Electronics Production | December 17, 2008

iSuppli issues alert for global semiconductor inventories

Excess semiconductor stockpiles in the global electronics supply chain are likely to nearly triple in the fourth quarter, spurring iSuppli Corp. to issue a red alert regarding chip inventory levels.
iSuppli projects that in the fourth quarter of 2008, excess semiconductor inventories could balloon up to $10.2 billion in value, up 268 percent from $3.8 billion at the end of the third quarter. This rise is having a deleterious impact on semiconductor pricing, revenue and profitability, and could delay the semiconductor industry's recovery from the current downturn—even when demand rebounds.

This represents the first time that iSuppli has issued a red alert on semiconductor inventory levels. iSuppli issued a yellow alert warning on semiconductor inventory in July of 2004, in light of a major surge in stockpiles in the third quarter of that year.

The attached figure presents iSuppli's forecast of excess semiconductor inventories in the global electronics supply chain.

“Three critical factors are driving semiconductor inventories to a higher level than expected,” said Derek Lidow, president and chief executive officer of iSuppli Corp. “First, many companies have reduced inventory targets during the fourth quarter, even as revenues are plummeting,” Lidow noted.

Inventory targets often are expressed in terms of Days-Of-Inventory (DOI), and these targets rarely change. However, inventory levels fluctuate proportionally with changes in forecasted revenues.

In the fourth quarter, many industries have reset their inventory target levels in anticipation of a long economic downturn, expecting that the reduced stockpile goals will help their cash balances. These new targets mean that even if semiconductor revenues were anticipated to remain flat, inventory levels would need to drop in proportion to the new lowered DOI targets in order not to have any "excess" inventory at that node of the supply chain.

“The second factor is that semiconductor demand has fallen in the fourth quarter, and it declined much faster than expected at the end of the third quarter, as shown by a rash of lowered guidance announcements,” Lidow added. “This means that initial fourth-quarter production schedules were set too high. Production schedules have been ratcheted down during the quarter in what are mainly reactive moves, resulting in excess inventory buildup.

“Third, OEMs have not been able to cut production as fast as they would like to due to supply chain rigidities, mostly because of workforce rules in some parts of the globe and cancellation windows at subcontractors and component suppliers.”

Extended time
The near-tripling of excess semiconductor inventory throughout the electronics supply chain in the fourth quarter will significantly extend the time necessary for the semiconductor industry and contract manufacturers to benefit from any recovery in demand. It also will wipe out several additional percentage points of growth from the semiconductor industry in 2009.

iSuppli's methodology, developed in 2001, involves estimating the value of excess semiconductors throughout the electronics value chain, whether in component inventories, Work in Progress (WIP) or as part of intermediate or finished products. iSuppli has determined that the level of excess semiconductor inventories is the factor that most directly relates to future electronic industry production levels.

As a result...
Retailers likely will not build up major excess inventories of finished products in the fourth quarter. iSuppli sources indicate that retailers are planning to price inventory at whatever levels are required to hit their January inventory targets, or in the case of Wal-Mart and a few of the mega-chains, to return unsold stock. In most cases, retailers did not significantly reset their target inventory levels, and instead have focused on OEMs giving price protection or return privileges.

Similar to retailers, wireless service providers also are not likely to build up significant additional inventories, and are modestly targeting reduced inventory levels. They have been ordering smaller lots to be shipped in the fourth quarter, with return privileges or price protection on unsold inventory.

PC OEMs have been particularly aggressive in setting lower inventory targets and also in pushing out build schedules and component orders. These companies will reduce overall inventories by several billion dollars, and these cancellations and production cuts will show up as inventory increases further upstream in the supply chain.

The PC OEMs will, however, show an increase in excess semiconductor inventory of $1 billion because they had been running below their old targets; now they will be running slightly above their new targets.

Everything in excess
OEMs producing products destined for consumers, whether consumer electronics, mobile handsets or automotive electronics and infotainment, will accumulate major excess inventories, both from resetting their target inventory levels and also from production they could not cut fast enough. iSuppli expects significant jumps in excess inventory in these three areas, with the automotive supply chain adding up to $1.7 billion in surplus semiconductor stockpiles. Wireless OEMs and consumer product makers, including companies that produce both consumer and non-consumer items, should see their overall product inventories increase by $2.4 billion, adding $300 million to iSuppli's tally of excess semiconductor inventories.

Original Design Manufacturers (ODMs) also are resetting target inventory levels and will be forced to hold some PC and consumer electronics shipments in inventory, resulting in an increase of about $1.1 billion in stockpiles by the end of the fourth quarter, and adding almost $200 million to the excess semiconductor inventory count.

Electronic Manufacturing Services (EMS) suppliers were holding excess inventories at the end of the third quarter, but have been particularly aggressive, often as a matter of survival, about pushing out orders while tightening inventory targets. This will result in a drop of more than $1 billion in absolute inventories, but will still slightly exceed their new revised target DOI. In general, excess inventories are not the biggest worry for this very troubled industry.

Electronics distributors also have aggressively cut inventory targets, as they worry that anything on their shelf could grow stale in a prolonged downturn. But electronics distributors have become excellent inventory managers over the past three years, and iSuppli predicts they will meet their new lowered targets.

Semiconductor companies will see their stockpiles rise by at least another $1.5 billion, but with reduced inventory targets, excess inventories on their shelves will actually increase by almost $2.2 billion.

Living in excess
Overall, from iSuppli's sampling of 180 electronics companies, representing more than 80 percent of the revenues of the industry, total inventories are expected to grow from $94 billion at the end of the third quarter to more than $104 billion at the end of the fourth quarter. Of the total semiconductor inventories throughout the entire electronics supply chain, $3.8 billion represented excess at the end of the third quarter. However, iSuppli predicts that $10.2 billion will be excess at the end of the fourth quarter, for the three reasons listed above.

Another major shift to be aware of is that for most of the period since the dot-com recovery, more than 80 percent--and often almost 90 percent--of excess semiconductor inventories have been on the shelves of chip suppliers. This will change dramatically in the fourth quarter, with $4.23 billion--or 41.5 percent--of the excess inventory now being held downstream of the semiconductor suppliers. This will result in at least 2 percent reduced semiconductor growth in 2009 that has not been factored into most people's forecasts.

Putting the $10.4 billion into perspective, at the beginning of the bust, iSuppli measured $13.4 billion in excess inventory, which took two years to work down to manageable levels.
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