Semiconductor Equipment Service Supply
Chain—Anticipating the Upturn
John Nunes, Vice President, Strategic Consulting, MCA Solutions Inc.
The technology sector took a big hit this year, with industry
veterans calling this the worst recession in history. The downturn,
coupled with an inventory correction across the electronics
supply chain, drove a "bull whip" effect that struck semiconductor
equipment manufacturers and their suppliers particularly hard.
Traditionally, the aftermarket has managed to sustain equipment
manufacturers through a downturn. In previous downturns,
equipment sales fell, but utilization of existing equipment remained
at reasonable levels, and revenue from service contracts, consumables
and other support activities remained strong. But this downturn has
been significantly worse than others. As utilization and output have
fallen dramatically, some chipmakers have taken drastic measures to
reduce operating costs—idling machines, stretching maintenance
intervals and cannibalizing existing equipment for maintenance
parts.
The good news is that business is beginning to turnaround, with
companies such as TSMC predicting growth in the second half of
2009; and a July report noted that chip inventory levels are now
down to appropriate levels, clearing the way for stockpile rebuilding
and higher sales in the second half of the year.1 But with massive
layoffs and capacity reductions, the equipment service supply chain
is in a weak position to respond to an upturn. To make matters
worse, some are predicting a real capacity squeeze in 2010. If that's
the case, there will be increased pressure on existing fabs and the
service supply chain that keeps them running at maximum capacity.
In the short term, increasing fab utilization is likely to drive a spike
in service parts demand to which equipment suppliers may be unable
to respond.
Figure 1. The High-Tech Global Supply Chain
Falling demand and inventory corrections had a devastating impact on equipment manufacturers and their suppliers.
Source: Dvorak, P. (2009, May 18). Clarity Is Missing Link in Supply Chain. The Wall Street Journal. Retrieved from online.wsj.com/article/SB124260855682928885.html.
However, there are actions equipment manufacturers can take
now to prepare for an upturn and position themselves for long-term
growth.2 Based on interviews with semiconductor equipment service
executives and leading companies in other industries,3 here are four
focus areas that will help equipment manufacturers position their
service supply chain for short-term flexibility and build capabilities
for long-term aftermarket revenue growth as the semiconductor
business moves into an upturn.
- Use leading indicators and causal-based forecasting tools to
react to changes in business.
- Assess the service supply chain to understand risks and develop
contingency plans.
- Develop new service products that are suited to the changing
business cycle.
- Develop performance-based contracts as a way to redefine your
relationship with both customers and suppliers.
Apply Enhanced Forecasting Tools to Respond to
Dynamic Business Fluctuations
The service executives interviewed emphasized the need for more
responsive forecasting methods to enhance their ability to respond
to rapid shifts in demand. They recognize that advanced planning
and optimization tools are critical to building a forward-looking
forecasting capability using a blend of historical time series and
forward-looking, economic-causal analysis.
But most companies rely heavily on a backward-looking view
to forecast, and when business levels shift, long lead times make
it difficult to respond quickly. That's certainly the story for many
suppliers in the electronics industry. Now, the service supply chain
presents a unique opportunity where demand is mostly driven by
installed base operating levels rather than buying patterns, and
operating data is often available from customers via remote data
collection tools.
To be successful coming out of the downturn, equipment
manufacturers need to work closely with customers to understand
changes to equipment utilization, throughput levels and operating
conditions, and use this information to manage their service supply
chain. Unfortunately, looking out the rearview mirror at the downturn
is not going to be helpful. This kind of forward-looking forecasting
and planning requires more sophisticated tools that make use of relevant, causal data, such as laser pulses, radio frequency (RF) hours, beam hours and wafer passes, to predict ongoing demand levels. It
also requires a higher level of collaboration and communication with
both customers and suppliers, and the elimination of buffer stocks
between customer and supplier that can make it difficult to assess
true operating levels.
Several of the semiconductor companies interviewed are already
using advanced planning solutions to develop causal forecasts based
on operating data collected at the equipment level. While they were
caught off guard by the sudden drop in demand, they were able
to react quickly to minimize the impact. With a forward-looking
approach to planning and frequent communications with customers,
they are also in a position to react quickly when business picks back
up.
If a forward-looking forecasting capability is to be effective for
ongoing service supply chain management, it must rely on both
customer operating data and installed base forecasts from product
marketing. A number of leading companies have established
formal sales and operations planning (S&OP) processes for both
manufacturing and service to obtain a consensus view on expected
demand and to develop a coordinated supply plan. While not
commonly applied to the service supply chain, S&OP is extremely
valuable, especially in highly cyclical businesses.
Assessing Supplier Risk
The ability to react to a sudden increase in service demand will
hinge on the capabilities of hundreds of small suppliers. Many of
those suppliers made deep cuts in personnel and capacity during the
downturn, and, more importantly, competitors are probably using
many of the same suppliers. Now is the time to assess the supply
base's ability to respond to an upturn and begin making contingency
plans. Looking at past demand levels against fab output will provide
an indication of how demand might increase with utilization. A
supply chain risk assessment of critical products and processes will
help identify maximum capacity levels, strategic material shortages
and bottleneck suppliers. With many equipment manufacturers
pursuing a single-source strategy, supplier capability is a key factor in
the ability to respond to increasing demand. While it will take time
to rebuild capacity, assessing the damage is the first step to recovery.
Nevertheless, understanding the capability of your suppliers is only
half the problem. There is also the need to assess supplier lead times
and capacity against various business scenarios and design a service
supply network suited to the dynamic nature of the semiconductor
industry. There has been significant consolidation across the industry,
and as business levels begin to increase, companies can expect
changes in customer demands for support and their willingness to
pay for different levels of responsiveness. These changes may require
significant restructuring of the service supply chain network and an
analysis of logistics suppliers' capabilities to deliver the required levels
of customer service.
As with causal-based forecasting, advanced modeling and
simulation tools are necessary to redesign and optimize a service
supply chain to deal with an increased level of risk beyond what
has been seen in historical cyclical variations in the semiconductor
industry.
Provide Flexible Service Products Suited to the
Business Cycle
If experts are right and demand exceeds capacity in 2010,4 there
will be extreme pressure on the service supply chain to deliver spare
parts and service that keeps fabs running at maximum capacity. With
limited capacity for rapid growth, there are bound to be supply chain
shortages as demand increases. As fab utilization increases, industry
leaders must find opportunities to develop and deploy new contract
offerings to suit the business cycle.
A number of the executives interviewed discussed new contract
offerings suited for the downturn. These executives recognized the
importance of keeping tools on contract while acknowledging that
business levels demanded a dramatic change to contract terms.
To be successful in the upturn, equipment manufacturers need
to design and deploy service products suited to increasing business
levels. The downturn has driven massive changes to both the customer
landscape and the global service infrastructure. Large semiconductor
manufacturers, such as TSMC and Samsung, will look to capitalize
on increased demand and response time for support services, which
will be critical to this strategy. New service products and contract
terms should be developed to meet this need.
Figure 2. Designing and Pricing Service Products
Source: Agrawal, N., Agrawal, V. and Cohen, M. (2006, May). Winning in the Aftermarket. Harvard Business Review. Retrieved from hbr.harvardbusiness.org/2006/05/winning-in-the-aftermarket/ar/1.
The key here is to engage with customers now in advance of the
upturn to prepare to react to their needs with service products that
add value and strengthen the relationship as partners.
Develop Performance-Based Contracts to Redefine the Relationship with Customers
and Suppliers
In traditional customer-supplier relationships, customers want
to lower their total cost of ownership by increasing product
performance, ultimately putting more demand on the support
infrastructure necessary to deliver performance and drive higher
costs for original equipment manufacturers (OEMs). Alternatively,
OEMs want to lower their costs and increase revenue and profits
through increased service revenues and future equipment purchases.
Customers are interested in seeing increased product performance
and are not interested in paying for more resources and services
needed to provide that service. Suppliers want to increase their profits
from services (and repeat business) and lower their cost in providing
support. This misalignment of incentives creates an ongoing conflict between
customers and suppliers—especially in a downturn.
In a number of capital equipment industries, most notably
aerospace and defense, there is a transition in the nature of service
contracts. Traditional relationships between manufacturers and
customers are being replaced by risk-sharing relationships commonly
referred to as performance-based contracting (PBC). In PBC, the
customer pays for the performance of the product—nothing more.
This means that it is up to the OEM to manage the maintenance
and repair of the product throughout its lifecycle and ensure that
the equipment meets the agreed upon availability and performance
targets.
Applied Materials pioneered the use of PBC in the semiconductor
industry with the introduction of its Total Service Solutions program
in the late 1990s, offering "price per wafer pass" contracts. Even still,
this hasn't been a widely adopted practice, and there has been limited
application across the industry over the past 10 years.
Table 1. Examples of Service Product Business Models
Business Model |
Product Ownership |
Terms |
Examples |
| Disposal |
Customer |
Dispose upon failure or upgrade |
Disposable cameras, cell phones |
| Ad Hoc Service |
Customer |
Pay as you go for service (time and materials) |
Consumer electronics, traditional automobiles |
| Cost Plus |
Customer |
Payment for service based on actual support costs plus agreed upon margin |
Construction, military weapon systems |
| Warranty/ Contract |
Customer |
Fixed price, paid in advance, guaranteed service targets |
Automobiles, computers, industrial capital equipment |
| Performance Based |
OEM/Service Provider |
Service payments based on actual up-time performance and unit of output |
Aircraft, aircraft engines, avionics, tires, industrial chemicals, wafer fab equipment |
Source: Agrawal, N., Agrawal, V. and Cohen, M. (2006, May). Winning in the Aftermarket. Harvard
Business Review. Retrieved from hbr.harvardbusiness.org/2006/05/winning-in-the-aftermarket/ar/1.
One of the most critical elements of PBC is the clear separation
between the customer's expectation of service and how the supplier
meets that expectation. Customer-driven efforts to prescribe how
performance targets should be achieved often multiply overall supply
chain costs without any tangible improvement in overall product
performance. The OEM is always in the best position to determine
how to achieve a performance improvement goal, but there aren't
always sufficient incentives to drive a change in OEM behavior.
A case in point in the semiconductor industry is the traditional
focus on spare parts "fill rate" as a surrogate for measuring the
impact of parts availability on equipment uptime. One equipment
manufacturer interviewed has successfully transitioned to "machine
down awaiting parts" as a more appropriate measure. This has allowed
them to increase performance while reducing overall inventory
investment with lower fill rates.
Using PBC, OEMs and their customers can effectively align
incentives by directly tying supplier compensation to product
performance and customer value. The OEM has an incentive to
achieve performance objectives at the lowest possible cost and to
take actions that would cost effectively improve the performance
of the system—which is also a significant benefit to the customer.
This gives the OEM the incentive they need to meet contractual
performance levels by separating the performance metric from the
tactical methodology behind achieving it.
While the implications of PBC can be enormous for both
OEMs and their customers, there are significant challenges to any
organization trying to implement a PBC system. These challenges
include:
- Pricing the contract correctly.
- Determining an accurate forecast of customer requirements.
- Analyzing the financial risk of a performance-based contract.
- Managing suppliers who are critical to achieving performance
objectives.
- Tracking and managing performance against contractual
metrics.
- Dealing with bad service data.
The common theme in all these issues is the need for advanced
tools and technology to measure contract performance and model
the infrastructure and costs associated with delivery target contract
performance.
Furthermore, new markets such as solar will provide an excellent
opportunity for equipment manufacturers to implement PBC.
For semiconductor equipment manufacturers, the solar market is
a unique but challenging opportunity as the market for solar fabs
includes both new customers and new geographies. To be successful
in this market, equipment manufacturers need to develop a new
business model for fab support that is built on a performance-based
relationship and addresses the changing needs of the customer over
the product lifecycle.
Summary
While this downturn has been extremely painful for the semiconductor
equipment industry, it's time to start looking forward and planning
for the future. The customer landscape and the equipment service
supply chain have changed dramatically over the past 12 months and
will continue to do so through 2010. Weaknesses in the supply chain
will create challenges during the upturn, but this is an opportunity to
re-think the service supply chain strategy and be better prepared for
future business cycles.
About the Author
John Nunes is the vice president of strategic consulting for MCA Solutions Inc.
He heads the company's strategic consulting business to help clients develop and
implement aftermarket and service supply chain strategies. John has senior
management experience in service operations and marketing at KLA-Tencor
and Applied Materials, and holds a bachelor's in mechanical engineering and
a master's in operations research from Columbia University in New York, New
York. John Nunes can be reached at john.nunes@mcasolutions.com.
References
1C(2009, July 20). Semiconductor Inventory Correction Concludes-Revenue Growth Begins.
(http://www.isuppli.com/NewsDetail.aspx?ID=20540).
2Dr. Morris A. Cohen, f. a. (2009, January 23). The Value of Aftermarket Service in a Down
Economy. Retrieved June 2009, from MCA Solutions: blog.mcasolutions.com/mca-value-of-service-in-a-downeconomy/Default.aspx?&utm_campaign=six_initiatives&utm_medium=web&utm_
content=&utm_term=&utm_source=internal.
3Dr. Morris A. Cohen, f. a. (2009, May 11). Service Matters. Retrieved May 2009, from
MCA Solutions: blog.mcasolutions.com/Blog/bid/20576/Will-Aftermarket-Service-Save-the-Manufacturing-Industry.
4Magee, M. (2009, June 22). Fab Shortage Looms. Retrieved June 2009, from TG Daily: www.tgdaily.com/content/view/42939/118/.
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