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Chip industry's new paradigm looks like the old one

THE chip industry's new paradigm looks like the old one. As cutting-edge semiconductors got harder to make and demand boomed from new fields like bitcoin mining, top manufacturers seemed invulnerable. But shrinking sales forecasts from Nvidia and Applied Materials show companies are as prone as ever to economic cycles and excess inventory.

The past decade has been a happy one for the traditionally boom-and-bust industry. It has become harder, and more expensive, to produce ever more sophisticated chips. To cope with rising costs, the industry consolidated, which restrained over-expansionist tendencies. At the same time, chip demand continued to rise. Profits boomed, and the Philadelphia Semiconductor Index rose sixfold over the past decade.

One of the hottest areas has been graphics processors. In addition to making games more realistic, these chips are useful for machine learning, self-driving cars, and mining cryptocurrencies. Specialist Nvidia saw its stock rise 20-fold over the past decade, boosting its market capitalisation to a lofty US$175 billion last month.

The euphoria blinded investors to the fact that other causes of past booms have not been overturned. Demand is cyclical, and a booming economy has inflated chip sales. In hot sectors where demand outruns supply, customers order more than they need, in hopes of receiving adequate supply. And chipmakers invest heavily to meet expected future sales.

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Nvidia's warning that next quarter's revenue will be about 20 per cent less than analysts had expected is a classic case.

The company blamed a burst cryptocurrency bubble, saying it would take another quarter or two to work through excess chip supply. Chief executive Huang Jen-Hsun said he was as "surprised by it, as anyone else" and noted that rivals faced similar problems. Perhaps, but demand for gaming and data centre chips also is coming off the boil. Inventories and accounts receivable have risen sharply, and now total a third more than estimated sales for next quarter.

Inventory problems are hard for chip firms. High fixed costs mean profits rise sharply alongside volumes, while margins fall through the floor as inventories are worked off. Moreover, advanced chips shed value as they sit around, losing their technological edge. Firms usually slash capital expenditure to deal with bloat. The recent warning by Applied Materials - the biggest maker of equipment for chipmakers - of slower future sales suggests this is happening across the industry.

This chip cycle is starting to resemble past ones. REUTERS