The new norm in manufacturing

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September 20, 2021
 
Significant innovation often leads to industry bifurcation. Companies with less capital and scale focus on the ‘blueprint’ while outsourcing work they performed in the past such as manufacturing. This type of industrial evolution can lead to new opportunities, according to Murdo Maclean, investment manager at Walter Scott.

Historically, many companies in the semiconductor industry conducted in-house design and front-end fabrication (manufacturing). These are called integrated device manufacturers (IDM). However, in recent years the number of IDMs has dwindled due to increased complexity and costs, according to Maclean.

Moore’s Law, which states the number of transistors on an integrated circuit (IC) doubles every two years, is largely responsible for the divergence of semiconductor companies into those that solely conduct design (fabless companies) and those that manufacture chips (foundries). Because of growing demand for a greater quantity of computers, smartphones and other electronic devices of increasing sophistication and performance, the level of chip complexity has increased – as have the costs, according to Maclean. Due to the rate of innovation, foundries require retooling every few years.1 The US fabrication industry’s costs for new plants and equipment increased from US$11bn in 2010 to $US22bn in 2018.2

“Moore’s law has been a critical factor in expanding the applications and industries that wish to use chips, which has then led to a need for scale and specialization,” Maclean says. “Not everyone can keep up with this. That’s why there’s been a gradual consolidation of the number of IDMs in the space. You’ve seen a lot of businesses that couldn’t keep up pivot to one of either design or manufacturing.”

This has led to the proliferation of fabless companies, which outsource manufacturing to third parties that specialize in the fabrication process.3 As more product innovation occurs and new applications crop up, the divergence continues to grow, according to Maclean. As a result, contractors on the manufacturing side, particularly in Asia, continue to gain market share.

“We’ve come to see a notable Taiwan-based manufacturer build out this outsourced speciality, become the dominant player in the space and really take over the global market,” Maclean says.

According to a 2019 report produced for the US Airforce, nearly 90% of high-volume integrated circuit (IC) production will be based in Taiwan and South Korea by 2022, while the US share of global fab capacity is expected to fall to 8%.4 However, those projections could be subject to change since US President Joe Biden carved out US$50bn in government funding for semiconductor manufacturing and research earlier this year.5

Other industries to follow?

In the pharmaceutical industry, a similar phenomenon is taking place: Eroom’s law (backwards for Moore’s). According to Eroom’s law, accelerated innovation and regulation has led to rising research and development (R&D) costs for drug manufacturers.

“Like chip design, drug manufacturing is beginning to require more capital, expertise and scale,” Maclean says. “Some of the businesses, central to the creation of the industry, found they would rather focus on the innovation of drugs without the manufacturing responsibility.”

Comparable to the emergence of third-party semiconductor foundries, the pharmaceutical industry has seen substantial growth of contract design manufacturing organizations (CDMOs), according to Maclean. Using this channel, drug developers can focus on design and innovation while outsourcing manufacturing and regulatory trials.

“In our view, the current market share of CDMOs is simply going in one direction—very much the same as we’ve seen with the semiconductor foundry industry,” Maclean says. “As a result, more innovation is taking place with drug developers. By using the CDMO channel, medium and even small size businesses are now capable of bringing drugs to market that otherwise would’ve been impossible.”

The future of manufacturing

Despite having dedicated manufacturers in both industries, drug and semiconductor production are increasing in complexity. However, factory automation has accelerated over the past few decades enabling contract manufacturers to work more efficiently. Recent data shows robotics use in electronics, photonics and semiconductors posted 11% year-on-year growth to Q1 2021 while life sciences and pharmaceutical robotics orders grew 69% over the same period.6

“When you marry this outsourcing ability in tech and pharma with automation, I think it’s very exciting,” Maclean says. “It’s also beginning to crop up in places like cosmetics and food manufacturing because it allows you to operate at scale. You can operate against many restrictions in the world, which has become more important throughout Covid-19.”

Additionally, factory automation allows companies to manufacture in closer proximity to their end market. Because it is not labor intensive, businesses can relocate factories and benefit local economies, Maclean adds. While China is currently the world leader in industrial robotic installations, followed by Japan and South Korea, 88% of businesses worldwide plan to adopt robotic automation into their infrastructure, according to global consultancy firm Mckinsey & Company.7

1 Congressional Research Service: Semiconductors: US Industry, Global Competition and Federal Policy. October 26, 2020.

2 Capital expenditures based on NAICS 3344 (semiconductors and other electronic component manufacturing) from the U.S. Census Bureau’s Annual Capital Expenditures Survey, at http://www.census.gov/programssurveys/ aces.html.

3 Investor’s Business Daily: Semiconductor companies: Where are they in the chip cycle. June 15, 2021.

4 Rick Switzer, U.S. National Security Implications of Microelectronics Supply Chain Concentrations in Taiwan, South Korea, and the People’s Republic of China, p. 4, September 2019, as prepared for the U.S. Air Force, Office of Commercial and Economic Analysis.

5 CNBC: How Asia came to dominate chipmaking and what the US wants to do about it. April 11, 2021.

6 Tech Jury: 27 + astonishing robotic industry statistics you should know in 2021. September 9, 2021.

7 Ibid.

 

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