TSMC: Trying To Keep Up with the Pack

The next step in chip density could threaten the Taiwanese leader

Over the past couple of years, during the chip industry's worst slump ever, Taiwan Semiconductor Manufacturing Co. (TSM ) had an ace up its sleeve. That card was Nvidia Corp. (NVDA ), a Silicon Valley designer of graphics chips, including those in Microsoft Corp.'s (MSFT ) Xbox game player. TSMC manufactures chips for Nvidia and for dozens of other semiconductor companies. Thanks to Nvidia's soaring sales, TSMC was able to stay in the black.

However, TSMC recently hit a serious snag, and it's pointing up the vulnerabilities of not only Taiwan's mightiest chipmaker but also its whole contract semiconductor industry. So-called foundries such as TSMC and its crosstown rival, United Microelectronics (UMC ), serve as contract manufacturers for scores of mostly American chip-design houses, such as Nvidia, Qualcomm (QCOM ), and Xilinx (XLNX ). The two Taiwanese giants account for two-thirds of the foundry business, which now produces some 10% of all the world's chips. TSMC Chairman Morris Chang and others have predicted that foundries will churn out 40% to 50% of all chips by around 2010.

That golden outlook got tarnished when TSMC tried to produce Nvidia's latest design. To cram this hot chip with 125 million transistors, a hefty 56% jump from its previous design, Nvidia used circuit lines a mere 130 nanometers wide. That's roughly 1,000 times smaller than a human hair and 30% thinner than previous-generation chips. But the first version that TSMC produced last year had big problems. For one, it generated too much heat. Fixing the glitches took six months, and only now is Nvidia shipping the new chip.

TSMC's stumble may prove costly. It prodded Nvidia to reevaluate its association with the world's No.1 foundry. Last month, Nvidia announced that it will also tap IBM's (IBM ) chipmaking prowess for advanced semiconductors. Given Big Blue's track record in pioneering new silicon technology, explains Di Ma, Nvidia's vice-president for operations, IBM's foundry "might have more to offer" when it comes to the most advanced circuit designs.

Losing a portion of Nvidia's world-beating chips is a major blow for TSMC. Chang is counting on high-end products to help stave off hungry newcomers -- the rival foundries in China, Korea, and Malaysia that are putting pressure on prices for low-end chips. Chang admits that protecting margins by offering advanced technology will grow increasingly difficult as circuit lines steadily shrink. "It's just more complicated," he says with a sigh.

Indeed, making next-generation chips will involve knowhow that few foundries possess, says Sumit Sadana, director of strategy at IBM Microelectronics. Chips with 130-nm lines mark the start of a new phase in chipmaking. From here on out, producers will have to marry innovations in materials with tweaks in basic transistor design. Just buying the latest equipment for "printing" circuits on silicon, which Sadana says has been the main focus of foundries, won't suffice for the 90-nm lines that will appear next year -- and that are already in pilot production at Intel Corp. (INTC ) and Texas Instruments Inc. (TXN )

The foundries' shortcomings have been clearly evident in 130-nm chips, says G. Dan Hutcheson, president of market watcher VLSI Research Inc. "The yields were terrible," he notes. Joseph A. Osha, semiconductor analyst at Merrill Lynch & Co., terms TSMC's 130-nm efforts a "debacle." To TSMC's chief rival, all this is a portent of dramatic change: "The days of the high-margin foundry are gone forever," according to UMC Chairman Robert Tsao.

Chang isn't caving in, though. He says that 130-nm production now accounts for about 10% of TSMC's revenue and will jump to 25% next year. "We have a lot of customers" at 130-nm, he insists. "We are meeting their demands without any difficulty."

In other words, the troubles won't dampen the foundries' momentum. In fact, their influence will inevitably increase over time, says Sandeep Vij, vice-president for worldwide marketing at Xilinx Inc., a "fabless" chip designer. With the price of a chip factory, or wafer fab, now at around $3 billion and climbing, fewer and fewer chipmakers will be able to justify the investment. And since several of the top 25 companies in the U.S. and Europe have bumped into the same problem as TSMC, Vij says, they will soon be forced to seek foundry partners.

That should be music to the ears of Morris Chang -- except for one thing. Xilinx says that UMC and IBM, its two foundries, are "far ahead" of TSMC in 90-nm technology. So Chang finds himself in the uncomfortable position of playing catch-up as he tries to convince the chip world that TSMC will continue to lead the foundry business.

Read a Letter to the Editor about this story.

By Bruce Einhorn in Hong Kong, Cliff Edwards in San Mateo, Calif., Andrew Park in Dallas, and Spencer E. Ante in New York

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