Smartphone Biz Hurt by Own Success as Chip Supply Shrinks
May 15 (Bloomberg) -- A new generation of smartphones running on speedier wireless networks from Verizon Wireless and AT&T Inc. may be held back because makers of a key component can't keep up with demand.
Qualcomm Inc., the largest maker of chips for phones, said last month it can't get enough supply of the latest so-called baseband chips. Taiwan Semiconductor Manufacturing Co., the biggest contract manufacturer for the industry, has said it needs to add machinery to keep up with orders.
Qualcomm is currently the main provider of Long Term Evolution, or LTE, chips that offer the fastest connections to the Internet, meaning a shortage may crimp supply for new devices from Apple Inc., HTC Corp. and Samsung Electronics Co. The challenges present a hurdle for the growth of smartphones, a product category that will generate an estimated $219 billion this year, according to Bloomberg Industries data.
"It's looking like a big problem because Qualcomm is the single source," said Sravan Kundojjala, an analyst with Strategy Analytics Ltd. "Whoever is playing in the LTE markets -- Korea, Japan and the U.S. are very important -- will face shortages."
As smartphones such as the iPhone take on more of people's everyday computing needs, LTE networks give customers speedier Internet access for browsing the Web, downloading applications and streaming videos. The fourth-generation system is being introduced in major metropolitan areas first and will roll out more broadly globally in addition to existing 3G networks. Apple's next iPhone, expected to be released later this year, will probably work on the faster network, according to analysts.
Old & New
Apple, like other companies, relies on Qualcomm for LTE components. The San Diego-based company is the only chipmaker capable of delivering semiconductors that provide both LTE and connections to older networks -- something necessary for limiting the number of chips in a phone, keeping them slim and not sucking battery life, according to market researcher Strategy Analytics. That makes its output central to almost all new phone introductions this year.
"The only player in the market right now is Qualcomm," said Kundojjala. "All the others are playing catch-up."
Although there is demand for at least 30 million of its new combined LTE baseband chips this year, Qualcomm can only supply as little has half that number, he added.
Qualcomm Chief Executive Officer Paul Jacobs said the company is trying to bring other suppliers up to speed in producing its chips and aims to be able to meet all of the orders it gets by year-end. Taiwan Semiconductor boosted spending on its plants and also intends to accommodate all orders by the fourth quarter.
'Blasting Off'
"It's putting a lot of pressure on the industry," said Walter Price, a fund manager at RCM Capital Management, which owns shares of Apple and Qualcomm as part of its more than $100 billion in assets. "That market is absolutely blasting off."
Smartphones have replaced the personal computer business as the technology industry's engine of growth. Global smartphone shipments are projected to hit 655 million in 2012, up from 299 million in 2010, according to Gartner Inc. By comparison, the PC market will have grown about 5 percent in that period, to 368 million units.
Unlike Intel Corp.'s dominance in PC chips, Qualcomm, Broadcom Corp. and other makers of key semiconductors in smartphones have built their success on outsourcing.
Surprise
That tactic is causing trouble now because the chip producers aren't able to keep up. Taiwan Semiconductor and a handful of other so-called foundries in Asia make the chips on a contract basis. Those companies have been swamped by the demands of making increasingly complex processors and baseband chips in the kind of numbers required.
"They were taken greatly by surprise by how much they need," said Rick Wallace, CEO of KLA-Tencor Corp., a supplier of chipmaking machinery. "They are making progress on the yields but they're a long way from where they need to get."
Taiwan Semiconductor's lead over its rivals means there is a lack of alternative suppliers as United Microelectronics Corp. and Globalfoundries Inc. struggle to keep up on the latest production techniques. Even if other foundries had the capacity and the technology, it takes customers as long as nine months to go through the technical process of switching to a new supplier, according to Randy Abrams, an analyst at Credit Suisse Group.
Nvidia, HTC
Nvidia Corp. CEO Jen-Hsun Huang said he can't get enough of the latest graphics chips from Taiwan Semiconductor to meet demand. Huang said in an interview last week that he's glad he chose to build his Tegra 3 phone-chip processor on older technology.
"We don't have much more supply than demand, but every customer order can be filled," he said.
The pain from the chip shortage may not be shared equally. Apple and Samsung, with a growing lead in the smartphone market, are more important to suppliers and puts them at the front of the line for parts, according to RCM's Price.
HTC Corp., the fifth-largest maker of smartphones, may be among those to suffer the most because of the shortage, said Richard Ko, an analyst at KGI Securities Co. The Taoyuan, Taiwan-based company's shipments will be reduced by as much as 2 million units this quarter, Ko said.
"The window of opportunity for HTC to be ahead in the most-advanced products is shrinking because of the delay," Ko said. HTC declined to respond to e-mailed questions.
Front of the Line
Apple, the maker of the top-selling iPhone, hasn't been immune. The supply shortages from Qualcomm led analysts including Gene Munster of Piper Jaffray Cos. to say the next iPhone will come out later than anticipated. Apple's stock slumped 10 percent over a 10-day period last month in part because of Qualcomm's problems.
Apple CEO Tim Cook declined to discuss a potential supply shortfall during a call with analysts last month. Still, he said the company is working with suppliers to avoid those kinds of issues.
"We work very closely with our supplier partners and do everything that we can do to get supply and sometimes we're successful with that and sometimes we're not," Cook said April 24. "You can bet that we are focused on anything that we think may impact us and trying to push every button within our disposal to work on it."
Samsung, which is also the world's second-largest chipmaker, and Apple, which buys chips from its South Korean rival, may also be less susceptible because they aren't as dependent on Qualcomm as other phone makers.
Flexibility
Samsung, which passed Nokia Oyj to become the world's largest maker of phones last quarter, produces many of its own components. Its smartphone shipments surged 267 percent in the first quarter while Apple's jumped 89 percent. All others in the top five reported declines.
"Our strong partnership with multiple vendors allows Samsung to have flexibility to react quickly to changes in consumer and market demands," the company said in an e-mailed statement.
Underlining the importance of smartphones, shipments jumped 43 percent even as the total mobile-phone market shrank 1.5 percent, according to research company IDC. Smartphones now represent more than a third of the market, up from 25 percent in the first quarter of last year.
Chipmakers haven't put enough capacity in place because they didn't believe the market could grow as quickly as their customers told them and didn't want to be stuck with factories that weren't operating full-bore, said Andrew Dailey, who studies supply chains as managing director of MGI Research in Mill Valley, California.
"Everyone believes in their heart of hearts that companies, like markets and trees, don't grow to the sky," Dailey said.
To contact the reporters on this story: Ian King in San Francisco at ianking@bloomberg.net; Adam Satariano in San Francisco at asatariano1@bloomberg.net; Tim Culpan in Taipei at tculpan1@bloomberg.net
To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net
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