Chip industry to stay in high gear until 2002, study predicts

The global semiconductor industry is doing so well that Dataquest has raised its earlier projections for the next two years. In its five-year outlook, the San Jose, Calif.-based company predicts that sales will grow 36.9 percent this year to $231.6 billion and another 27.5 percent in 2001. That's up from Dataquest's previous forecast of 31.3 percent growth in 2000 and 26.9 percent growth for 2001.

The growth rate will then slow in 2002, the company predicts, with the overall market shrinking the following year before rebounding in 2004.

"The overall trend remains quite positive," Dataquest analyst Mark Giudici said.

In the chip industry, such good times mean that capacity is relatively tight. That allows chipmakers such as Texas Instruments and National Semiconductor to charge higher prices and reap stronger profits. In turn, tight capacity and good profits spur demand for chipmaking equipment, which is sold by companies such as Applied Materials and KLA-Tencor.

After 2001, Dataquest analysts are predicting a bit of a slump.

Growth will slow in 2002 to 13.9 percent, with a 5.3 percent decline in sales in 2003. As is typical for the cyclical chip industry, the downturn will be fueled by chipmakers adding too much capacity in response to strong demand.

"That will fuel a competitive overinvestment that will hit in 2002, leading to price erosion," Dataquest analyst Klaus Rinnen said.

The biggest culprit will again be standard memory chips. After several years of steady increases in sales, prices for dynamic random access memory (DRAM) will "fall like a rock" in 2003, according to Dataquest.

During the last chip downturn in the late 1990s, the DRAM market went from $45 billion in 1996 to the $20 billion-to-$30 billion range in 1997. Despite the upcoming dip, Dataquest said, the DRAM market will reach $76 billion in 2002.

Growth in sales of other types of chips should prevent a massive decline in total chip sales. Flash memory, which is used in cell phones, digital cameras and MP3 players, will become increasingly important. Dataquest expects that by 2003, flash memory will account for $22 billion in sales--or nearly 7 percent of the $320.9 billion overall chip market. In the past, flash memory has accounted for about 1 percent of the market.

Dataquest analyst Jim Handy rejects the idea that a recent drop in memory prices means the chip industry is already headed downward. The drop is most likely a temporary phenomenon, Handy said, caused by PC makers having built up a "war chest" of memory chips in anticipation that prices would rise sharply this year.

"Everyone, ourselves included, was forecasting a capacity equilibrium in the second half," he said. Instead, PC demand has slowed. This has resulted in excess memory chips and other components in PC makers' warehouses, putting pressure on both the spot market for memory chips and the contract prices paid by PC makers to suppliers such as Micron Technology.

Handy expects that memory prices will rise somewhat during the first quarter of next year, even amid what is usually the slow season for PC sales.

Another market forecaster, the Semiconductor Industry Association, plans to issue an update to its twice-yearly outlook on Nov. 1.

In its most recent forecast, which came out in June, the chip industry trade group said it expected overall sales to reach $195 billion this year. It forecast 25 percent growth next year, pushing sales to $244 billion. The group also predicted a slowdown, projecting only 14 percent growth in 2002 and 12 percent sales growth in 2003, producing sales of $312 billion that year.