Fabless firms face formidable competition

Although fabless semi companies are making waves in the internetwork equipment arena, it's not as if the big traditional semiconductor companies are standing still. In fact, the conventional wisdom says the larger players should be able to win on cost because they manufacture their own chips, although they tend to be less nimble than the small design firms.

But fabless companies claim they can compete on cost as well.

"Silicon manufacturing used to be a competitive advantage," says Tim Lindenfelser, vice president of marketing at fabless semi firm Broadcom Corp. "But now we can get wafers at the same price" as semiconductor companies with their own foundries.

James Hines, a semiconductor analyst with Dataquest, Inc., in San Jose, Calif., says the average price fabless companies pay for chips dropped 40% last year on top of a 25% cut in 1996. "We've seen some pretty stunning declines," Hines says, referring to prices for top-of-the-line fabrication technology. There have also been less dramatic price cuts at older foundries. Hines says the price of fabricating chips should slip another 5% to 10% before stabilizing in 1999.

But Diane Myers, a senior analyst with In-Stat, a semiconductor market research firm in Scottsdale, Ariz., says she wouldn't count out Lucent Technologies, Inc., Texas Instruments, Inc. and other firms with foundries. TI, for instance, has shipped enough ThunderSWITCH chips to support 1 million Ethernet ports.

Lucent likewise recognizes the opportunity that network-specific chips represent. President and CEO Richard McGinn, when asked to say what two or three technologies are most important to Lucent long-term, responded: "So much value is going to silicon and software for networks that sometimes I almost think of them as similar areas. So certainly communications-based microelectronics and semiconductors is a big one for us."

Equipment vendors also worry about how reliable the small fabless companies will be when it comes to shipping chips. 3Com Corp., for example, always tries to find a second source for the chips or develops its own backup design in-house, said Robert Ciampa, the company's product technology manager.

Fabless companies try to cover the supply base by lining up multiple foundries to churn out their chips. MMC Networks, Inc., for example, relies on Oki Semiconductor and NEC Corp. in Japan, Motorola, Inc. in the U.S. and Taiwan Semiconductor Manufacturing Co. in Taiwan, which is the foundry of choice for most of the fabless firms. MMC admits it has had supply problems in the past as foundries juggle demand from multiple customers.

Hines says there is now plenty of extra capacity at foundries around the world for independent start-ups to tap into. Indeed, the Fabless Semiconductor Association lists 140 semiconductor fabricators worldwide. Clark Westmont, an analyst with NationsBanc Montgomery Securities LLC, agrees the risk is "pretty low" that a fabless firm would be unable to find fabricator capacity somewhere.