UK chips keep US at arm's length

Following the success of ARM, Imagination Technologies and Parthus, the UK is developing a nascent semi-conductor sector which...

Following the success of ARM, Imagination Technologies and Parthus, the UK is developing a nascent semi-conductor sector which allows it to compete and beat the US in a market it has traditionally considered its own.

Until recently, the problem for companies wanting to break into the semiconductor sector was the huge costs involved in setting up manufacturing operations and building a reputation for their product and company. Not to be underestimated, either, is the problem of having to compete against huge US companies such as Intel and Texas Instruments and gaining the backing of venture capitalists to take them on.

But ARM pioneered a method of diffusing these problems by concentrating on designing chips and licensing the design to companies such as Intel which, under a more traditional model, it would have seen as competition.

Now there are a few, high quality UK companies adopting ARM's model and designing the chips that will power the next stage of the high technology revolution.

UK-quoted companies such as Parthus and Imagination Technologies, as well as private companies like Arc International and Cambridge Silicon Radio have been dubbed the Silicon Intellectual Property (SIP) sector. They provide designs for semiconductor systems on a chip that are powering everything from mobile phones, games consoles and personal digital assistants to cable modems, network connection devices and internet appliances.

The pressures for semiconductor manufacturers are that increasing competition requires them to bring their products to market more quickly, but there is a scarcity of experienced silicon designers and applications engineers.

Meanwhile, the increasing complexity required of chips coupled with the inflexibility of traditional chips has led manufacturers to embrace external intellectual property sources and opened the door to the SIP sector.

SIP companies have adopted a model known as fabless (for fabrication-less, ie no manufacturing work is involved) which allows them to concentrate on developing higher performance chips which require less power but are also configurable for greater flexibility.

Once patented, these designs are then licensed to chip manufacturers which pass back a basic fee, plus a royalty per chip sold, to the designers. The licensing model is extremely powerful and profitable and circumvents the time and effort required to build a mass sales infrastructure.

The UK has always been a leader in engineering and design, but has lagged behind US competitors because of capital requirements and the fact that the home market is one tenth that of America's.

Now it appears that the tables have been turned and the quality of UK designers is allowing companies to build significant businesses.

ARM, for instance, has gone from nothing, to a FTSE 100 company with a £7bn market capitalisation in 10 years. That's an amazing performance, and justified when you consider the future profitability, the barriers to entry for competition and the market size for semiconductor design and manufacture.

Ian Mitchell is an IT analyst with stockbroker Beeson Gregory. His opinions should not be construed as investment advice.

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