According to Dr. Walden (Wally) C. Rhines, chairman and CEO, Mentor Graphics Corp., customers pay a premium for differentiated products. Gross profit margin (GPM) percentage is the best measure for the differentiation of a manufactured product. He was speaking at the Mentor Graphics' EDA Tech Forum 2011 in Bangalore, India.
The difficulty of switching suppliers is proportional to differentiation and GPM. As an example, Apple released the Mac Classic to compete with IBM clones to regain market share in the PC industry. However, it did not gain market ascendancy. It was only when Apple introduced the iPod in 2H' 01 that things began changing. Later, it introduced the Apple iPad 2H '07. The rest is, for now, history.
Product differentiation is said to be easiest in new and emerging markets. Apple has since invested in semiconductor design, while Nokia has divested. Apple now reduces power and improves performance through design differentiation.
On the other hand, Nokia has divested of IC design as it is now difficult to create a differentiated ecosystem even for the leader (Nokia). As of now, it is using Windows Mobile 7 for developing smartphones. The question is: is the Android vs. iPhone an analogy to the PC vs. the Mac?
The smartphone market will eventually commoditize. However, this time, there has been substantial differentiation. Product differentiation does provide temporary differentiation. However, a company created infrastructure sustains differentiation. The third-party ecosystem drives a longer term differentiation.
Now, Apple isn't the only company with sustainable differentiation. Intel and AMD have also invested in application development, with Intel's x86 MPUs differentiation a prime example.
In mature commodity products, system integration reduces cost and power with increasing performance. For example, Texas Instruments' calculators are commoditized and selling well. The practise of involving education in product development has helped TI.
Differentiation in semiconductor industry
Earlier, the electronic components were not so different. Today, there are products with high growth margins. The difficulty of switching suppliers today is greatest for field programmable logic (FPGAs) due to product differentiation, infrastructure and the ecosystem. The gross margins for FPGAs are the highest among any product class in the semiconductor industry.
Switching memory suppliers is relatively easier. Margins of memory suppliers are said to be the lowest in the semiconductor industry. Margins seem to decrease with the focus on the memory market.
Product differentiation alone makes switching analog suppliers difficult. Differentiation in analog components leads to gross margins of over 50 percent. The micro-component segment generates high GPM percentage. Also, the foundry GPM percentage is influenced by the infrastructure and the ecosystem.
TI's long-term GPM has more than doubled. It divested from low profit business to get there.
A look at the top 10 companies by GPM last year would be: Linear Technology (77 percent), Altera, PMC-Sierra, National Semiconductor, Qualcomm, Silicon Labs, Intel, Analog Devices, Xilinx and Conexant (60.9 percent).
So, what are the factors that have traditionally driven semiconductors? These are: design differentiation, semiconductor IP, infrastructire, especially, applications support, and ecosystem, viz., third-party software. In the future, product differentiation will be more around design.