Why The Chip Industry Could Get Scorched

Ordinarily, an industrial accident in a remote Japanese village wouldn't cause a stir across the Pacific. But when an explosion on July 4 gutted a plastics plant in Niihama, on the island of Shikoku, the entire global semiconductor industry felt the shock. The factory, belonging to Osaka-based Sumitomo Chemical Co., produced about 60% of the world's supply of epoxy resins used in the plastic packages that permanently house most semiconductors.

At first, chip executives fretted that shortages of resin would cripple some semiconductor production lines. Now, they're breathing easier, figuring they have two to three months of inventory available. Still, unless other suppliers ramp up production quickly, tight supplies of plastic packaging could drive up prices of dynamic random-access memories and other chips by as much as 30% by yearend. That could badly hurt big chip buyers such as U.S. computer companies, which are struggling to cut costs. At best, says Steve Myers, who is an analyst with Jardine Fleming Securities in Tokyo, "it's a serious inconvenience."

UNCERTAIN FATE. U.S. chip companies, including Intel, Micron, Advanced Micro Devices, and National Semiconductor, have rushed to reassure customers that they have adequate inventories. Japanese DRAM giants Toshiba Corp. and NEC Corp. also insist that they are covered through early fall. PC makers so far seem unruffled: "It appears that there's a sufficient pipeline of those materials," says Michael S. Dell, CEO and chairman of Dell Computer Corp. In private, though, some are less sanguine. "This is really a crisis," says one Japanese chip company executive. "Japanese manufacturers are all trying to keep it quiet. But no company has sufficient inventories."

Right now, the biggest problem is the uncertain fate of the Sumitomo plant itself. Police have sealed off the Niihama facility while they investigate the cause of the explosion, so Sumitomo can't assess the damage or predict how quickly it can rebuild. Three other Japanese companies producing smaller quantities of high-grade resin could pick up some of the slack, and Dow Chemical Co. and Swiss-based Ciba-Geigy Ltd. also have the knowhow. But the resins business has notoriously low profit margins. No company wants to shell out millions of dollars to crank up new facilities, only to see Sumitomo come roaring back in six months or a year.

Even Dow, which was driven out of the market by a price war in early 1992, can't easily reenter the business. Chip manufacturing is nothing if not a precise science, and the faintest trace of chloride or other contaminants can lead to corrosion and malfunction. As a result, there's a "qualification" period of up to three months for monitoring all materials purchased from a new supplier. Not everyone is convinced new entrants will brave that vetting. "The biggest concern," says S.G. Warburg Securities (Japan) Inc. senior analyst Chuck Goto, "is whether new sources of resin can be found and whether chip companies can respond fast enough in getting themapproved."

"WINDFALL." Sumitomo President Akio Kosai hopes they can. In an attempt to support customers and fend off criticism, his company has asked Dow, Ciba-Geigy, and Nippon Kayaku Co. to begin or increase production to fill the gap. Japan's Ministry of International Trade & Industry is quietly lobbying for the same solution. But executives at Dow, for one, say they haven't decided whether to get back into the market.

If they choose not to, the Sumitomo explosion could actually end up benefiting Japanese and Korean chipmakers. The industry is on the verge of a glut in memory chips, because over the next six months as many as three huge wafer-processing plants will come on stream in South Korea and Singapore. Many of those chips won't reach the market right away if there aren't plastic packages to put them in, and that could keep prices high. Especially if large customers in America try to lock in long-term contracts at current prices, "there could actually be a windfall for Japanese chipmakers," says Warburg's Goto.

Such effects won't last forever. Even worst-case scenarios acknowledge that Sumitomo will return to capacity within 18 months. Nevertheless, for the next year or so, tremors from the explosion in Niihama may continue to be felt around the world.

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