Can lean innovation bring growth and profits back to semiconductors? New approaches to start-ups can unlock mega-trend opportunities. BY MIKE NOONEN, Silicon Catalyst, San Jose, CA; SCOTT JONES and NORD SAMUELSON, AlixPartners, San Francisco, CA The semiconductor industry returned growth and reached record revenues in 2013, breaking $300 billion for the first time after the industry had contracted in 2011 and 2012 (FIGURE 1). FIGURE 1. Worldwide semiconductor revenue. Source: World Semiconductor Trade Statistics, February 2014. However, even with that return to growth, underlying trends in the semiconductor industry are disturbing: The semiconductor cycle continues its gyrations, but overall growth is slowing. And despite 5% year-on-year revenue growth in 2013 (the highest since 2010), the expectation is that semiconductor growth will likely continue to be at a rate below its long-term trend of 8 to 10% for the next three to five years (FIGURE 2). An AlixPartners 2014 publication , Cashing In with Chips, showed that semiconductor industry growth had slowed to roughly half of its long-term growth average since the 2010 recovery—with no expectation that it will return to historical growth until at least 2017. Other studies have also shownthat semiconductor growth has slowed not only relative to its previous performance but also versus growth in other industries. And a study conducted by New York University’s Stern School of Business found that the semiconductor industry’s revenue growth lagged the average revenue growth of all industries and ranked 60th out of 94 industries surveyed. Surprisingly, the industry’s net income growth of semiconductor companies lagged even further behind—ranking 84th out of 94 companies surveyed—and had actually been negative during the previous five years. FIGURE 2. Semiconductor revenue growth. Sources: Semiconductor Industry Association and AlixPartners research. In another study released by AlixPartners that looked at a broader picture of the semiconductor value chain, including areas such as equipment suppliers and packaging and test companies, the research showed that outside of the top 5 companies, the remainder of the 186 companies surveyed had declining earnings before interest, taxes, depreciation, and amortization (FIGURE 3). FIGURE 3. Spotlight on the top five (fiscal year 2012). Source: AlixPartners Research. As revenue growth slows, costs increase at a rapid rate As semiconductor technology advances, the cost of developing a system on chip (SoC) has risen dramatically for leading-edge process technologies. Semico Research has estimated that the total cost of an SoC development, design, intellectual property (IP) procurement, software, testing has tripled from 40/45 nanometers (nm) to 20 nm and could exceed $250 million for future 10-nm designs(FIGURE 4) . This does not bode well for an economic progression of Moore’s law, and it means that very few applications will have the volume and pricing power to afford such outlandish investment. If we assume that a 28nm SoC can achieve a 20% market share and 50% gross margins, the end market would have to be worth over $1 billion to recoup R&D costs of $100 million. By 10 nm, end markets would have to result in more than $2.5 billion to recoup projected development costs. With few end markets capable of supporting that high a level of development costs, the number of companies willing to invest in SoCs on the leading edge will likely decline significantly each generation. FIGURE 4. Development Costs are Skyrocketing. Source: Semico Research Corp. What happened to semiconductor start- ups? The history of the semiconductor industry has been shaped by the semiconductor start-up. Going back to Fairchild, the start-up has been the driving force for growth and innovation. Start-ups helped shape the industry, and they are now some of the largest and most successful companies in the industry. But the environment that lasted from the 1960s until the early 2000s—and that made the success of those companies possible—has changed dramatically. The number of venture capital investments in new semiconductor start-ups in the United States has fallen dramatically, from 50 per year to the low single digits (FIGURE 5). And even though that drop is not as dramatic in other countries — such as China and Israel — it is indicative of an overall lack of investment in semiconductors. FIGURE 5. Number of seed/series a deals. Source: Global Semiconductor Alliance. The main reason for the decline is the attractiveness of other businesses for the same investment. In the fourth quarter of 2013, nearly 400 software start-ups received almost $3 billion of funding, whereas only 25 semiconductor start-ups received just $178 million (representing all stages) (FIGURE 6). It seems that (1) the lower cost of starting a software company, (2) the relatively short time frame to realize revenue, and (3) attractive initial-public-offering and acquisition markets possibly make the software start-up segment more interesting than semiconductors. FIGURE 6. Funding of software and semiconductor start- ups. Source: PwC, US Investments by Industry/Q4 2013. This situation is unfortunate and has conspired to create a vicious and downward cycle (FIGURE 7). Lack of investment limits start-ups Lack of start-ups limits innovation Lack of innovation and fewer start-ups limits the number of potential acquisition targets for established companies. Reduced potential acquisition targets in turn limit returns for companies and returns for those who would have invested in start-ups. Limited returns make future investments less likely and continue the cycle of less innovation and lower investment . FIGURE 7. A vicious cycle limits innovation. Therefore, it is reasonable to conclude that the demise of semiconductor start-ups is a contributing cause to the lackluster results of the overall semiconductor industry. And that demise and those lackluster results are further exacerbated by the rise of activist shareholders who demand a more rapid return on their investment, which possibly reduces the potential for innovation in an industry that has lengthy development cycles. What about other industries? It is tempting to think that the semiconductor industry is alone in this predicament, but other industries face similar challenges and have figured out accretive paths forward. For example, biotechnology has some of the same issues: An industry that grows by bringing innovation to market Similarly lengthy development cycles Potentially capital intensive at the research and production stages In addition, the biotech industry faces a challenge the semiconductor world does not — namely, the need for government regulatory approval before moving to production and then volume sales. Gaining that regulatory approval is a go-to-market hurdle that can add years and uncertainty to a product cycle. However, in spite of its similarities to the semiconductor business and the added regulatory hurdles, the biotech industry enjoys a very healthy venture-funding and start-up environment. In fact, in the fourth quarter of 2013 in the United States, biotech was the second-largest business sector for venture funding in both dollars and total number of deals (FIGURE 8). FIGURE 8. Funding of software and semiconductor start- ups. Source: PwC, US Investments by Industry/Q4 2013. Why is this? What do biotech executives, entre- preneurs, and investors know that the semiconductor industry can take advantage of? There are several lessons to be learned. Big biotech companies have made investing, cultivating, and acquiring start-ups key parts of their innovation and product development processes. Biotech and venture investors identify interesting problems to solve and then match the problems to skilled and passionate entrepreneurs to solve them. Those entrepreneurs are motivated to create and develop solutions much faster and usually more frugally than if they were working inside a large company. The entrepreneurs and investors are creating businesses to be acquired versus creating businesses that will rival major industry players. The acquiring companies apply their manufacturing economies of scale and well-estab- lished sales and marketing strategies to rapidly— and profitably—bring the newly acquired solutions to market. For several reasons, certain megatrends are driving the high-technology sector and the economy as a whole, and all of them are enabled by semiconductor innovation (FIGURE 9). Among the major trends: Mobile computing will likely continue to merge functions and drive computing power. Security concerns appear to be increasing at all levels: government, enterprise, and personal. Cloud computing will possibly cause an upheaval in information technology. Personalization through technology and logistics appears to be on the rise. Energy efficiency is likely need for sustainability and lower cost of ownership. Next generation wireless will likely be driven by insatiable coverage and bandwidth needs. The Internet of things will likely lead to mobile processing at low power with ubiquitous radio frequency. FIGURE 9. Global internet device installed base forecast. Sources: Gartner, IDC, Strategy Analytics, Machina Research, company filings, BII estimates. The Internet of Things megatrend alone will result in a tremendous amount of new semiconductor innovation that in turn will likely lead to volume markets. Cisco Systems CEO John Chambers has predicted a $19-trillion market by 2020 resulting from Internet of Things applications . Does it really cost $100 million to start a semiconductor company? The prevailing conventional wisdom is that it takes $100 million to start a new semiconductor company, and in some cases that covers only the cost of a silicon development. It is true that recently, several companies have spent eight- or nine-figure sums of money to develop their products, but those are very much exceptions. The reality is that most semiconductor development is not at the bleeding edge, nor is the development of billion-transistor SoCs. The majority of design starts in 2013 were in .13 μm, and this year, 65, 55, 45, and 40nm are all growing (FIGURE 10). These technologies are becoming very affordable as they mature. And costs will likely continue to decrease as more capacity becomes available once new companies enter the foundry business and as former DRAM vendors in Taiwan and new fab in China come online. FIGURE 10: .13um has the most design starts; 65nm and 45nm have yet to peak. Another thing to consider is whether a new company would sell solutions that use existing technology or platforms (i.e., a chipless start-up) or whether a company would choose to originate IP that enables functionality for incorporation into another integrated circuit. A chipless start-up would add value to an existing architecture or platform. It could be an algorithm or an application-specific solution on, say, a field-programmable gate array, a microcontroller unit or an application-specific standard product. It could also be service based on an existing hardware platform. A company developing innovative new functionality for inclusion into another SoC paves a path to getting to revenue quickly. Such IP solution providers would supply functionality for integration not only into a larger SoC but also into the emerging market for 2.5-D and 3-D applications. In both situations (the chipless start-up and the IP provider), significant cost may be avoided by the use of existing technology or the absence of the need to build infrastructure or capabilities already provided by partners. In addition, those paths have much faster times to revenue as well as inherently lower burn rates, which are conducive to higher returns for investors. Even for start-ups that intend to develop leading-edge multicore SoCs, a $100-million investment is not inevitable. Take, for example, Adapteva, an innovative start-up in Lexington, Massachusetts. Founded by Andreas Olofsson, Adapteva has developed a 64-core parallel processing solution in 28 nm. The processor is the highest gigaflops/watt solution available today, beating solutions from much larger and more-established companies. However, Adapteva has raised only about $5 million to date, a good portion of which funding was crowd sourced on the Kickstarter Web site. This just shows that even a leading-edge multicore SoC can be developed cost-effectively—and effectively—through the use of multiproject wafers and other frugal methods. Several conclusions can be drawn at this point. Even though the semiconductor industry is growing again, the underlying trends for profitability and growth are not encouraging. Cost development is increasingly rapid on leading-edge SoCs. Historically, start-ups have been engines of innovation of growth and innovation for semiconductors. In recent years, venture funding for new semiconductor companies has almost completely dried up. That lack of investment of semiconductor start-ups has contributed to a downward and vicious cycle that will further erode the economics of semiconductor companies. The biotechnology industry has many parallels to the semiconductor. Interestingly, biotechnology has a relatively thriving venture funding and start-up environment, and we can apply that industry’s successful approach to semiconductors. Despite the state of start-ups, it is now one of the most exciting times to be in semiconductors because most of the megatrends driving the economy are either enabled by or dependent on semiconductor innovation. It does not need to take $100 million to start the typical semiconductor company, because a great deal of innovation will use very affordable technologies, and come from chipless start-ups or IP providers that have much lower burn rates and ties to revenue. Even leading-edge multicore SoCs can be developed frugally (for single-digit millions of dollars) and profitably. References 1. http://people.stern.nyu.edu/adamodar/New_Home_ Page/datafile/histgr.html 2. SoC Silicon and Software Design Cost Analysis: Costs for Higher Complexity Continue to Rise SC102-13 May 2013. 3. AlixPartners and Silicon Catalyst analysis and experi- ence. 4. Cisco Systems public statements.