Based on recent statements from some of the industry's leading players, plant utilization levels could slide to 50 percent or lower in the ongoing quarter before slowly picking up in the second quarter due to what analysts describe "as inventory cleansing" at OEMs, many of which began tightening inventory levels early in the fourth quarter of 2008--well ahead of their component suppliers.

The forced reduction in plant utilization is bound to hurt already depressed margins at the leading semiconductor suppliers and foundries, complicating recovery plans and vendor-managed inventory programs while throwing the industry inventory equilibrium into a state of imbalance for much of the year.

While plant utilization could be easily ramped up again under normal circumstances, the urgent need to reduce payroll costs could make this difficult as more vendors trim their workforces.

Intel Corp. gave the clearest signal earlier this week (Jan. 15) of what the major semiconductor vendors and foundries must do to regain control of their inventories during a conference call to discuss its fourth quarter results, noting that supply chain partners--especially OEMs--aggressively began cutting component stocks as soon as they noticed softening demand from their customers.

Intel's fourth quarter revenue declined sequentially for "only the second time in 20 years," according to Intel CEO Paul Otellini, who described the three-month period as "a weak ending to a tremendous year of accomplishment."

Otellini said Intel's fourth quarter revenue decline "was dramatic, and resulted from reduced demand and inventory contraction across the supply chain," adding: "While inventories in total have declined, we are assuming further reduction in the first quarter."

In response, Intel CFO Stacy Smith said the company was "aggressively reducing build plans in order to avoid putting unnecessary cost into inventory. And while that will have a significant impact on our financials in the first quarter, it is the prudent response to the current environment and will benefit us when demand stabilizes."

Ballooning inventory

Other companies will quickly follow Intel's lead, cutting plant utilization or idling facilities until they get a clearer view of the demand environment, which weakened dramatically in the fourth quarter, leading to large inventories at suppliers. Industry sources said the pace and format of plant rationalization this time would be somewhat different from what chip vendors attempted during the 2001 downturn.

For example, Taiwanese PC makers and other subassembly vendors, which typically retain large inventories even during market recessions, have instead responded by cutting off all but the most essential production. This has happened because of the broad nature of the current economic downturn, according to industry sources.

"Every one of our customers seems to be taking very aggressive action across the board to reduce the build and to not get stuck with unsold or potentially unsalable product," said Intel's Otellini. "What we saw was a really unprecedented hitting-of-the-brakes in the December timeframe. And I think that those brakes are off a little bit right now, but they're likely to start again around the Chinese New Year."

The sharp reduction in semiconductor production is unlikely to immediately resolve the industry's excess component problem. In recent years, OEMs and electronics manufacturers have successfully transferred component liability onto suppliers, meaning that chip makers, interconnect, passive and electromechanical companies will still end up with the bulk of inventories and the associated costs, according to analysts.

"While OEMs, distributors and EMS providers have been furiously working [to reduce] inventory amid weak demand trends, we expect actual inventory dollars to be flat to be up slightly at these segments, and [the number of] days of inventory to be up," Matthew Sheerin, an analyst at Thomas Weisel Partners LLC, said in a report.

"At the supplier level, we would not be surprised to see inventory climb to record highs in the fourth or first quarter."

The market researcher is forecasting that the number of inventory days rose throughout the electronic supply chain in the fourth quarter, but said the majority of the increase occurred at semiconductor, passives and connector makers. Despite strong efforts by most companies to trim component inventory in the fourth quarter, Sheerin believes the "magnitude of the demand falloff is making it difficult to make a significant progress."

By: DocMemory
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