What Is Driving the AMD Foundry Spin-Off?

We will look at AMD, ATIC, Mubadala and their plans for AMD’s fabrication assets soon, but first we should explain some of the economic and industry factors driving their decisions. This article will explain vertical integration, and the next will discuss how appropriate a strategy it is for AMD. If you already know the difference between a vertically integrated IDM, a Fabless designer, and a merchant foundry, you can skip to the next article and we’ll be there in a second.

Everyone else can stick with me for a bit while I go over things. As in computing, there is a lot of jargon that is tossed around that can make financial economics confusing, but many principals are actually pretty straightforward if explained in an accessible fashion. I am not dumbing things down: we assume you’re an intelligent person who doesn’t happen to have an MBA or CFA. As it happens, I have a DMS, so I can make heads or tails of this for us almost as well as I can help with your PC hardware. If you get frightened by all the capitalist banter, cling to my leftist-looking beard.

All this means is that you try to grow your organization by developing the ability to produce its own supplies (backward integration, like a sausage maker buying a hog farm), or the ability to get its own product into consumer’s hands (forward integration, like a sausage maker buying a butchers shop). A sausage maker that has its own farms and its own shops would be said to have balanced vertical integration. This is different than horizontal or lateral integration, where you grow by buying other businesses in the same industry (the sausage maker buys other sausage makers).

A technological example of backward integration would be the common practice of a software publisher buying a software development house. In the semiconductor industry, a company that designs and manufactures chips is called an Integrated Device Manufacturer, or IDM (like Motorola, Samsung, or, for the time being, AMD); a firm that designs semiconductors and contracts out to have them made is called Fabless (i.e.: having no fabrication, like NVIDIA) and the businesses to which the manufacturing is contracted out are called Merchant Foundries, or just Foundries. These aren’t hard and fast definitions: many IDMs also offer Foundry services.

Actually, that is how the Foundry idea got started. Fabless companies, along with government and academic researchers, relied on excess capacity from IDMs. The IDMs were happy to keep their expensive fab lines running when they didn’t need them for their own products, but the Fabless customers could get left out in the cold if the capacity was needed internally. Also, if you just designed a mobile phone chip far better than what is out there, you might be wary of sending the plans off to Motorola to get it made, an immense complication in terms of nondisclosure and non-competition components of a contract.

Until the Taiwan Semiconductor Manufacturing Company, the first “pure-play” Foundry, hit the scene in 1987, that was the situation for Fabless companies. TSMC success and the other Foundries that have started since lend some credence to the business model.

Forward integration is more visible, since it involves where you and I buy our stuff. Perhaps most famous is The Apple Store. Buy something there and Apple not only keeps the retail markup in addition to their manufacturing margin, but they control how the place looks, how the staff is trained and managed, what goes on sale, when something gets taken off the shelves, and so on. That is crucial to Apple’s biggest advantage: marketing. You don’t want the guy selling your sexy, hip, hyped product line to look like John Hodgman (PC from the ads, Daily Show Correspondent) in a Geek Squad t-shirt.

The picture on Apple's retail home page features people who aren't just friendly looking: they have funky hair and adding up the four of their ages is unlikely to break the nonagenarian boundary. The problem is, if Apple has a slow Christmas, they don’t just take the hit along with everyone else making consumer electronics; they are also paying rent and employees in shopping malls all over.

Obviously, vertical integration is not an across the board solution for corporate growth. We examine how vertical integration affects AMD next.