Global pressures are forcing even the fiercest competitors to do something that all the industrial policy in the world couldn't: cooperate* * *
Let's start with three propositions.
First: the marketplace today is intensely, brutally competitive. No doubt that's a cliché; even so, it's worth remembering how much has changed in recent years. American companies in the past rarely had to worry about imports, let alone compete with foreign-owned businesses operating here in the United States. They could assume that the technologies of business -- production machinery, communications and information systems, and so on -- would change only slowly. Those were the days.
Second: nearly all the management advice you get -- yes, even from this magazine -- merely qualifies you to enter the race. Of course you have to cut costs, boost quality, pay endless attention to customer service. But high-quality goods and services at a reasonable price are no more than a ticket of admission to today's marketplace. To succeed, you need another kind of competitive edge.
Third: year after year, the only reliable edge is continually leapfrogging the competition. Jumping into new niches, or into next-generation products and services. Improving your internal efficiency by orders of magnitude. Learning to serve your customers in different ways from everyone else. Notice that word "continually." Recent history is littered with the carcasses of businesses that leapfrogged once, then forgot to look behind them.
Are you with me? If you accept these propositions, I'll offer you an unusual hypothesis, then back it up with some pretty startling evidence from the semiconductor business.
The hypothesis is this. Companies that are the most successful at leapfrogging -- companies that literally build themselves around constant learning and constant innovation -- don't do it alone. On the contrary: they are embedded in webs of the most intricate business relationships you'll ever want to see. They set up long-term strategic alliances, not with just one partner but with several. They depend on other companies for critically important operations, and for help in developing new products. They share people, equipment, and information -- even with competitors -- in ways that would appall traditional managers. At times, it can be hard to tell where one company ends and another begins.* * *
If there's an industry more competitive than semiconductors, I'm not sure what it is.
Semiconductors, of course, is shorthand for integrated circuits, the silicon chips that make possible desktop computers and a hundred other miracles of modern technology. Chip makers take it for granted that today's products and processes will be obsolete in a few years. They also take for granted a formidable array of potential competitors, from giants such as Intel and Fujitsu to the latest high-glamour, venture capital funded start-ups. The competitive struggle takes periodic tolls. Most U.S. companies, for example, have been forced out of the biggest memory-chip markets. Advanced Micro Devices (AMD), a billion-dollar company, recently had to sell one of its production facilities to Sony.
And yet: despite the intensity of the competition, despite the recurrent wails in the press about the imminent collapse of Silicon Valley, plenty of semiconductor companies are thriving. Consider Chips & Technologies or Cypress Semiconductor, each with projected 1990 revenues of more than $200 million and aftertax earnings in the 15% range. Chips is only five years old, Cypress seven. A dozen other young companies, though not so big, are both well established and remarkably profitable. Weitek, which specializes in chips for math-intensive operations, did $49 million in sales in 1989, with net income close to $7 million. Altera, a maker of programmable logic devices (PLDs), was up near $60 million sales and $11 million net. Weitek grew 40% last year, Altera 55%.
The key to this growth has been innovation. Cypress introduced 56 new chips and chip subsystems in 1989 alone. Altera pioneered a new family of PLDs five years ago; came out with a second-generation product cluster last year; and expects a third generation by 1992. That's fast even by Silicon Valley standards. Japanese customers, among others, are lining up to buy. Altera does 15% of its business in Japan, Weitek about 6%, and both companies are expanding their presence there. Novellus Systems, which makes chemical vapor-deposition equipment for semiconductor wafer fabrication, expects to do 30% of its sales in Japan in 1990 (see "Factory of the Future," page 5).
The people running these businesses, in short, are successfully steering them through one of the most perilous marketplaces in the world. But what's interesting isn't their success, it's their secrets. As experts such as AnnaLee Saxenian of the University of California/Berkeley are discovering, they've created a new model of what a corporation is and how it goes about its business (see "Resurgence of a Region," page 5).
In the past, the leading companies in the semiconductor industry were such giants as Intel and AMD. They looked like most big, integrated manufacturing enterprises: a research-and-development division, a manufacturing division running huge production facilities (fabs, in industry lingo), a big sales force pushing a broad product line. They also had the usual American keep-your-powder-dry attitude toward others in the business. Suppliers were just vendors, to be handled by purchasing agents. Customers were taken care of by salespeople. The competition was, well, the competition.
"Our business is tough, and silicon companies tend to be very adversarial, both with their customers and with each other," says Cypress founder T. J. Rodgers, a 15-year industry veteran.
The traditional industry practice of second sourcing -- that is, licensing out proprietary products so customers can feel confident their supplies won't be interrupted -- typically intensified rather than mitigated the competitiveness. "Even though you're in a [second-source] partnership," says Rodgers, "you do everything you can to prevent the other company from being successful." The licensing agreements between Intel and AMD, he points out, have been marked by lawsuits on both sides.
The upstarts, by contrast, stand both the traditional strategy and the traditional attitude on their heads. Instead of establishing broad product lines, they focus on niche markets. Instead of trying to do as much as possible themselves, they specialize in one part of the production process. Weitek and Altera concentrate on chip design and new-product development. Cypress, though it has a sizable product line of its own, pours resources into its leading-edge manufacturing capability and relies on other companies to provide additional new products through second sourcing. A company called Orbit Semiconductor does nothing but manufacture chips to others' specifications -- and has doubled its revenues in two years, to more than $21 million.
These newer companies extend their economic reach not through big factories and big payrolls but by establishing alliances, both with one another and with the industry's largest corporations. So close are these ties -- and so numerous -- that the lines separating one business from another can begin to blur. Consider the examples of Altera, on the one hand, and Weitek on the other.
Altera, whose PLDs are widely considered state of the art, has no chip-production facilities of its own. Instead, it has long-term manufacturing agreements with such companies as Intel, Texas Instruments (TI), and Cypress. The manufacturers, in turn, get the right to make and sell some of Altera's innovative devices for their own accounts.
These relationships don't look much like conventional procurement contracts. In a conventional contract, the buyer hands the specs to the supplier and says we'll take delivery in six weeks, or maybe every six weeks for a year. End of discussion. When Altera signed its agreement with TI in 1989, by contrast, it initiated a relationship that would last a minimum of seven years. Altera had a design for a new family of products but knew that at least a year of testing and refinement would be necessary before the products could be brought to market.
So the two companies began to work on the products together, with people and information moving freely across corporate borders. "We're in the development phase with TI now," explains Altera president Rodney Smith. "We put runs through their fab, generate test programs, generate the software to support [the part]. Within the year we'll be figuring out the process technology, and which fab it'll be manufactured in." Engineers from both companies work jointly on all these issues. By the time the new product appears on the market, they will have spent thousands of hours in direct collaboration.
Plenty of companies contract out their manufacturing when they're young, then build a plant of their own once they get big enough. Altera, however, has become more rather than less intertwined with its manufacturing partners over time. Only last April, for example, Smith took the unusual step of buying equity in one of his suppliers: he paid $7.4 million -- and has agreed to go as high as $15 million -- for an interest in the Cypress subsidiary that runs the company's most up-to-date fabrication facility.
It's a deal with remarkable benefits for both sides. As a minority owner Altera gets a guaranteed fraction of the fab's output at cost plus, along with full access to the information it needs to determine what cost really is. It also gets early access to Cypress's next-generation manufacturing technology, an area in which Cypress is a leader. Cypress -- which already has the rights to produce and sell some of Altera's products -- gets a sizable cash investment, plus a chance to run its fab closer to capacity, thereby lowering costs. And it has rights to the flagship products Altera develops in the future.
Weitek, the specialist in math-intensive chips, presents a different but no less complex model of a relationship-based company. Like Altera, it has no fab of its own, relying instead on manufacturers both here and in Japan. But the company's relationships extend into customers' shops as well as into suppliers'. Even more than Altera's, they define its way of doing business.
Rather than sell to large numbers of customers all over the world, as Altera does, Weitek designs high-performance chips for specific applications. Its chips can be found in Hewlett-Packard computers, for example, and in the workstations produced by Sun Microsystems. So Weitek chip designers have to work closely with the computer engineers who will utilize their products.
Closeness like this we all should have. When Sun needed a so-called floating-point chip for its SPARCstation 1, it asked Weitek for a design -- then sent two engineers and two costly computers over to Weitek's building to help in the development. Hewlett-Packard (HP) began buying Weitek chips -- then offered to manufacture them for Weitek in its state-of-the-art fab. Not that Weitek president Art Collmeyer has allowed his 240-employee company to be swallowed up by Sun (11,000 employees) or HP (93,000). He happily sells chips to Sun's competitors as well as to Sun. And when he agreed to use HP's fab, he did so on the condition that he could sell chips made there to other customers. Giant HP now finds itself in the peculiar position of manufacturing chips for someone else -- Weitek -- that will wind up in a competitor's computers.
So where are Weitek's borders? Eric Larson, marketing manager for HP's circuit technology group, seems to define his own giant corporation almost as a continuation of the smaller company. "We recognized that teaming with [Weitek] could provide us with access to the leading-edge technology they had," says Larson. "We could do that by becoming a supplier to them, really an extension of their manufacturing operation."* * *
In an environment as competitive as semiconductors, there are obvious benefits to specialization. Altera, for example, is by common consent the number-one company in the design of PLDs, and as such attracts the best and brightest programmable-logic engineers. Its $10-million R&D budget goes exclusively to new-product development in this field -- an expenditure matched by no one else. Relationships are a concomitant of specialization. Cypress can boost its own new-product portfolio by licensing some of Altera's, and so can spend more money on cash-eaters such as a new fab. Result: faster introduction of new products and new manufacturing processes all around.
But a relationship-based strategy has virtues of its own as well. Relationships allow an otherwise small company, for example, to leverage its presence in the marketplace. If Altera or Weitek had the same sales per employee as an integrated company such as Hewlett-Packard, the smaller companies' work forces could generate only a fraction of the revenue they do now. Relationships also help minimize fixed costs, no small matter in a cyclical business. Altera may have to spend as much as $15 million for a share of Cypress's fab. But to build a fab of its own would cost two or three times as much -- and the fab would have to be kept busy through thick times and thin.
Yet for all the benefits, the new relationship-based strategy raises some vexed questions. Altera is entrusting many of its products to some of the biggest and best-known companies in its industry. How many small companies have climbed into bed with larger ones, only to find themselves either ignored or swallowed up? And when Weitek's Collmeyer mentions that a lot of his company's chips are manufactured in Japan, you can't help worrying that the Japanese are learning the technology and are getting ready to blow Weitek out of the water.
To become mired in such worries, however, is to miss what distinguishes the new relationships from traditional alliances or contractual deals.
It's true, for example, that neither Weitek nor Altera can make chips. But where is the value in one of today's integrated circuits? "Our manufacturing cost is only 9% of the final price," explains Collmeyer. The rest of the chip's value lies in what Weitek brings to the party -- specialized design expertise, close relationships with customers, the proprietary test programs that can separate good chips from bad. That's why a Hewlett-Packard still needs Weitek even when it's making the chips in its own fab. It's also why Collmeyer loses no sleep over the Japanese. "Because they don't test our products, they don't know how we make 'em. Besides, we're doing something different every two years. By the time they caught up we'd be on to the next generation of products." Toshiba, as it happens, recently asked Weitek to provide a chip for a Sun workstation clone.
Sizable amounts of value are safely ensconced behind Altera's corporate borders as well. The company's programmable devices require specialized hardware and software to be used efficiently. Cypress, TI, and the others may make the devices -- but only Altera makes the specialized equipment necessary for their use.
In fact, Altera has seen itself grow stronger vis-à-vis its manufacturing partners, not weaker. As a start-up it cut a manufacturing-and-licensing deal with Intel, and had to give away all its designs, test programs, and so on. Observers figured the company was entrusting its chickens to a fox -- "Intel can put the parts on the market a lot faster than Altera can," said one market watcher. But highly focused Altera has outsold sprawling Intel three-to-one on products made by both companies. And every deal since then, explains CEO Smith, has been sweeter, because Altera now has expertise a big company can't get anywhere else. To obtain only a portion of Altera's second-generation products, for example, Texas Instruments granted Altera the right to use some of TI's manufacturing processes in other companies' fabs. It also agreed to pay a royalty on products TI made for its own account.
What has kept these relationships thriving, so far, is a funny combination of mutual dependence and independence. Unlike an Intel, forced into second-sourcing some of its chips by the demands of the marketplace, companies such as Weitek and Altera can't exist without their manufacturing partners. But unlike start-ups in biotechnology, for example -- which are often tied so closely to giant pharmaceutical partners they end up at their mercy -- the chip companies have been careful to spread their dependence. They typically work with three to five suppliers, shifting production from one to another when bottlenecks occur. On the customer end, most try not to let any one buyer account for more than 20% of sales. At the moment, Weitek has been riding the coattails of Sun Microsystems' explosive growth, and Sun now accounts for 40% of the smaller company's revenues. Instead of cozying up to Sun brass, Collmeyer is hitting the road cultivating other customers -- looking hard, he says, "for another Sun."
The relationships will keep on thriving, say the people who have developed them, if and only if one condition is met: that both sides gain benefits over and above what they'd gain from a standard contractual deal. "If the relationship were purely buy-and-sell," explains the CEO of another fabless chip maker, "it would be in a supplier's interest to reduce output or raise prices if capacity is tight. If there are other interests -- if, for instance, we're developing products for them or assisting them in manufacturing -- the response will be different. There's long-term self-interest being created."
Such mutual gain, of course, is precisely what enables the new relationships to overcome the us-against-them mentality that can crop up even in new-style companies. For a while after Cypress and Altera signed their first production deal, says T. J. Rodgers, the bugs in the production system were still being worked out, and the output of "good" silicon wafers varied considerably. During one quarter things went better than expected and Altera got more good wafers than the contract called for.
The next quarter? "Sure enough, one of my bright young men decides, well, we'll have to cut you below the contract so we'll be even again. From a legalistic point of view that may be reasonable. But with the extra wafers we'd given them, Altera had gone out and built up a business. Now we wipe them out? We make them go to their customers and say they can't deliver?
"I got a phone call from Rodney and he told me the problem. I said, 'Don't worry, it's not going to happen. I'll just go kick somebody in the ass.' The next day the problem was solved." Rodgers adds, however, that orders from the president can't substitute for a bottom-up understanding of the relationship; that's why it's so important Cypress gets a significant product line from the deal, not just money. "Now if they have to stay late, or whatever, they're working on our product, not just the other guy's."* * *
In Silicon Valley, there aren't many doubts that relationships are the wave of the future, so long as the Japanese are on the horizon. "Japanese companies have an amazing ability to work together," says G. Dan Hutcheson of VLSI Research, a market research firm. "They look at the long term: 'If we as a company are going to survive, we all have to survive.' That approach made Japanese industry stronger. When Americans recognized this, they began doing these alliances."
Some of the biggest U.S. chip makers have been slow to adapt and have found themselves losing markets. That's why they've been screaming so loud for tariff barriers in recent years. But while the biggies struggle, the smaller companies are doing very well indeed, not just by being agile but by leveraging their strengths into a substantial economic presence. In the emerging relationship-based branch of the business, bigger and smaller enterprises support one another, as they do in Japan, rather than trying to outmuscle or outflank one another.
Because of the Japanese, and because of its rapidly changing technology, the semiconductor industry is three steps more competitive than most businesses. But it may not take long for companies in other industries to catch on to the benefits of specialization and relationship building. It's easier to do something very, very well when it's the only thing you do. More and more, today's marketplace requires that you do something very, very well.
In semiconductors, at any rate, the new strategy has proven itself a powerful competitive tool, both for individual companies and for the United States as it confronts the Japanese. Rodgers, who has become a kind of spokesman for the upstarts in the U.S. semiconductor industry, is only too aware of both sides; asked if he expects to see more relationship building in the future, he smiles broadly.
"As an American, I hope so. As the president of Cypress Semiconductor, speaking selfishly, I hope not. Think about it! Intel and Advanced Micro Devices, my competitors, have spent so much money on lawyers. They could each own half of my fab. They could each own half of the four start-ups [sponsored by Cypress], which account for half of Cypress's growth this year. But they don't. All they've got is lawyers' bills marked paid.
"So I certainly hope that Intel and Advanced Micro Devices never learn to cooperate with each other. It's the most potent competitive weapon I've got."
FACTORY OF THE FUTURE
What's wrong with this picture? You are looking at the main manufacturing floor of a $51-million semiconductor equipment company. You count the production workers on your fingers, and you have three fingers left over. Yet this isn't some automated Japanese factory with robots laboring in the dark. There are no robots here, only the seven gowned and booted human beings.
Robert Graham, president of six-year-old Novellus Systems Inc., chuckles at a visitor's mystification. "How did we produce $51 million in shipments last year with seven people? Simple. We buy completed, tested modules from our vendors. We don't allow them in here until a week before they'll be used. In a week and a half, our seven people can put together an $800,000 or $900,000 machine."
Like the new chip companies, semiconductor equipment manufacturers such as Novellus are setting up long-term relationships with suppliers, relying on partners for all but a couple of key modules in the production process. But building and maintaining the necessary relationships is a demanding managerial art.
Vendors must first be qualified and, as Graham puts it, trained. "We look at a shop and see what kind of equipment is in it. We look to be sure they're solvent. We ask if they'll do special things for us." A welding company Novellus wanted to work with did high-quality work but didn't know how to test for vacuum tightness. "We bought them a vacuum tester and showed them how to use it."
When a problem crops up at a vendor's shop, that problem is by definition Novellus's. A laser weld on one part was never even, and the vendor complained that he just couldn't get it right. Novellus engineers paid him a visit -- and ended up buying $10,000 worth of tooling to solve the problem. If a supplier needs financial help to ensure just-in-time delivery, Novellus provides it. "We'll buy the inventory and sell it back to them," says Graham. "They don't pay until it's delivered as finished product."
Novellus's nearly incredible productivity figures -- $365,000 to $380,000 in sales per employee -- reflect the extension of the company's boundaries into its suppliers' shops. But if the productivity figure is partly illusory, the bottom line is not: aftertax earnings of 22%. "And that's in an industry," says Graham, "that's supposed to be sick."
RESURGENCE OF A REGION
Studying Silicon Valley for a master's thesis back in 1980, AnnaLee Saxenian heard what was then the standard line about the region: its growth was over. The big chip companies were building huge plants elsewhere, often overseas. Start-ups could no longer afford to enter the business. Whenever she returned to the valley over the next several years, though, both the region and the semiconductor industry seemed to be bursting at the seams.
"It kept growing and growing," muses Saxenian, now a professor of city and regional planning at the University of California/Berkeley. "Obviously we hadn't heard the whole story." Embarking on another round of research, she discovered the new wave of thriving semiconductor start-ups -- 85 new companies founded between 1979 and 1989, generating some 25,000 jobs and $2 billion in annual sales. She also found that most of these new companies were specialist producers who established close, long-term relationships with suppliers and with customers.
And what made these relationships work? The answer contradicts the common wisdom that with today's technology and high-speed communications, companies can successfully compete no matter where they are located. In many cases, says Saxenian, geographic proximity was key to the relationships. When your supplier or customer is down the street -- within biking range, as one CEO put it -- you can work out the bugs that inevitably crop up in any high-tech product development. Engineers from both companies can get to know one another, boosting the trust and teamwork necessary for collaboration. "There is no good way to [collaborate] if you're more than 50 miles away," one of the CEOs she interviewed told her.
The gloomy prognoses of 10 years ago, Saxenian points out, focused only on the region's drawbacks, such as its high costs. They missed its strengths, such as the range and depth of expertise to be found among companies within that 50-mile radius. Fortunately, the new wave of chip companies didn't.