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Can anyone other than Nvidia make big money from chips?

Can anyone other than Nvidia make big money from chips?

Adam Smith would have been baffled by microelectronics. When the great economist died in 1790, James Watt’s two-cylinder steam engine was considered the height of technological excellence. If he had recognized the prefix “nano”—a fair bet for a precocious classicist who speaks dead languages ​​by age 14—it would have been a derivative of the Greek word for “dwarf,” rather than a reference to the billionths of a meter in which modern semiconductors are measured . The word “billion” had entered the English language by Smith’s time, but the number it represents might seem incomprehensible. Are there some 200 billion transistors etched onto a few halfpennies in Nvidia Blackwell’s latest artificial intelligence (AI) chip? Black magic, even for an enlightened person, Scottish rationalist.

A person who observed that “the division of labor is limited by the size of the market” would nevertheless be in familiar territory, observing the global chip industry. Stripped of modern jargon, the semiconductor supply chain is Smith’s insight in action. The market size has increased from $45 billion in sales in 1979 (in today’s money) to perhaps $600 billion in 2024, and forecasters estimate that by the early 2030s the workforce will be divided into more than 1 trillion dollars.

Gone are the integrated chip giants of the 1970s, which, like the American Intel in its time, did everything themselves. This is an era of hyperspecialization. Nvidia and other designers are preparing drawings. “Foundries” such as TSMC in Taiwan turn them into physical products, supplying silicon from one company to machines assembled by another. These in turn contain sponges from even more specialized suppliers, and so on.

What hasn’t been shared in as much detail is the AI ​​windfall. Since mid-2022, the world’s 100 largest semiconductor companies by market capitalization have added $5.4 trillion in shareholder value. Of these, 48 foundries and equipment manufacturers received just $1 trillion. 32 fabless-free chipmakers that design but do not manufacture their own processors received $4.2 trillion. Nvidia, whose chips are favored by AI model makers, received three-quarters of that amount. (20 firms continue to develop both models) and chipmakers such as Intel and Samsung have had little success.)

Nvidia’s fortunes can be attributed to its stellar financial results. Its revenue nearly quadrupled from the first half of 2022 to the same period this year. The company plans to generate $71 billion in net income in 2024, up from $8.4 billion two years ago. Still, foundries and tool makers can be forgiven for their irritation. Nvidia’s 31 peers that don’t have their own manufacturing facilities are worth almost as much as foundries and OEMs, despite generating half the revenue and only two-fifths of net profit. They also spend half as much on fixed assets and research and development (R&D). What’s more, OEMs (though not asset-heavy foundries) boast higher operating profits and higher returns on equity than chipmakers without their own manufacturing facilities.

This disparity becomes even more curious in light of a side effect of Smith’s hyperspecialization in the chip industry: its hyperconcentration everywhere except at the busy end without manufacturing capacity. As product niches have narrowed, the chip supply chain has begun to resemble a chain of micromonopolies and duopolies. TSMC and Samsung (which makes chips for both customers and itself) dominate the foundry business. ASML in the Netherlands is the only supplier of modern lithography equipment. The Japanese company DISCO sells 85% of precision tools for grinding and cutting silicon wafers. Cadence and Synopsys, two American firms, share the chip design software market. Advantest from Japan and Teradyne from America oversee post-production testing of the chips.

The niches may be small, but the barriers to entry are very high. Compared to the size of the market, processing companies spend huge amounts on capital investment and R&D. For DISCOs, the annual figure is equivalent to 10% of the total addressable market; for ASML and TSMC it exceeds 20%. State-controlled Chinese competitors willing to accept needed investment are being shut out of foreign markets for reasons of national security. On top of that, incumbents could face $150 billion in handouts from Western and Japanese governments desperate to revive the domestic chip industry.

If this all sounds like a rent-seekers’ paradise, it isn’t, sighs the chief financial officer of a major tool manufacturer. For some micro-oligopolists, this is because they sell directly to equally dominant firms in the value chain. Having only a handful of buyers reduces the bargaining power of the seller. Other companies benefit from a more diverse customer base but choose not to push big buyers like TSMC, said Chris Miller, a semiconductor history researcher at Tufts University.

By the pool

Stability is harder to maintain when demand for artificial intelligence chips from deep-pocketed buyers like Microsoft and Google allows Nvidia to charge a fortune for each new model. The company’s gross margin is now 75%, up from 60% in 2022. Blackwells could cost $40,000 apiece, and tech giants are mulling purchases worth a million or more. TSMC, the second-largest company in the profit pool, is expected to raise prices for the latest production by up to 15%. Other firms that help bring projects to life feel entitled to a share of the wealth, especially as the flow of revenue from China slows as America restricts high-tech exports to its geopolitical rival.

Fabless and their suppliers could simultaneously improve their profitability if they all raised their prices. But this may reduce demand for the final product. Investors’ willingness to punish any hint of such softness, such as the outlandish Oct. 29 sales forecasts of AMD, an unscrupulous rival of Nvidia, limits the pricing power of chip makers. This may prove to be less of a deterrent in the future. Don’t be surprised if reluctant oligopolists become a little less shy as they flex their muscles in search of rent by the pool.

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