This is part of IEEE Spectrum's special report: What's Wrong—What's Next: 2003 Technology Forecast & Review.
Skies were blue and trade winds were steady as the SS Semiconductor set sail in early 2001. The previous year's haul had set records, and forecasters were heralding yet another banner year. But powerful forces were to shake even this vessel's sturdy timbers.
A low-pressure center caused by the bursting dot-com bubble and warm moist Y2K air from around the globe stirred up a storm so violent that it shredded the mainsail. Gales of corporate malfeasance from the southwest and typhoons of terrorism from the east swept wave after wave of stock-market volatility over the decks. While many of the crew were tossed overboard, cargo destined for distant ports sat idle in the holds.
It was a long time before the winds grew calm enough for the crew to repair the battered boat and limp to port. But customers there, who had also been buffeted by the foul weather, were scarce. And the ship's officers were forced to sell their cargo at a fraction of its original value.
Now, almost two years after the near-fatal voyage, forecasters are again predicting blue skies, and officers and crew are guardedly optimistic that good fortune awaits in the year ahead.
"It was a perfect storm of external events," says Ray Burgess, corporate vice president and director of strategy for Motorola Inc.'s Semiconductor Products Sector (Austin, Texas). "Y2K, the Internet bust, and the telecom depression combined with an overzealous industry believing itself to be looking at 25 percent growth." The result was tremendous overcapacity in the semiconductor industry.
"I have been in this industry since 1980 and I have seen a lot of ups and downs," Burgess told IEEE Spectrum, "And this is the worst downturn that the industry has ever had, both psychologically and from the standpoint of the numbers. If you take a rolling five-year average growth rate, this year  we are at the lowest five-year compound growth rate in the history of the semiconductor industry."
According to Burgess, the scenario has been something like this: the last two years of the 20th century were extremely profitable for the industry. Corporations were spending a lot of money on Y2K, upgrading their computers and network infrastructures for better fault tolerance. As late as the fourth quarter of 2000, analysts were predicting that revenues would grow 25 percent in 2001 to US $250 billion from an all-time high of more than $200 billion in 2000. Anticipating huge increases in demand for chips, semiconductor companies were investing billions in new chip fabrication lines and equipment.
But then in early 2001 the implosion of the dot-com bubble—which was actually sparked in late 2000—began to take its toll. Sales of networking equipment, disk drives, and computers for Web hosting farms plunged, driving down demand for chips that go into these systems. And because the chip fab lines had to be kept full in order to be cost-effective, IC prices dropped dramatically.
Semiconductor revenues are cyclic, reflecting the boom-bust capital equipment cycle, notes Burgess. "And then if the demand drops in the low part of the cycle, it dramatically exacerbates the situation."
But Moore's Law may also be playing into the IC price decline. With each new generation of semiconductors, the same functions cost less to produce, observes Bijan Davari, vice president of technology and emerging products at IBM Microelectronics Division (Hopewell Junction, N.Y.) and an IEEE Fellow. The reason is that the same functionality can be fit on a smaller chip in a smaller package. Smaller chips mean that more of them can be diced from a wafer at little extra cost. Productivity enhancement is Davari's term for this increasing functionality for a given cost.
As long as chip consumption grows faster than productivity enhancement, revenues remain healthy. "From the late 1970s up to the mid-1990s, the productivity enhancement was about 100 times for every 10 years. And the consumption rate was about 400 for every 10 years. So revenue increased about four times for every 10 years," says Davari. But since the mid-1990s, productivity enhancement has risen by 200-300 times per 10 years. So in effect the capabilities of chips are increasing faster than customers are buying them. "We are selling more and more chips, but revenues are staying flat or going down."
"So how do we fix the problem?" Davari asks. One solution would be to develop applications that will compel users to upgrade their electronics, be they PCs, PDAs, cars, or microwave ovens. The IEEE Fellow can see that happening in some interesting ways. "Take speech," he says. "It is very processing intensive, and we have not crossed the threshold on the capability that would motivate the average person to use it. It's not good enough. When speech recognition and speech translation cross that threshold, they can fuel a lot of growth."
A break in the clouds
It's not obvious, given the roller-coaster ride of technology stocks and wholesale layoffs, but the semiconductor industry is actually entering its second year of recovery. The low point in worldwide sales was the third quarter of 2001. In the same quarter of 2002, sales were up 20 percent. Over the entire year, though, total revenues in 2002 were about the same as in 2001.
"The recovery of the industry has picked up breadth and strength as the year  has progressed," George Scalise, president of the Semiconductor Industry Association (SIA, San Jose, Calif.) observed in November. Global sales in the third quarter of 2002 rose 21 percent over the same quarter of 2001, he said. As to the future, the 2002-05 forecast released by the SIA in November predicts that worldwide sales of semiconductors will grow by 19.8 percent in 2003 and by 21.7 percent in 2004, surpassing the peak revenues of 2000.
The SIA believes that the huge growth of revenues in 2000 was an anomaly that pushed compound annual growth rates above 16 percent. "Over the long run," said W.J. ("Jerry") Sanders III, founder and chairman of the board of Advanced Micro Devices Inc. (AMD, Sunnyvale, Calif.), who delivered the forecast, "we believe that compound annual growth rates in the 8-10-percent range will be the norm."