Fabless companies refer to semiconductor companies that innovate, design, and market microchips while outsourcing the wafer processing, packaging, and testing to third-party partners. They partner with Foundries such as TSMC and Global Foundries to print designs on wafers and contract out testing and packaging services to outsourced semiconductor assembling and testing (OSAT) service providers. Clients of microchips of fabless companies are original equipment makers (OEMs) or end-user device innovators with microchips inside their products.
Notable examples of fabless companies are QUALCOMM, Nvidia, Broadcom, MediaTek and AMD. The size of fabless companies varies from having a few million-dollar revenues to more than $40 billion. For example, in 2022, the revenues of Nvidia, Qualcomm, MediaTek, and Broadcom were almost $27 billion, $44 billion, $18 billion, and $33 billion, respectively.
In addition to growing revenue, reaching $135 billion in 2023 (according to a media report), the market capitalization of Nvidia, over $1 trillion, was great news for the semiconductor industry in 2023. Besides, the upsurge of the fabless business model has been the underlying cause of the fall of Japan’s semiconductor market share, the progression of TSMC as the most advanced foundry, the advent of Taiwan as the semiconductor industry hub, and the US’s supremacy in microchip intellectual properties.
Key Takeaways
- Fabless companies innovate, design, and market microchips while contracting out wafer processing, testing, and packaging to third-party partners.
- Due to the low entry barrier, fabless companies rapidly grew, creating demand for foundry services.
- Pure play foundries like TSMC became preferred partners due to the lack of threat of intellectual property infringement and low cost for high scale advantage.
- US-based fabless companies have been playing a vital role in increasing the US market share and reducing Japan’s footprint in the global semiconductor industry.
- The rise of Taiwan as a global semiconductor industry has been due to serving fabless companies, both for wafer processing and testing and packaging.
- Due to the low entry barrier and growing microchip Innovation scope, new entrants may target fabless as an entry strategy.
- To succeed in fabless, R&D is crucial for innovating microchips to support target product evolution.
Top fabless companies
In 2022, the top five fabless companies were (i) Qualcomm (23.3%), (ii) Broadcom (16.4%), (iii) Nvidia (17.9%), (iv) MediaTek (16.6%) and (v) AMD (13.4%). Among them, four are American companies. Only one, MediaTek, is outside the USA, from Taiwan. These top five companies occupy as high as 88 percent of the revenue of the fabless segment of the semiconductor industry value chain. Interestingly, Apple is a big, fabless company. In 2017, it occupied the 5th position. Besides, Amazon, Facebook (Meta), and Google have emerged as fabless companies due to their venture to design critical chips to support their innovation agenda. For example, in May 2023, Meta unveiled its custom-designed AI microchip—MTIA. Similarly, in 2023, Amazon Web Services, Inc. (AWS) announced two AWS-designed chip families—AWS Graviton4 and AWS Trainium2.
The evolution of the semiconductor industry and the birth of fabless companies
During the first five years of the semiconductor industry, from 1947 to 1952, only AT&T (the inventing company of Transistor) was involved in designing and making semiconductor devices—transistors and diodes. However, the semiconductor industry started with issuing the license of Transistors by AT&T’s Bell Labs to 40 companies at a licensing fee of $25,000 each. These licensees and other companies entering the semiconductor industry developed their in-house capacity to design and produce semiconductor devices. They are called IDMs—integrated device makers. IDMs own and operate their silicon-wafer fabrication facilities. They develop their process technology for manufacturing their chips. IDMS also performed the assembly and testing of their chips.
Due to the high capital investment need, notably for foundry, the entry barrier in the semiconductor industry was very high. However, the vertically integrated model of the semiconductor industry started to change in 1985 with the establishment of the first fabless company—called Chips and Technologies. In addition to the low entry barrier for Startups, IDMs found fabless startups to be the customers of their excess fab capacity. Hence, due to the merit of the fabless business model, there was a surge in the formation of fabless startups, reaching almost 500 by 1995.
Engineers in these newly formed companies started designing and selling microchips without owning expensive foundries. However, more or less all of them were the US based. This model accelerated further with the establishment of a pure-play foundry by Dr. Morris Chang in Taiwan in 1987—Taiwan Semiconductor Manufacturing Company (TSMC). In this rapidly growing business model, TSMC became the cornerstone for its role as a non-competitive and dedicated manufacturing partner for fabless companies.
Role of fabless companies in Japan’s loss and USA’s rise of semiconductor market share
During the birth year of the fabless model in the semiconductor industry in 1985, Japan had a market share as high as 50 percent of the global output of semiconductor devices. Even in 1988, Japanese companies accounted for 51% of worldwide sales. However, since then, Japan’s share of global semiconductor output has been falling, reaching 9 percent in 2022.
One of the primary reasons for Japan’s steady decline in semiconductor output has been due to the growing market share of US-based fabless companies. Data indicate that from 1985 to 2005, Japanese companies lost 20 percent market share, while the USA gained the same percentage point during that period. Interestingly, US-based fabless companies gained market share from nothing to 20 percent of global semiconductor output during this time. These US-based fabless companies were creating new markets, such as mobile devices for the semiconductor industry. Unfortunately, despite having strong manufacturing capability and domestic demand, Japan could not develop fabless companies.
Rise of TSMC and Taiwan’s semiconductor industry due to fabless
The fabless business model created two significant segments of the semiconductor industry value chain—foundry and OSAT. Taiwan holds approximately 64 percent of the global semiconductor foundry market, followed by South Korea with 17 percent and China with 6 percent global share (based on 2020 sales data). In addition to leading the foundry segment through TSMC’s 56 percent global share, Taiwan also has also established a strong foothold in the OSAT segment. Notable Taiwanese OSAT companies offering microchip testing and packaging services to fabless companies are ASE, PTI, and KYEC. ASE alone has more than 30 percent of the global OSAT market share.
Besides Foundry and OSAT, Taiwan has also made substantial progress in the fabless companies, generating more than $40 billion in revenue in 2022. Its MediaTek has already attained the 4th position. In addition to the growing market share, Taiwanese companies have far higher net margins than the industry average. For example, TSMC’s net margin is around 30 percent.
Growing monopoly power of foundries due to the rise of fabless
Due to growing capital investment and R&D scope of optimization, Economies of Scale advantage of foundries have been growing. On the other hand, due to the low entry barrier, fabless companies’ population and market share have been growing. Besides intellectual property infringement threats, IDMs like Intel have been facing obstacles to expanding in the foundry segment. Such a reality has been working in favor of pure-play foundry service providers like TSMC. Due to the high cost and learning barrier, operating at the latest node has become feasible only for the winner, TSMC. Such a reality is the recipe for attaining price-setting capability by the winner. Hence, we should not be surprised by the reporting of TSMC’s gross profit margin of 59.6% in December 2022.
The fabless model has been weakening IDMs such as Intel
Due to the cost advantage distilling from economies of scale and process node superiority of TSMC, fabless companies like AMD have been taking away market share from IDMs. On other hand, OEMs like Apple have migrated from using the microchips of IDMs like Intel to their proprietary designs—fabricated by third party foundries. As a result, despite the growing financial performance of fabless, foundry, and OSAT companies, IDMs like Intel and Tis have been struggling to remain afloat.
Building fabless companies and growing opportunities
Almost all industrial products and production processes have been evolving with growing microchip density. Conventional products like automobiles have an increasing role of microchips for improving performance and safety. Ubiquitous mobile internet has also made it feasible to connect all kinds of products, making them the Internet of Things (IoTs). Besides, an opportunity to make industrial products artificially intelligent through real-time data gathering and processing has been becoming a profit-making possibility. Consequentially, there has been a growing demand for microchip innovation. Hence, the opportunity for entry of fabless companies has been expanding.
Leveraging fabless as an entry option for building and reviving the semiconductor industry
Due to its growing importance, several countries have a strategic initiative to build the semiconductor industry, either by making an entry or reviving it. Initiatives of the USA, Japan, India, China, and the European Union are notable. For example, Japan has come up with a $13 billion state subsidy for developing the latest node foundry capacity. One of the prominent Japanese initiatives has been the Rapidus project to set up a 2nm foundry.
Besides, the USA’s Chips Act is entirely highlighted, allocating $52 billion in public money. Similar initiatives have taken root in the European Union and member countries. India’s $10 billion public-funded program is quite visible among the less developed countries. In all these significant initiatives, offering subsidies for attracting or expanding foundry and OSAT capacities has been the cornerstone. For example, India has provided a 70% subsidy to Micron’s capital expenditure for setting up its testing and packaging facility in India. However, the history and implications of the fabless business model suggest that aspiring new entrants should invest in developing the fabless companies. In addition to evolving products and processes through next-generation microchips innovation, the footprint in fabless will create local demand for foundry and OSAT services.
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