A Different View on Demand Elasticity for Semiconductor Capital Equipment

by  Joe Verderber

It has been said that the demand for capital equipment in the semiconductor industry is inelastic. That is, it is claimed that the market for semiconductor manufacturing equipment (SME) would not be markedly increased or decreased by changes in the price of such equipment. The argument behind that claim is that semiconductor manufacturing is a highly concentrated industry, with a substantial set of barriers to entry. Availability of even a markedly lower priced version of any one piece of semiconductor process equipment, it is said, would not likely attract others to become semiconductor manufacturers, thereby not increasing the total market for SME.

If you are a supplier of SME though, I'll bet that you are much more concerned with your own total revenue than that of the "market" as a whole. Obviously there are factors other than pricing that impact your market, and critical ones. But, I believe that at least a portion of your company's SME business depends on your SME pricing. That means that your company's own set of sales opportunities is more elastic than the "market" as a whole. I'll use "Market" with a capital M to refer to the overall one, and "market" with a small m to relate to what your company actually sells.

Let's consider what makes up the SME Market. In this discussion I'll use the word "factory" to represent a semiconductor manufacturing facility. I'm consciously not using "fabrication facility" or "fab" because, to many people, that conjures up a vision of "front end" activity and ignores the test, assembly and packaging or final manufacturing activity often referred to as "back end". By using the word "factory" I'll including "fab", foundry, and "assembly house" or final manufacturing plant.

The Market for SME is generally described as the revenue total derived from shipments of the equipment. Equipment is purchased and shipments occur in a number of specific circumstances. They can be classified as follows:

    1. Equipping a factory by a new entrant into semiconductor manufacturing.

    2. Equipping another fab by an existing manufacturer.
      a. By replicating existing equipment for more capacity
      b. By purchasing similar (second source) equipment for more capacity
      c. By purchasing equipment to embody a new process or step

    3. Purchasing more equipment for an existing factory
      a. To replicate existing equipment for more capacity
      b. To add similar (second source) equipment for more capacity
      c. To add equipment to embody a new process or step
      d. To replace in kind retiring equipment

In some of the situations listed above, the incumbent vendor is going to get the new business. In other cases, the business can be competed for. Let's tabulate the instances when an alternative vendor might have a chance of getting business.

Current Vendor Alternative (non-current) Vendor
Case has a "lock" on business has at least a chance has a good chance
1 N.A.  
2a    
2b    
2c    
3a    
3b    
3c    
3d    

In Case 1, if you are the SME vendor with the largest Market share and Market presence, you represent a low risk choice for the new entrant customer because of your history and reputation. If you are the Market share leader you have the best change of getting the business because you represent the least risk. If you are not that Market share leader, then you must provide a strong argument to overcome the inherently larger relative risk to the customer in dealing with you. If your value proposition is based on a proprietary position in a new and desirable process technology, the more valuable the technology the less you depend on price to make your sale. The smaller the demonstrable dollar value of the benefits from the new technology, the more your equipment price will be a factor in the decision. Therefore, this opportunity for you represents an elastic competitive demand situation.

In Case 3b, if the customer is conceptually open to the possibility of bringing in a second source and buying equipment "similar to" what is installed, there is a built-in economic hurdle. Support infrastructure for the installed equipment is already in place. Operating and maintenance training, spare parts inventory, and familiarity of vendor technicians with the processes and procedures may all favor the incumbent vendor. The customer will be well aware of at least some of the costs of adding a new vendor. A good sales job by the alternative vendor is needed to make the customer equally aware of the benefits of having a second source. Pricing can increase the odds of success against the incumbent. I contend that this represents an elastic competitive portion of your market.

In Case 2b, where equipment choices are to be made for a new factory, the incumbent's advantage is not as strong as it is in a factory where equipment is already installed. The hurdle for an alternative vendor still exists, even though it is not as high as in the Case 3b situation. Price is a factor here too, and the odds of success are higher than in 3b.

This is definitely an elastic competitive situation.

In Case 3c, let's assume you bring new technology which, for purposes of this discussion, is not matched in kind by the incumbent vendor. In this case, the customer is faced with trying to objectively evaluate the benefits of the new technology. The customer will weigh the reduced expenses or eliminated costs or the productivity gains against the costs of change, including learning curve retrogression. The customer will consider equipment price and expected maintenance costs as well as the risks and rewards.

Since price is a factor, this too is an elastic situation for you.

In Case 2c the fact that this is a new plant means that there are new people, and new training, and probably less perceived risk in trying something different.. Price is still a factor in the decision if there are process alternatives.

So, results will be at least partially price dependent, and therefore, competitively elastic.

Let's summarize. If your company is not the Market leader, but is a SME supplier that is trying to sell to new entrants into semiconductor manufacturing, or if you're competing to become at least a second-source vendor to an existing manufacturer, or if you're attempting to provide a technology which will supplant an existing process or process step, your success will depend at least in part on your pricing. Therefore in those instances, your own market opportunity shows competitive demand elasticity. You can and should take that into account in making your pricing decisions as you attempt to optimize profitability.

To evaluate your own company's competitive demand elasticity, either historically or on an ongoing basis, look at your order intake rather than revenue recognition.

"Market" is usually described in terms of shipment value or revenue. (The SEC's Staff Accounting Bulletin 101 draws strong distinctions between shipment to a customer and revenue recognition. If you're in the SME business, you're probably familiar with that.). When you assess your "Market share", you typically compare your own revenue to the published or estimated value of Market revenue. To evaluate your own market elasticity though, you should shift conceptual gears and look at order intake rather than shipments.

The selling cycle in semiconductor capital equipment is long. Even once a product is developed and available, the evaluation and perhaps trials by prospects will occupy many months, and quarters slip by. Once the product selection choice is essentially made, the customer's internal approval process and availability of capital may take many additional months, and more quarters slip by. So, to get a correlation of order intake to pricing it will be necessary to measure results for a period at least as long as your estimated selling cycle, and ideally longer.

Once orders are in, the SME industry also tends to have long delivery lead times, which are functions of the degree of customization as well as of the current supply and demand balance. So, it usually takes quite a while before an attempt to sell SME results in revenue recognition. You'll get a better feeling for your company's own competitive market demand elasticity by looking at order intake rather than revenue.

‹‹ Joe Verderber
[About the Author]

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