Feeling the Crunch From Foreign Chips

By Stephen Koepp

Texas Instruments seemed as determined last week as the troops that defended the Alamo. The beleaguered electronics giant took out a two-page advertisement in the Wall Street Journal that was intended to have the impact of a barrage of cannonballs. "Suddenly an era of explosive invention begins," proclaimed the company, as it touted an array of new technologies. This time the heroic struggle is over the manufacture of semiconductors, the tiny silicon chips that form the brains of virtually every advanced product from microwave ovens to mainframe computers. The attacker is Japan, whose aggressive electronics industry is on the verge of toppling the U.S. as the world leader in the $27 billion semiconductor market.

Texas Instruments, which invented the first practical chip in 1958 and remains a major producer, is determined to help lead a U.S. counteroffensive. The company is rolling out devilishly tiny weapons, among them the world's first four-megabit chip, a supersophisticated semiconductor that can store more than 4 million bits of information on a wafer the size of a child's fingernail. Declares Norman Neureiter, a Texas Instruments vice president: "The U.S. semiconductor industry is not rolling over and dying."

Few industrial struggles, even over supremacy in autos or steel, have ever been more important to the U.S. economy. "The semiconductor is at the heart of modern industrial processes," says Bruce Smart, the Commerce Department's Under Secretary for International Trade. A flood of low-priced chips from Japan has squeezed the profits of U.S. chipmakers so severely that many of them could fail, thus leaving the country dependent on foreign supplies for a strategic resource. Says Smart: "If we were to be forced out of business and had to buy our semiconductors from foreigners, they would in effect control one of the vital parts of our industrial and military strength."

The semiconductor industry got a measure of help last July when the Reagan Administration persuaded Japan to sign a five-year agreement to stop "dumping" chips at below-cost prices and to make its semiconductor market more open to foreign manufacturers. But the pact has stirred sharp controversy over its side effects. By forcing chip prices in the U.S. dramatically upward, critics say, the pact could severely harm the competitive ability of other high-tech industries whose products contain semiconductors.

Nonetheless, almost everyone agrees that U.S. chipmakers needed emergency relief. In a slump for two years, the industry has laid off 65,000 workers and is expected to post total operating losses of $800 million this year. Even the most innovative stars have been humbled. Earlier this month Intel startled Wall Street by posting a record quarterly loss of $114.2 million. Advanced Micro Devices said it lost $46.9 million during the comparable quarter and announced its first layoffs in a decade, dismissing 500 of its 13,300 workers. Many smaller companies that have developed highly advanced manufacturing processes, notably GCA of Andover, Mass., and Micron Technology of Boise, Idaho, are now in deep financial trouble. "There's no question that we're in the fight of our lives right now," says Ralph Thomson, senior vice president of the American Electronics Association.

The U.S. semiconductor business has seen slowdowns before, but the current struggle has been the worst yet. The problem has its roots partly in the electronics boom of the early 1980s, when sales of products ranging from personal computers to video games created intense demand for chips. Semiconductor makers in Japan and the U.S. vastly increased their capacity, expecting an annual sales growth of 30% to 100%. But when the computer industry's expansion stagnated two years ago, the resulting glut of chipmakers and chips triggered sharp price cutting. The cost of a 256K dynamic RAM (random access memory) chip, for example, which can store more than 256,000 bits of information, fell from almost $40 to as little as $3. Says Andrew Grove, president of Intel: "There are just too damn many of us. It is trench warfare by the commercial armies of two countries."

By leading the discounting binge, the Japanese have grabbed customers away from U.S. rivals. As recently as 1982, the American share of the global market for integrated circuits, which include the most advanced and widely used types of semiconductors, stood at 49.1%, compared with Japan's 26.9%. At the end of this year, Japan is expected to have taken the lead with 38% of circuit sales, vs. 35.5% for the U.S., according to In-Stat, an Arizona-based research firm.

Embittered manufacturers in the U.S. contend that Japanese makers have managed this coup by selling semiconductors at a loss, with the aim of pushing their U.S. competitors out of the market. The Japanese chipmakers tend to be diversified electronics giants (the big three: NEC, Hitachi and Toshiba) that can afford to lose money temporarily on semiconductors because they can rely on other revenue to tide them over. In contrast, U.S. chipmakers tend to be specialized, entrepreneurial companies that are more sensitive to profit slumps. An exception is IBM, the world's largest semiconductor maker, but the computer giant sells none of its chips separately because it uses the entire output in its own products.

The Japanese companies have excelled most of all in the popular dynamic RAM chips, which are used by the dozens in personal computers and by the hundreds in larger models. While this type of integrated circuit was developed in the U.S., Japanese companies have proved adept at efficiently turning them out in mass volumes. Part of the problem is a difference in high-tech corporate culture. Says Richard Skinner, president of Integrated Circuit Engineering, a Scottsdale, Ariz., semiconductor-research firm: "In the U.S., the real glamour jobs are in designing the chips. But in Japan the manufacturing guys are equal." Indeed, each time U.S. companies have developed a larger-capacity memory chip (first the 1K dynamic RAM, then the 4K, 16K, 64K and now the 256K), Japanese manufacturers have quickly come up with a lower-priced version.

Even so, U.S. manufacturers claim they could compete head to head with Japanese rivals if the foreigners stopped selling below cost. The U.S. chipmakers are somewhat optimistic about the new trade pact, under which the Department of Commerce is setting so-called fair market values for each Japanese company's chip exports to the U.S. To arrive at the fair market value, which is the minimum price at which the manufacturer is allowed to sell the semiconductor, the department tallies up an individual Japanese ( chipmaker's costs in making each product and adds a profit of 8%. The Government's first fair market values, set in August, temporarily pushed prices shockingly high. The 256K dynamic RAM chip, for example, shot from about $3 each to as much as $8.75. But last week the Commerce Department recalculated those prices downward, bringing the 256K generally below $4 each.

In addition to raising U.S. prices, the pact could help American chipmakers compete overseas, since it requires the Japanese government to prevent its chipmakers from selling semiconductors below cost in all other countries as well -- though that provision may be difficult to enforce. Perhaps more important, the Japanese government has agreed to help the U.S. and other countries boost their chip sales in Japan, which currently total about $750 million, by as much as $2 billion within five years. Says Thomas Kurlak, who follows the industry for Merrill Lynch: "It has stopped the Japanese ability to steamroll."

Many buyers of chips, however, complain that the Government is protecting one high-tech industry by raising costs for many others. The protests have even come from the European Community, which believes its computer makers could be hurt by rising semiconductor costs. At Silicon Graphics in Mountain View, Calif., the cost of producing a system containing 144 one-megabit memory chips has nearly doubled because the semiconductors have increased in price from $22 to $107. Says Jerry Sugar, president of Classic Technology, a computer-systems maker in San Jose: "I called Washington to protest. Higher chip prices are going to kill the U.S. computer industry." A more likely possibility is that some U.S. computer manufacturers will consider moving their plants to the Far East, where Japanese chips are still being sold cheap despite the agreement.

Still other critics of the pact think it could be detrimental to U.S. chipmakers in the long run by giving the Japanese a respite from cost cutting, during which they can pour their profits into research and development. In the meantime, other discounters, like the Koreans, are rushing into the U.S. market to fill the discount gap. "I'm meeting with a group from Seoul tomorrow. Their prices will be better," says Donald Kingsborough, chairman of a California toy company, Worlds of Wonder, that uses a high volume of chips in products like Teddy Ruxpin, the talking bear.

U.S. chipmakers never expected much relief from competition. They have already turned their attention to types of semiconductors that foreign rivals will find more difficult to copy. The chipmakers believe their future lies in fabricating relatively small batches -- thousands instead of millions -- of custom chips for specialized uses. Companies like National Semiconductor and Intel are moving away from commodity-like memory chips to concentrate on microprocessors and other products that perform more advanced functions.

But at least one company, Texas Instruments, has stubbornly refused to give up the race with the Japanese to make ever more densely packed memory chips. Its experimental, 4 million-bit chip contains components smaller than one micron, or .000039 of an inch. Now that the company has created a superchip, the tougher task will be to manufacture them by the millions before the wily Japanese can catch on.

With reporting by Gisela Bolte/Washington and Cristina Garcia/San Francisco