Semiconductor Prices on a Downward Spiral

Like a PlayStation 2 on eBay (EBAY), semiconductor prices are dropping daily.

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Perspective

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Why Did the Fed Cut Rates Today?

And despite the Federal Reserve's surprise decision Wednesday to cut interest rates -- which potentially could boost economic activity -- consumers still aren't likely to run out tomorrow and start buying the techie items that use these chips, making the possibility of a rebound in chip prices unlikely. Rate cuts take time to work, and the rate reduction's size -- half a percentage point -- raises the possibility that the economy is in worse shape than most people believed.

Consumer confidence has weakened so broadly that the Fed cited it as one of the concerns that led it to cut rates. While supply and demand imbalances may have started with commodity chips like DRAM, or dynamic random access memory, used in PCs, the effect of waning consumer confidence has spread to all chip types. Even chips going into previously hot areas such as cell phones and handheld devices may be at risk.

Here's how the PC scenario has worked. Weak demand combined with a buildup of PC and component inventory to push PC makers to lower prices. For 2001, Lehman Brothers analyst Dan Niles believes PC prices are going to decline in the high single digits on a percentage basis, and because PCs use chips, he sees a similar decline in microprocessor prices.

Waiting for Earnings

Niles' call on falling PC and chip prices comes just about two weeks ahead of earnings announcements from both chip and PC makers, putting into question the ability of blue-chip companies such as Dell (DELL) and Intel (INTC) to meet Wall Street's previously reduced expectations. When companies don't come through with promised growth, typically their stocks suffer. Already, these conditions have conspired during the past four months to push Dell and Intel far off their annual highs.

Now there are signs the downward pricing trend is accelerating. PC Data, a technology research firm in Reston, Va., said Wednesday that retail selling prices for PCs for 2000 fell to $906 from $916 in the previous year. But in December alone, those prices fell 3% from November and nearly 10% from October. Compared with the previous December, prices were off 7%.

On the chip side, the spot price for 64-megabyte and 128-megabyte DRAM, for instance, has fallen 17% to 18% since the beginning of December, according to Fechtor Detwiler, a Boston investment firm that tracks DRAM prices. On Wednesday, spot prices for 64MB chips fell 3.7% or 10 cents, to $2.60, while prices for the 128MB chip fell 2.6%, or 15 cents, to $5.50.

I Feel the Need

And this trend may be gathering speed.

Intel, maker of the industry's premium microprocessor, the Pentium IV, has begun shipping a slightly slower and thus cheaper version of the chip. The new 1.3 gigahertz chip can be put into a PC that sells for about $1,500, rather than the $2,000 or more that a 1.4 or 1.5 gigahertz Pentium IV-based machine would cost, an Intel spokesman explained. The move is part of an effort to increase the volume of Pentium IVs sold during the next year, the spokesman said. The chip was launched late last year.

In another move, one that targets the high end of the low-end PC market, Intel on Wednesday launched an 800-megahertz Celeron chip. Used in PCs that cost less than $1,000, the chip goes for $170 each in units of 1,000. The next chip down -- the previously premium 766 megahertz chip -- now sells for $155 after having its price cut from $170 in December.

While some industry analysts expect that over the first half of the year chips will work through the inventory issues that have dogged them during the past four months, the road to higher prices is much longer.

Plenty of Issues

IC Insights, a Scottsdale, Ariz., market research and consultancy group, says weak demand, additional production capacity and an inventory glut mean that chip prices are headed down for a few years.

"We do see a slight decline in overall average selling price in 2001 and 2002. That starts to increase as we get out to 2005," said Brian Matas, vice president of market research.

Of course, there's always the chance that the Fed's decision to lower rates will change all that doom and gloom. Millions of Americans could be checking out the latest Motorola (MOT) phone right now, suddenly deciding that they were wrong about not needing a new PC or maybe jumping on eBay and driving up PlayStation prices. Or not.

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