VIEWPOINTS : Blame IBM for Sorry State of U.S. Chip Manufacturers

With its dominant position in the computer business, International Business Machines holds a pivotal role in the U.S. economy. The company’s actions have pervasive and far-reaching effects. Unfortunately, IBM’s strength has not always been a blessing.

The state of the nation’s semiconductor industry is a case in point. U.S. semiconductor firms, particularly those making high-density memory chips, have fallen behind their Japanese competitors.

And IBM, which forged the current structure of the U.S. semiconductor industry through systematic exploitation of its power amid a lack of vigorous antitrust enforcement, is largely to blame.

Many of the factors that helped the U.S. semiconductor industry lose its early lead no longer apply. U.S. wage rates and the dollar are no longer significantly overvalued.

The Japanese market now is much more open to U.S. firms than before. Japanese firms also do not clearly receive more government assistance than do U.S. companies, which in many cases have defense contracts for new weapon systems.

The U.S. firms’ remaining drawback, and their most intractable problem, is pricing. They are losing simply because they cannot profitably match their Japanese competitors’ prices.

To succeed internationally, U.S. firms need to invest at least as much in equipment and research and development as their rivals do. But with chip prices low, many U.S. manufacturers lack the financial strength to invest heavily in the future. Meanwhile, Japanese firms are able to make that investment because of the way they are structured.

What is this structural difference? In short, it is the greater degree to which the Japanese firms are vertically integrated.

Put simply, many Japanese firms make both semiconductors and products that use semiconductors. Those suppliers gain a cost advantage in making more profitable products containing chips such as videocassette recorders.

Provides Double Benefit

That cost advantage stemming from vertical integration perpetuates itself in two ways.

First, profits earned on the VCRs and the like can pay for the development of more advanced chips. As a result, they arrive at market earlier and in larger scale. Firms unable to make comparable investments fail.

In addition, the diversified, vertically integrated firm can afford to price its chips lower since its prices need not reflect the total cost of the chips.

A diversified company’s other products that use chips can cover some of the heavy overhead costs.

The combination of higher investment and lower prices, over time, did the trick for the Japanese firms--their market share rapidly increased, at the expense of the U.S. firms that lacked comparable resources.

The Japanese firms are not the first companies, nor is the chip business the first business, to take advantage of their position that way.

My research indicates that IBM has used exactly the same tactics for decades when it has moved into new markets or is facing tough competition.

IBM has priced its products aggressively in those cases, exploiting its advantage as the world’s most vertically integrated company with the widest product line.

Internal IBM documents show, for example, that the company priced many of its System/360 computers in the mid-1960s so low that it was losing money.

Consequently, IBM drove some very substantial U.S. firms from the business such as RCA, General Electric and Xerox. IBM’s actions provoked a number of antitrust cases, but the company won them all.

Ironically, the federal government accuses Japanese semiconductor firms of dumping, or unfairly selling products at below-market prices, when they do the same.

Spurred Japanese Government

IBM has influenced Japanese industry in other ways. IBM, in fact, prompted the Japanese government to get involved in both the computer and semiconductor businesses.

The Japanese believe strongly in the value of highly competitive domestic markets, and therefore resented IBM’s domination of their large mainframe business.

In the mid-1960s, the Japanese government decided to do something about this and started to aid firms that were trying to gain more of that market.

To carry out the policy, the Japanese firms needed a low-priced supply of the fastest semiconductors.

The resulting government assistance pushed the Japanese semiconductor business ahead. Once a chip design was perfected for a Hitachi mainframe, for example, it also could be sold in the commodity chip market, yielding economies of scale. Meanwhile, more specialized U.S. semiconductor firms lacked the broader product base.

That left them unable to develop similar efficiencies, making the U.S. firms vulnerable to foreign competitors.

Why didn’t the U.S. firms diversify and achieve greater economies of scale? In my opinion, it was because IBM was standing in the way.

To begin with, IBM took away much of the U.S. semiconductor market by making most of the memory chips it needs.

On top of that, IBM’s power effectively blocked the U.S. semiconductor firms from entering the more lucrative mainframe computer business.

IBM also refused to sell its chips to other U.S. mainframe makers. Why? To make it more difficult for a firm to challenge IBM’s profitable mainframe business.

The result is that IBM’s dominance has imposed a structural gridlock over the computer and semiconductor markets.

This has prevented innovative U.S. semiconductor firms from diversifying into mainframe manufacturing, hurting them in international competition.

Left without an alternative in the domestic marketplace, U.S. semiconductor firms such as Fairchild are merging or otherwise teaming up with Japanese concerns, further consolidating IBM’s power.