Restructuring the American semiconductor industry: Vertical integration of design houses and wafer fabricators

Recent restructuring of the fabless design segment of the U.S. semiconductor industry provides an opportunity to evaluate the role of transaction costs and international ownership in the reorganization of production systems. Beginning in 1993, a boom in global semiconductor demand strained the capacity of manufacturing facilities and squeezed design firms' supplies of fabricated wafers. This study uses a transaction cost framework to explore the vertical integration of semiconductor designers and wafer fabricators from 1994-1995. Integration into wafer fabricating was necessary because Asian governments, particularly those in Taiwan and Singapore, declined to subsidize a new round of semiconductor manufacturing investment. Fabless design firms had to shoulder large portions of fabrication investment expense or face escalating transaction costs if they relied exclusively on other firms for wafers. Some design firms bought fabrication facilities, and others entered manufacturing-equity joint ventures. On the other hand, several companies cultivated relational contracts with manufacturers, and some continued to rely on spot market contracts for wafers. A probit model associates corporate attributes with those integration choices. The results show that firm size related positively with integration into wafer fabricating. Firms that committed large proportions of their revenues to research and development were less inclined to integrate. Location with respect to Silicon Valley, the acknowledged premier center of the U.S. semiconductor industry, did not influence integration selections. The findings support the transaction cost theory of the firm and offer a different interpretation of the organization of the semiconductor industry from that advanced by proponents of the flexible specialization thesis.