Unbridled Outsourcing Breeds Supply Insecurity

At the corporate level, the disruption to manufacturing worldwide caused by the Japan earthquake and tsunami on March 11 will force a rethink of how companies manage their production in the food chain, and especially in chip manufacturing.

What if a force-9 earthquake and tsunami hit Taiwan? The 60 percent combined share Taiwan Semiconductor Manufacturing Co. (TSMC) (NYSE: TSM) and United Microelectronics Corp. (UMC) (NYSE: UMC) have in the foundry business would affect every IC firm. It would be akin to Mitsubishi Gas Chemical's and Hitachi Chemical's joint 90 percent control of the specialty resin market.

GlobalFoundries Inc. and Samsung Electronics Co. Ltd. (Korea: SEC) are in no way capable of taking up the slack in the foundry market if a major disruption occurs at TSMC and UMC. Both companies are fully utilized, meaning they would need new factories, and a minimum of two years, until the start of new production (one year, in the case of Global Foundries, given its current expansion plans). The process differences, the minimum one-year delay to redesign the ICs and generate new mask sets, and other management/operational issues will further complicate the situation.

The Memory IC market is not as susceptible. Firstly, Korea has a lower overall earthquake risk, and secondly, the fallout risks are minimal. You can always get by with less DRAM or FLASH memory. Think back to the mid-1980s, when DRAM prices went vertical for three years in a row -- Microsoft just rewrote Windows to use less memory.

Of course, outsourcing can be beneficial, just as borrowing money can be, but it needs to be prudent and measured -- it's not the be-all and end-all it's made out to be. Too many firms have been seduced into believing outsourcing would make them more competitive, and they've bet their futures on it. Problems related to supply security do not go away with outsourcing; they actually get worse.

Unlike integrated device manufacturers, the top fabless companies (Broadcom, Qualcomm, and Xilinx), along with a few OEMs like Apple, understand the security risks associated with not having their own manufacturing facilities. These companies, too, may have underestimated the extent to which a fabless operation could be problematic.