System houses remain weak link for silicon foundries

System house demand has remained a very small portion of the total foundry demand. System houses are OEM manufacturers that may or may not have their own semiconductor manufacturing facility. They utilize foundry services to manufacture the system house product designs.

Four years ago Semico believed that system house demand would grow as a proportion of total foundry demand due to the design services and other intellectual property offerings that large dedicated foundries began offering. System house demand has not grown. In fact, it has declined over the past few years.

Semico believes there are several reasons for the weak growth in direct foundry sales to system houses. One reason is the downturn in the overall industry and in particular the communications market. Companies such as Cisco, Ericsson, and Sun Microsystems are companies with strong semiconductor design teams but when their markets declined in 2001, there was very little need to contract directly with foundries.

More importantly, today it has become extremely difficult to successfully transition advanced designs into manufacturing without a significant amount of process tweaking, re-design and coordination between process and design groups. There is a fine line between who is really designing the chips.

In April 2004, TSMC announced an agreement with Microsoft Corp. to provide manufacturing services for Microsoft's future Xbox semiconductor chips. TSMC has been a key foundry manufacturer for Nvidia, VIA and other chip suppliers to the video game console and computer market.

Although this relationship appears to be a System house contracting directly with a foundry supplier, Semico believes this is a coordinated effort to get semiconductor companies designed to Microsoft's specifications on TSMC's process.

So what chips will be manufactured in Taiwan? IBM and Microsoft announced that the PowerPC will be the host processor designed into the Xbox II. That product will be manufactured by IBM or possibly by Chartered Semiconductor, through IBM's relationship with Chartered. Semico speculates that the area still being scoped include the graphics chip and chipset and possibly the communications interface for access to the world of the Internet.

The digital home arena is definitely a focus of most industry players as the consumer buyer continues to be the market with huge potential growth.

What are the implications for the foundry market and the industry overall? Of course this is a win for TSMC. The partnership with Microsoft, does not necessarily mean that Microsoft is working directly through TSMC and eliminating the 'middleman'. Microsoft will continue their relationships with semiconductor chip vendors such as Nvidia or ATI or whoever has the best graphics solution for that video game player.

The icing on the cake is that TSMC will get better planning information. TSMC is partnering with a company higher up the food chain. TSMC could potentially get a direct link into Microsoft's expectations for production units or at least has more exposure to which semiconductor vendor may or may not get the Microsoft order.

Semico believes that this signals a more concerted effort on the part of the major foundry suppliers to get a better handle on the wafer demand situation. This helps replace the planning techniques that were flawed by double bookings due to a multiple number of chip suppliers all believing they would get 40%+ of the market.

Maybe one of these days, our industry will find a way to better plan for the swings in capacity needs. TSMC's and other foundries' attempt to collaborate with system houses, is a step in the right direction.