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TI's Strategy in the Slump: "Play Offense"

Tom Engibous has been at Texas Instruments his entire career -- since 1976. By the 1990s, the living was easy. The biggest boom in chip-industry history lifted sales of TI (TXN) -- the world's largest maker of processors for cell phones, arguably the best chip market to be in -- to a record $11.9 billion in 2000. Then came the worst downturn in chip history. And Engibous, who in the late 1990s became TI's president, CEO, and chairman, suddenly had to navigate a difficult course.

Under Engibous, TI has suffered less pain than most other chipmakers. In the third quarter, TI returned to profitability. Its sales even grew 4% sequentially and 22% year-over-year, to $2.2 billion. But the good news ends there for now: TI expects its revenues to fall 10% sequentially in the fourth quarter because of the semiconductor industry's wobbly recovery.

Still, many analysts believe that TI's wireless business will enjoy more growth than most other chip-using areas when the good times roll once again. To prepare for that day, the outfit has been maintaining its research and development, cutting fat, and improving its manufacturing processes. Engibous talked to BusinessWeek Online's Olga Kharif on Nov. 11 about the outlook for the market, the possibility of consolidation in the chip industry, and TI's latest products. Here are edited excerpts from that conversation:

Q: You've projected a decline in revenues [in the fourth quarter.] What's your sense of demand?

A: Our growth rate is parallel to [our customers'], and their growth rate is fairly stagnant.

Q: What do you think needs to happen to jump-start sales?

A: For a modest recovery, we need to see the overall economic environment change. Particularly, we need to see corporate earnings improve. But to have the really robust, fun periods that we've had in the past, we need to see a new level of functionality come into electronics.

The good news is I think we're on the cusp of that -- the ability to connect to the network wirelessly at all times and to have access to the network at home at megabits-per-second data rates. That should allow for video and picture downloads, and should drive a robust and prolonged period of growth for semiconductors. The bad news is that isn't going to be next quarter.

Q: In the meantime, the industry relies on mature markets, like PCs and cell phones, for sales. Could that change the cyclical nature of the semiconductor business?

A: I would love to tell you that we're going to have no more cycles, but I think that's naive, and with the speed at which the demand changes vs. the lack of speed at which the supply changes, I think it's inevitable that cyclicality will continue. That said, I don't think we're going to see a repeat of the blow-up of 1999 and 2000 -- and then the blow-down of 2001. I think the cyclicality that we saw prior to the 2000 time frame will be more the norm.

Q: The slower growth spells more trouble for chipmakers that are already having financial problems. Do you expect to see much consolidation in the industry?

A: During prior semiconductor cycles, there really hasn't been much consolidation. There have been more divestitures and spin-outs than acquisitions. I believe that in an industry where the rate of [technological] change is so great, and where next year's -- or even 10-year -- revenues depend greatly on this year's research and development, the cost of consolidating is such a distraction that the [penalty for it] is too great.

I think people shied away from doing acquisitions that for that reason. And I don't think we're going to see massive consolidation [this time].

Q: What's your strategy when it comes to research and development?

A: The foremost thing that we're doing during this downturn is we're not slowing our R&D investment. In fact, our R&D is the same this year as it was at the peak of the economic cycle. We're using the fact that we have a strong balance sheet and are generating more than $1 billion in cash this year to play offense.

Meanwhile, a number of our competitors have had to make significant cuts in their R&D investments. I believe that if we invest in certain areas -- such as wireless, broadband, and standard, high-performance analog products and high-performance digital-signal processing products [used in cell phones] -- we will be paid back handsomely over the next two to five years.

Q: You've just announced a breakthrough chip for wireless local-area networks, or Wi-Fi, which offer high-speed Internet access. How important is Wi-Fi for TI?

A: This is a market where we're investing in quite aggressively because we believe Wi-Fi is the de facto standard not only for home networking but also for a lot of applications in the commercial world. Today, when I turn on my notebook in my office, it's connecting to the Web through a Wi-Fi network. Still, I think the largest number of applications will be found in the home. We believe it's going to turn into a very large semiconductor market.

Q: You've made the decision this year to outsource more of your production as well. What's your manufacturing strategy?

A: We've historically run about 10% to 15% of our manufacturing through foundries [outside suppliers]. The only change that we've made in recent times is to augment some of our most recent leading-edge technology with some foundry support while the yields are in the learning stages so that we don't overbuild our capacity. That change has increased our foundry reliance by only about 5%.

We could afford to make the investment. We just believe it's a way to save a couple hundred million dollars of capital and be a little bit more efficient. W're still, at any given time, talking about building 80% to 90% of our own capacity.

We believe [having so much in-house chipmaking capacity] is a strategic advantage for us going forward. We will be rewarded for doing that more than we have in the past because of the sheer number of companies opting out of committed manufacturing capacity. A number of companies, such as [server king] Sun Microsystems (SUNW) and [global cell-phone leader] Nokia (NOK), which bet their companies on the future competitiveness of their semiconductor suppliers, [will reward our efforts]. We believe we will receive more than our share from those relationships.

Q: One concern some analysts have is that wireless phones have turned into commodities. Will a bigger share of the business help?

A: We need to distinguish between cellular phones -- a commodity business -- and the semiconductors that go into them. On the semiconductor side, the opposite [of commoditization] is happening. The business model used to be: A multinational cell-phone maker would buy one chip from TI and several other chips from other companies. It would write all of the software. So we were basically selling components.

Today, the fastest-growing segment of that industry is chipsets. In other words, if we want to sell to [phone makers], we have to have all of the components. That's a far more differentiated, less commodity-like business. There are fewer players.

Q: With wireless subscriber growth slowing, what do you expect to drive demand for cell phones?

A: The big growth in new subscribers is in Asia. What will drive [the growth in more mature markets, like the U.S.] is cell-phone replacement. And what drives replacement rates is new features. Demand has picked up a little bit with the advent of cell phones with color displays. But the new data services [for these new phones] really don't exist yet. For people who've tried them -- even people like ourselves, who are biased in favor of new wireless services -- they're less than satisfying.

But that, too, is changing on a daily basis. When those real data services get deployed and are good, we're going to see a big step up in replacement rates.

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