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Recession Invokes Dramatic Reaction in Technology Supply Chain


Are we likely to see the type of situation we saw in the late '90s?

You can't listen to a quarterly conference call from a technology company (software excepted) without the subject of double-ordering being raised. In fact, there have been a number of analysts focused on the issue as early as last summer. That may have had more to do with their bearish stance on the sector and desire to find facts to support a thesis than anything else.

But, like it or not, capacity is tight throughout the supply chain and in certain areas within semiconductors, lead-times have stretched out. That's the typical environment in which you see double-ordering. In the past (i.e. the late '90s) the perceived demand (think $$$$) motivated suppliers to add capacity. When that demand never materialized, we went through one of the biggest inventory corrections on record.

What you see in the graph below is really a dramatic change in the supply chain's ability to manage inventory. The wild fluctuations of the 1990s have long since been ironed out. More importantly, while semiconductor companies are carrying larger inventories than a decade ago, their customers are carrying dramatically less and it's far less volatile.

Currently, the supply chain stands at 110 days-of-inventory (DOI) which is below the optimal bracket of 113-116 days. Semiconductor companies are at 65 days which is below their optimal level of 68-70 days and their customers stand at 45 days, dead-center with the 44-46 days that are optimal.

The recent recession invoked a typical but dramatic reaction in the technology supply chain. As you can see in the graph of the last six quarters, the reaction to the recession was quite pronounced. Inventory days have been cut across the board with the exception of the contract manufacturers and distributors, but they tend not to carry much at any point in the cycle. Semiconductor companies overcompensated on the downside and are now just starting to work their way back up. Lastly, the communications and other hardware OEMs are very lean echoing some of the commentary we've heard on calls in recent weeks.

Are we likely to see the type of situation we saw in the late '90s now?

I don't think so. You're not hearing anything from the semiconductor side of the equation about adding much capacity in the form of new fabs. For the most part, industry capacity utilization rate has returned to the point at which it was in late 2007 (i.e. 85%-90%) as of the fourth quarter of '09. However, the capacity available is about 5%-10% below what existed two-plus years ago. And right now, there's little sign that will change in any way other than technology shrinks. That process enables the semiconductor supplier to increase output in a far more controlled and less expensive (think risky) manner as they assess the "recovery."

Expanding output via shrinks may be able to shake out any double-ordering. Then again, it may not. But the real risk to investors doesn't show its face until the new fabs start going up. Then we find out what's real and what's Memorex, and that's not likely to be an issue until 2011.
No positions in stocks mentioned.
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