A Hiccup In The Tech Revival

Surging demand for chips and LCDs is nudging up prices and shaving margins

In some ways the tech rebound is like a shot of schnapps: plenty sweet, followed by a searing aftertaste. Although long- awaited, the tech recovery has come on fast and furious now that it has finally arrived. And that has meant tight supplies of key components like liquid-crystal display panels and memory chips. Products are selling briskly, but some industry players are paying a hefty price to get vital parts.

It's a problem that could fester for much of 2004. After unexpectedly strong demand, particularly the 15%-plus growth in new PC purchases over the past three quarters, makers of everything from laptops and flat-panel TVs, to cell phones and networking equipment are paying more for key parts. And while component makers are scrambling to ramp up production to meet unexpected demand, high prices could persist through much of the year. "People always expect that prices will drop month by month, quarter by quarter," says Tai-Kang Wu, president of HannStar Display Corp., a Taiwanese producer of LCDs. "But the prices have stopped dropping."

To be sure, this industry hiccup isn't likely to dampen the tech recovery. Increased component prices are offset by declining prices for other parts, such as disk drives. Overall, prices of computers continue to decline, albeit at a slower pace than usual. Corporate buyers increasingly are taking the plunge and overhauling their computer systems after a three-year drought. And consumers are still shopping, though they're likely to pay more for a flat-panel display or additional memory than they would have six months ago. All of which means that while PC makers and networking vendors could see their gross margins slip somewhat, for the most part the pain may be relatively limited.

Still, some companies could feel the component squeeze more acutely than others. Dell Inc. (DELL ), for instance, saw its stock dip 3% on May 14, the day after it announced first-quarter earnings had jumped 22%. The reason: A squeeze in dynamic random-access memory (DRAM) chips tacked on about $10 to every computer Dell sold. That cut about $20 million from Dell's bottom line for the quarter, pruning its gross margins by 0.2% to 18%. "We could see further tightness through the next six months," says Richard Chu, analyst at SG Cowen.

SUNNY ON THE SUPPLY SIDE. The equipment makers' pain means gains for component makers, however. Samsung Group, a major supplier of LCDs and memory chips, nearly tripled its first-quarter operating profits to $3.4 billion. And it's not just PC suppliers. Qualcomm Inc. (QCOM ), in its latest quarter, quadrupled profits to $488 million as demand for its mobile-phone chips exceeded supply.

But the component crunch won't last forever. Corning, for instance, which supplies more than 50% of the LCD industry's glass, is pumping hundreds of millions of dollars into increasing its capacity, including a new glass furnace in Taiwan. And analysts expect increased output from several manufacturers to gradually fill demand by midsummer. Supply chain researcher iSuppli Corp., predicts prices for LCD monitors, notebooks, and TVs will begin decreasing no later than July.

Cranking out enough DRAM chips could be trickier. That's because of a surprise surge in corporate demand for PCs. In addition, chipmakers have shifted capacity away from volatile DRAM to more promising bets like flash memory chips. The ensuing DRAM squeeze has propped up prices. Instead of the typical 28% yearly decline in DRAM prices, researcher Gartner Inc. expects prices to dip only 5% in 2004. "Prices will stay firm all year," says Gartner analyst Joseph Unsworth.

In the end, that means customers may pay $10 to $20 more for a computer -- or simply settle on a machine with a bit less memory. Even so, it's clear is that the pricier market has done little to curb buyers' appetites.

By Ben Elgin with Peter Burrows in San Mateo, Bruce Einhorn in Hong Kong, and Andrew Park in Dallas

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