity. Mask work filing provides immediate registration at minimal cost without a time- consuming search.

SEMICONDUCTORS 281 The SCPA nevertheless may play an important, albeit unintended, economic role in the fabless segment of the U.S. semiconductor industry. In order to main- tain short design cycles, fabless firms must extensively reuse design data, "port- ing" designs from one product to another, or contracting with another firm for all or some part of the design. Reusable design components are generally referred to as "intellectual property (IP) blocks," and protection for these IF blocks under the S CPA facilitates the licensing process. The growth of licensing of IF blocks has supported further specialization by some design firms in specific components of overall device designs. These "virtual companies" operate by licensing their pro- prietary designs and architecture to other semiconductor design firms that pro- duce an integrated design, contract with a foundry, and, in many cases, market the final product. The broader shift of federal policy toward stronger enforcement of patent holder rights has been associated with a dramatic increase in patenting and licens- ing among integrated semiconductor manufacturers in the U.S. industry.35 Li- censing has become an important component of profits for some leading manu- facturers. The royalty income of Texas Instruments has grown from roughly $200 million in 1987 to more than $600 million in 1995 (Grindley and Teece, 1997~. Other firms, such as Intel, IBM and AT&T, now rely on licensing to generate revenues and protect product and process technologies. The historic strengths of U.S. firms in product design and rapid innovation should be reinforced by stronger enforcement of patents and trade secrets. The distribution of these benefits within the industry, however, is less clear. Stronger intellectual property protection appears to have benefited established firms. Intel's strong position in its microprocessor product line relies in large part on the firm's intellectual property rights. Another historic strength of the U.S. industry, however, is the ease with which new firms can enter. The effects of stronger intellectual property rights on rates of new-firm formation and entry are less clear. On the one hand, new firms with strong patent positions often find it much easier to attract financing. On the other hand, the costs, in terms of litigation and patent prosecution expenses, of establishing such a patent position are very high. The empirical evidence on the social benefits from stronger intellectual property pro- tection is thin and equivocal. Certainly, the increased litigiousness of established U.S. semiconductor firms has attracted criticism from other U.S. semiconductor producers. In the semiconductor industry, as in others, the U.S. is conducting an experiment in the effects of stronger intellectual property protection, and the im- plications of these new policies for long-term industry performance are surpris- ingly uncertain. 35The number of patents granted in the category "Semiconductor Devices and Manufacture" in- creased from 1655 in 1981 to 5427 in 1994 (U.S. Department of Commerce: Patent & Trademark Office, 1995).

282 U.S. INDUSTRYIN2000 CONCLUSION Forecasts of the impending demise of the U.S. semiconductor industry in the late 1980s were considerably overstated. After declining through much of the 1980s, U.S. semiconductor firms undertook corrective actions on several fronts. They exited from product lines in which their historic skills at product innovation provided limited competitive advantage and their foreign competitors' superior access to capital made long-term competition difficult. U.S. firms also improved their product quality and appear to have enhanced their manufacturing perfor- mance, narrowing the gaps between them and foreign competitors, rather than moving ahead. The results of these steps have been dramatic. The U.S. semicon- ductor industry has regained its formerly dominant global market share, and the financial performance of U.S. semiconductor manufacturers now outstrips that of their South Korean and Japanese competitors. Moreover, the revival of the U.S. semiconductor manufacturing industry has reinvigorated the U.S. semiconductor equipment industry. Simultaneously, the South Korean and Japanese firms that specialize in the production of DRAMs are experiencing serious financial losses. In many respects, the revival of the U.S. semiconductor industry relied on the elements of its structure that were the target of criticism in the 1989 report of the M.I.T. Commission on Industrial Productivity. The structure of the U.S. semiconductor manufacturing industry remains very different from that of the Western European or Japanese industries, although the structure of the emergent Taiwanese semiconductor industry is based on the U.S. model and still bears a passing resemblance to it. Populated by numerous, comparatively small, highly innovative firms, and exposed to competition by new entrants pursuing new prod- uct opportunities and new approaches to the semiconductor business, the U.S. industry remains adept at product innovation and rapid strategic repositioning. In addition, U.S. firms have relied on collaboration among semiconductor manufac- turers, and between manufacturing firms and suppliers of equipment, to improve their manufacturing performance. The links between the collaborative initiatives of the 1980s and 1990s and the industry's improved performance remain elusive, however, and further research on these issues is essential if the current strengths of U.S. manufacturers and equipment producers are to be maintained. Although the M.I.T. Commission's overall prognosis of the industry's future prospects was inaccurate, its analysis of the U.S. industry's weaknesses in manu- facturing and long-term R&D investment highlighted other issues that could lead to future competitive difficulties. The very best U.S. semiconductor manufactur- ers appear to be capable of matching the yield and productivity of the best non- U.S. producers, but there is little evidence of consistently superior U.S. manufac- turing performance. As a result, U.S. firms are likely to do best in periods of rapid innovation, especially because of their ability to exploit their presence in one of the world's most dynamic markets for applications of new products that use semiconductor components. But U.S. firms may have trouble competing on

SEMICONDUCTORS 283 the basis of their manufacturing skills alone and therefore are likely to face chal- lenges in future periods where they and foreign competitors are pursuing incre- mental innovations within a well-defined technological "trajectory." The U.S. industry is enormously effective in exploiting scientific advances for rapid com- mercialization but may underinvest in the basic research supporting these ad- vances. This is a serious issue for debate, although the recent performance of the much larger Western European and Japanese firms in this industry that have made such investments suggests that simply creating large, diversified firms is an inef- fective solution to this problem. From its very inception, the U.S. semiconductor industry has had close rela- tionships with federal government agencies in charge of R&D and procurement programs. Like other post-war U.S. high-technology industries, the U.S. semi- conductor industry benefited from large-scale investments in defense-related R&D in both industry and academia as well as the procurement programs of federal military and space programs in the 1950s and 1960s. Federal policies in other areas, such as antitrust and trade policy, also have affected this industry throughout its history. But during the 1980s, apart from steel and automobiles, the semiconductor industry was almost without peer in the attention devoted to its welfare and competitive prospects by federal policymakers. The record and legacy of federal intervention in this industry during the 1980s has been criticized by many observers. Nevertheless, one of the most remarkable features of federal policy in semiconductors was the rejection of some alterna- tives that almost certainly would have been far worse for the industry's competi- tive prospects. For example, consider the costs and consequences of a public- private venture like U.S. Memories, specializing in DRAMs, during the l990s. Policymakers and industry managers might well have faced some very unpleas- ant choices between erecting trade barriers against competing imports or allow- ing this venture to slide into insolvency. The proposal of the National Advisory Commission on Semiconductors for a government-backed Consumer Electronics Capital Corporation, which would have been charged with financing the revival of a U.S. industry to consume the products of the domestic semiconductor indus- try, experienced an even more rapid and fortuitous demise. In hindsight, the avoidance by federal policymakers in the Executive and Congressional branches of government of programs that would involve the support with public funds of specific designs of commercial products was wise and consistent with well-estab- lished principles of technology policy. The revival of the U.S. semiconductor industry is an impressive feat, for which government policymakers and industry managers, engineers, and research- ers should share in the credit. But the unexpected nature of this revival, its rather complex causes, the contributions to it of cyclical factors, and the fragility of its foundation all suggest that competitive strength in this industry cannot be taken for granted. Indeed, some foreign producers, notably Taiwanese semiconductor firms, now are entering markets traditionally dominated by U.S. producers, a

284 U.S. INDUSTRYIN2000 development that will intensify pressure on U.S. firms and increase the impor- tance of manufacturing performance for competitive leadership. In other words, U.S. semiconductor firms must maintain their strategic agility and strength in product innovation while avoiding significant erosion in their manufacturing ca- pabilities in order to maintain their strength. This task will require imagination and collaboration among government, industry, and academia. REFERENCES Appleyard, M.M., N. Hatch, and D.C. Mowery. "Managing New Process Introduction in the Sem conductor Industry," forthcoming in Corporate Capabilities and Competitiveness, G. Dosi, R. Nelson, and S. Winter, eds. London: Pinter. Barron, C.A. (1980). "Microelectronics Survey: All That Is Electronic Does Not Glitter," Economist 1 March. Braun, E., and S. MacDonald. (1978). Revolution in Miniature: The History and Impact of Semicon ductor Electronics, Cambridge: Cambridge University Press. Brown, H. (1990). "Fear and Loathing of the Paper Trail: Originality in Products of Reverse Engi- neering Under the Semiconductor Chip Protection Act as Analogized to the Fair Use of Nonfic- tion Literary Works," Syracuse Law Review. Burrows, P. (1992). "Bill Spencer Struggles to reform SEMATECH," Electronic Business May 18. Cole, R.C. Managing Quality Fads: How American Business Learned to Play the Quality Game, New York: Oxford University Press, forthcoming. Erickson, K., and A. Kanagal. (1992). "Partnering for Total Quality," Quality, Sept. Fabless Semiconductor Association. (1997). "State of the Fabless Business Model," mimeo, Septem ber. Finan, W. (1993). "Matching Japan in Quality: How the Leading U.S. Semiconductor Firms Caught Up With the Best in Japan," M.I.T.-Japan Working Paper. Flamm, K. (1996). Mismanaged Trade? Strategic Policy and the Semiconductor Industry. Washing- ton, DC: Brookings Institution. Florida, R., and M. Kenney. (1990). "Silicon Valley and Route 128 Won't Save Us," California Management Review 33(1). Grindley, P., D.C. Mowery, and B. Silverman. (1994). "SEMATECH and Collaborative Research: Lessons in the Design of High-Technology Consortia," Journal of Policy Analysis and Manage ment. Grindley, P., and D.J. Teece. (1997). "Managing Intellectual Capital: Licensing and Cross-Licensing in Semiconductors and Electronics," California Management Review. Hatch, N.W., and D.C. Mowery. (1998). "Process Innovation and Learning by Doing in Semiconduc- tor Manufacturing," Management Science, forthcoming. Integrated Circuit Engineering Corporation (ICE). (1987, 1988, 1990-1998). "ASIC Outlook: An Application Specific IC Report and Directory," Integrated Circuit Engineering. Integrated Circuit Engineering Corporation (ICE). (1997). "Cost Effective IC Manufacturing 1998- 1999," Integrated Circuit Engineering. Integrated Circuit Engineering Corporation (ICE). (1997). "Memory 1997," Integrated Circuit Engi- neer~ng. Integrated Circuit Engineering Corporation (ICE). (1998). "Memory 1998," Integrated Circuit Engi- neer~ng. Integrated Circuit Engineering Corporation (ICE). (1997). "Microprocessor Outlook 1997," Integrated Circuit Engineering. Integrated Circuit Engineering Corporation (ICE). (1998). "Microprocessor Outlook 1998," Integrated Circuit Engineering.

SEMICONDUCTORS 285 Integrated Circuit Engineering Corporation (ICE). (1976-1998). "Status: A Report on the Integrated Circuit Industry," Integrated Circuit Engineering. Kasch, S. (1993). "The Semiconductor Chip Protection Act: Past, Present and Future," High Technol- ogy Law Journal. Katz, M.L., and J.A. Ordover. (1990). "R&D Cooperation and Competition," Brookings Papers on Economic Activity, Washington, DC: The Brookings Institution. Langlois, R., and W.E. Steinmueller. (1998). "The Evolution of Competitive Advantage in the Global Semiconductor Industry: 1947-1996" in The Sources of Industrial Leadership, D.C. Mowery and R.R. Nelson, eds. New York: Cambridge University Press. Leachman, R., and C. Leachman. (1997). "National Performance in Semiconductor Manufacturing," University of California, Berkeley Competitive Semiconductor Research Program working pa- per (CSM-40). McLoughlin, G.J. (1992). "SEMATECH: Issues in Evaluation and Assessment," Congressional Re- search Service. Science Policy Research Division, #92-749SPR. Washington, DC. M.I.T. Commission on Industrial Productivity. (1989). Working Papers of the Commission on Indus- trial Productivity, Cambridge: M.I.T. Press, two volumes. Methe, D.T. (1991). Technological Competition in Global Industries: Marketing and Planning Strat- egies for American Industry, Westport, Conn.: Quorum Books. National Science Foundation. (1996). National Patterns of R&D Resources, Washington, DC: Na- tional Science Foundation. Rosenbloom, R.S., and W.J. Spencer (1996). "The Transformation of Industrial Research," Issues in Science and Technology 12(3):68-74. Semiconductor Business News. (1998). "Foundries may Build 40 percent of World's Chips by 2010." Semiconductor Industry Association. (1997). "1997 Annual Databook". Semiconductor Industry Association. (1992). "SIA Quarterly Quality Survey." Semiconductor Industry Association. (1997). "The National Technology Roadmap for Semiconduc- tors: Technology Needs," SEMATECH, Inc. Stern, R. (1986). Semiconductor Chip Protection, New York: Law & Business. Takahashi, D. (1998). "Chip Makers Enter Slump; Sales Fall 13 percent," Wall Street Journal July 6. Tilton, J. (1971). International Diffusion of Technology. The Case of Semiconductors, Brookings Institution: Washington, DC. U.S. Congressional Budget Office. (1990). "SEMATECH's Efforts to Strengthen the U.S. Semicon- ductor Industry," Washington, DC. U.S. Department of Commerce: Patent & Trademark Office. (1995). "Technology Profile Report: Semiconductor Devices and Manufacture: 1/1969-12/1994," February. U.S. General Accounting Office. (1992). "Federal Research: SEMATECH's Technological Progress and Proposed R&D Program," July. VLSI Research. (1998). "Semiconductor Equipment Consumption and Production by Region," m~meo.

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U.S. industry faced a gloomy outlook in the late 1980s. Then, industrial performance improved dramatically through the 1990s and appears pervasively brighter today. A look at any group of industries, however, reveals important differences in the factors behind the resurgence--in industry structure and strategy, research performance, and location of activities--as well as similarities in the national policy environment, impact of information technology, and other factors.

U.S. Industry in 2000 examines eleven key manufacturing and service industries and explores how they arrived at the present and what they face in the future. It assesses changing practices in research and innovation, technology adoption, and international operations.

Industry analyses shed light on how science and technology are applied in the marketplace, how workers fare as jobs require greater knowledge, and how U.S. firms responded to their chief competitors in Europe and Asia. The book will be important to a wide range of readers with a stake in U.S. industrial performance: corporate executives, investors, labor representatives, faculty and students in business and economics, and public policymakers.

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