Not many industries are as consistently volatile as semiconductors. Year -in and year-out, working and investing in the chip industry has been akin to regularly climbing aboard a furiously fast roller-coaster ride.

During the past decade, semiconductors have suffered wild ups and downs in supply and demand. In the months leading up to the Sept. 11 terrorist attacks, chip inventories were overflowing because of widespread anticipation that demand would be strong. After the attacks, many chipmakers dramatically scaled back production. It was a tough time to survive. Predicting demand has been one of the industry's thorniest problems for decades. Chipmakers consistently build too much inventory, or not enough—often at the worst times.

As in 2001, inventory concerns in 2008 topped the industry's agenda as signs emerged of an impending global recession. This time the industry—in quite a desperate state—was so cautious about not getting burned by excess inventory that it cut production quicker and more deeply than usual. Some companies cut output by as much as 50 percent. Overall capacity utilization fell to just 50 percent, well below historic averages of 80 percent. With good reason, companies were cutting back swiftly in anticipation of a recession they suspected could last years. There were signs globally that this would be the case not only in semiconductors but in the overall economy.

Slamming on the brakes turned out to be one of this industry's finest moves ever. Learning from past mistakes, chipmakers were able to reduce production and inventory costs. By slowing manufacturing they not only saved money, but set themselves up for an unexpectedly swift, if unforeseen, market turnaround.

China helped fuel fast revival

The semiconductor industry's worst nightmare, in which the market crashed and stayed at ocean-floor depths for several years, didn't happen. The market rebounded sooner and more strongly than in perhaps any previous cycle in the industry's history. Better-than-expected consumer demand returned by the second quarter of 2009. The market is now expected to grow during the next few years. The industry has traveled a long way in a short period of time.

Why did the market come back so fast? There are several reasons.

1. Economic stimulus from the U.S. and Chinese governments played a role. More money in the economy spurred consumer purchases. With the investment by China to sustain internal growth, small luxury items (laptops, media devices, and smartphones) continued to attain unexpected growth there, with a ripple effect in North America. Thanks in part to this "small luxury item" trend, the semiconductor industry experienced sustained growth in the communications and consumer-electronics end markets.

2. Regardless of the global economic recession, China's growing demand, especially for mobile handsets—each of which houses numerous semiconductor chips—remained relatively robust. In fact, according to a recent Accenture (ACN) survey of Internet-enabled consumers, 63 percent of Chinese consumers occasionally watch videos on mobile devices. Some 59 percent use Web-enabled mobile handsets, which is more than in any other country surveyed.

3. Demand for analog chips used in consumer electronics and communications equipment remained relatively strong. Thanks to the rise of smartphones, sales of analog radio-frequency and power management chips used for Global Positioning System (GPS), Wi-Fi, and Bluetooth posted consistent sales growth. State-of-the-art power management chips allow smartphone battery charges to last several hours longer than before. Likewise, the location and navigation capabilities provided by GPS technology let smartphones address the intensifying need to improve the customer experience. Analog chips also are used in other relatively hot consumer electronics products such as Blu-ray players, set-top boxes, HDTVs, and digital video recorders.

4. A growing number of corporate IT organizations are again starting to buy and upgrade communications equipment. And PC sales have held up relatively well, despite tough economic conditions.

These forces helped semiconductor makers weather the downturn, but the industry can't afford to be complacent. To capitalize on market opportunities in the new growth cycle, chipmakers still need to make fundamental, structural improvements. They need to rethink their business models and strategies to make operations lower cost, more efficient, and more effective at generating revenues and profits. There are several ways to do this, including:

Transforming the Sales Force: Creating new metrics and reward structures is key to improving sales force effectiveness. These should make sales people accountable for pure sales (driven by commissions), the health of the pipeline, the accuracy of forecasts, the time between sales stages, and conversion rates. Companies should be mindful of the profitability, opportunity cost, and strategic value of each deal—not just its size. They also should consider taking steps to ensure that the potential value of each deal is depicted accurately.

Improving Research and Development: Semiconductor companies should focus sharply on improving research and development processes by using methods such as product life cycle management and product portfolio management. It's becoming increasingly important for semiconductor companies to possess deep knowledge about specific types of chips such as microprocessors or analog devices, not just general knowledge about the larger chip universe. Companies should focus their research in product areas where they can develop a potential design advantage. (If such an advantage persists for a business cycle or two, it may force competitors to shift away.) In addition, R&D efforts should focus more on leveraging a company's unique strengths, in keeping with the industry trend in this direction.

Innovating Supply Chains: Companies should focus on innovating and optimizing their supply chains and processes, including sharpening their demand-planning procedures. In some cases it will be necessary to reconstitute supply chains. Semiconductor companies should consider integrating with their suppliers by developing and deploying extended-relationship management capabilities. This improves demand forecasts, production plans, and the acquisition of manufacturing capacity. And it allows chip companies to make better decisions and improve customer service and profit.

Planning and Fulfillment: To expand visibility and use all available information, it's best to consolidate disparate planning systems and processes across the organization into a single, unified platform. Keys to success in this area are total data quality management (TDQM) programs that train employees to improve their order entry, planning, and reporting while standardizing the system. These management programs help cut errors, reduce the number of human touches on a given order, and enable better decision making. This results in more realistic and meaningful capacity planning and demand forecasts.

becoming valued-added chipmakers

A growing number of companies are asking us to get them ready for the market sprint that's about to begin. They are asking for help managing and monitoring engineering capacity and product inventories. Right now inventory management should be a huge priority. As with improved planning, the ultimate payoff of optimized fulfillment is the ability to provide customers with the products they need as quickly and consistently as possible.

Furthermore, companies need to become more deliberate with product offerings, product development, product innovation, R&D efficiency, product design operations, product management, human resources management, supply chain performance, inventory optimization, operational efficiency, and knowledge delivery.

In short, they need to convert themselves from transaction-based companies to value-added companies. The results will determine which ones finish as high performers during the impending industry rebound.

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