Olivier Coudert's Blog » outsourcing

Why service companies will eat up EDA

Olivier Coudert — Fri, 11 Dec 2009 23:27:07 +0000

Over the past week we heard good news from Xilinx and Altera, both raising their revenue targets for Q4CY09 (Q3FY10 and Q4FY09 respectively). Both of the FPGA giants are doing fine, and are poised to grow twice as fast as the semiconductor industry. The semiconductors companies are doing well too, with TI upping its Q4CY09 guidance, National leading the forecast in industrial demand, UMC and TSMC reporting a year-to-year sales increase of 52% in November, and the overall chip sales growing 14% year-to-year in October.

It is good to learn that the customers of the EDA industry are doing better –if they do badly, EDA will do too. But will that seemingly economic improvement of the semiconductor industry translate into better days for EDA? Nothing is less certain. The recent quarterly reports of Synopsys, Mentor, Cadence, and Magma, although slightly above guidance, show a bleak outlook. Most of the book-to-bill ratios decreased, and they all carefully announcing a lean year ahead.

I recently ran into some acquaintance working for a leading semiconductor company (in the top 15), who told me that they are reaching out to services companies to get more values out of them. The numbers speak for themselves: they will put $12 millions down for an evaluation project that will encompass the full backend part of the design cycle –about 8 months project. That is only for an evaluation! When was the last time any EDA company was given that amount of cash for a real-life trial?

More numbers? Let us only look at the VLSI service companies in India, i.e., in no specific order: HCL Technologies, KPIT Cummins Infosystems Ltd, MindTree Ltd, Sasken Communication Technologies, Tata Consultancy Services, Wipro Technologies. According to the India Semiconductor Association, VLSI design service revenues in India could hit $1.13 billion in 2009, while hardware and board design could reach $560 million and embedded design and services about $7.29 billion. Yes, that’s nearly $9 billion overall, nearly twice the EDA market, and China is not even in the picture yet. Despite the dramatic downturn in 2009, some of these services companies did quite well, and most expect an uptick with a recovery in the semi industry next year.

The truth is that EDA companies have been providing software solutions that are more and more seen as commodities. The license renewal rate is dropping and its volume is decreasing. In a flat, if not slowly shrinking market, the EDA firms have to eat their competitors’ share if they want to grow or just survive. They drop their prices and fork free AE support to sweet the deal for the customer. The vast majority of the designs can be done with last year’s generation suite, thus there is no urgency to buy new design tools. Then semiconductor companies might indeed be better off with a dedicated service company, which provides hands-on design expertise, and will be judged on results, i.e., the final tapeout. This is a win-win situation: the customer can fully rely on the service company, and since this business model commands a much higher fee than for a software license, the service company can expand and further invest to be an intimate part of their customers’ flows.

EDA has better look around and see what is happening. Semiconductors companies will more and more rely on service companies, tailored to their needs. Chip design and verification looks more and more like an IP assembly that requires an expertise that EDA tools do no longer deliver. The value-added is in that expertise, not in the tools that are becoming more and more push-process.

It is true that VLSI service companies buy tools to EDA companies, but the service companies factorize the license usage between several customers, which means that overall, less licenses are needed. Today, TCS can easily rent any EDA tool from the big 3 by the week or by the month. Imagine tomorrow Synopsys, Cadence, and Mentor dealing only with the top 6 hardware design service companies, themselves servicing the top 20-30 in the semi industry: EDA will loose a lot of leverage in the sale negotiation process. If Magma ends up as a cheap provider of IC implementation solutions, all developed in India, it will lower the bar even more.

EDA has to evolve quickly if it does not want to be sidelined as just an enabler. The EDA industry must be part of the design expertise, and work closely with its customers, even if it means its solution is no longer generic. And yes, as I said in the past, the value-added is in the system-level software, and this is where resides the growth of hardware designs. So the EDA industry must go into chip software design and verification if it wants to be relevant in five years from now.

How can Xilinx improve its bottom line

Olivier Coudert — Fri, 30 Oct 2009 22:45:05 +0000

Last week I wrote a post discussing Xilinx and Altera Q3’09 results, and I mentioned Xilinx’ operation margin consistently trailing Altera’s by 3-4%. I had a few emails regarding that gap, and why that gap would be closed eventually. Let me address this topic with this post.

Comparing the yearly fiscal exercises directly would be biased (Xilinx’ fiscal year end on March 31^st, and Altera’s fiscal year on Dec 31^st). Instead we can look at a quarter by quarter comparison, even though that can be too low a level. Better is to look for ttm (trailing twelve months) comparison to smooth out the local variations.

Source: Yahoo! Finance. All figures in thousands.

One can see that Altera’s operating margin is overall better. Also in their respective Q3’09 revenue reports, Xilinx expects its Q4’09 gross margin to improve to 62-63%, and Altera sees his to be 67-68%. So a 3-4% operating margin gap will remain, which is significant.

On the other hand, Xilinx quotes 3145 full time employees, and Altera 2760. This means that a Xilinx employee brings back revenue about 26% higher than an Altera employee! So it all boils down to the question: how can Xilinx be more cost efficient?

One of the differences is the way software is developed. Altera’s software is mostly done in their technology center of Penang, Malaysia, with a very small core technology group in Toronto, Canada. Xilinx’s software team is mostly in the US, and only 5% of the team is in their R&D facilities in Hyderabad, India. A back-of-the-envelop calculation shows that if Xilinx had the same software team but with a US/India ratio 1/3-2/3, which is a healthy ratio for a company that can leverage its India facility, Xilinx would improve its operating margin by one point.

If you extend the same reasoning to whole R&D –not only software–, then it is clear that Xilinx can get the upper hand. Looking at the R&D job listings, it is also clear that Xilinx is moving into that direction. The question then is whether Xilinx has the structure and the drive to achieve such a transformation successfully.

Software outsourcing, a necessary evil

Olivier Coudert — Mon, 21 Sep 2009 01:10:43 +0000

CodeProjectHere are the definitions of two words that have a bad press, especially in these harsh economic times:

Outsourcing (included in dictionaries in 1979): the procuring of services or products, such as the parts used in manufacturing a motor vehicle, from an outside supplier or manufacturer in order to cut costs.
Offshoring: relocation by a company of a business process from one country to another –typically an operational process, such as manufacturing, or supporting processes, such as accounting.

In many service and manufacturing industries, outsourcing implies that the 3^rd-party provider is established abroad, where the cost of labor and production is lower, or where the environmental laws and ethic is held to a lower standard. Signs of the times, outsourcing is often used interchangeably with offshoring.

Massive offshoring started with textile and clothe industry in the late 70’s. Then came toys, TV, hotlines, help desks, cars and electronics in the 80’s, to be followed by software in the late 90’s. Over the past 30 years, people have accepted the idea that the products they buy and use in everyday life can be produced and assembled on another continent, where the cost of labor is lower and the labor and business laws are less restrictive –today nobody expects a toy to be produced anywhere but in China. Soon people will be insensitive to the idea that their software is designed and produced in India or China, especially if it is embedded in ubiquitous hardware like cell phones, game consoles, or digital cameras. It will even be less of a question with web-based applications, where cloud computing and distributed data centers make physical location irrelevant.

Software offshoring results from a natural evolution of the industry. Like for so many other industries, complexity required a more organized production process. Software development evolved from a highly specialized, hand-crafted process, to an application-driven, methodology-centric, maintenance-heavy operation. The availability of skilled labor and software development methodologies open the door to outsourcing, then offshoring. For long held as a high-intellectual product that could only be conceived in a handful of countries in the western world, software can now be designed, produced, and maintained in any place that have access to highly educated engineers, with a relatively simple infrastructure –computers and fast internet connections. One should rejoice to the idea of an industry that can be established anywhere innovation has the opportunity of blossoming, as opposed to a monopoly held by a few companies in a couple of countries.

Indeed, outsourcing of intangible products –e.g., service, consulting, design— and BPO (Business Process Outsourcing) which started in the early 80’s, got a huge boost in the 90’s. With the tech and telecommunication bubble, massive investments in submarine cables for intercontinental high-bandwidth communication were done. Running from Europe to India via Egypt, hub centers in Bangalore, New Delhi, Hyderabad, Chennai, Pune, and Mumbai saw their capacity increase dramatically. Soon real-time and reliable data exchange via the internet made high-tech outsourcing a reality. After being a BPO bonanza, Bangalore quickly emerged as the Indian Silicon Valley. Hundreds of software and hardware design companies set foot there, first with help centers and QA engineering, then with HW/SW supporting development teams, to finally complete design and development entities. Other countries have developed huge HW/SW outsourcing businesses –China, Philippines, and Malaysia, to name a few, as well as some east-Europe countries.

Today, the cost of a software developer in India is about a third to a fourth than in the US –the figure varies depending on the industry, and it becomes cheaper as the experience and complexity requirements decrease. In China, it will cost about a fifth to a tenth –very dependent on the industry domain, as well as the location in China. Major US and European high-tech companies like Oracle, ST, Intel, Adobe, SAP, IBM, Microsoft, Google, Yahoo!, have very large R&D campuses in India and China. For many, their facilities in India are the biggest outside of the US. For some, most of the R&D growth is seen outside of the US/Europe. It is not rare to see successful high-tech companies, created in the Silicon Valley 10+ years ago, but with 90% of their R&D today outsourced in Asia.

As a consumer, pretty much nobody complains about outsourcing: in today’s world of rapid consumption of electronic gadgets and complex software, one needs to spin new products at a rapid pace and for an ever more competitive price. However, offshoring costs jobs at home, which eventually translate to lower disposable incomes and additional social costs, both negatively impacting the local economy. The creation of wealth in the host country has a side effect though: increasing the disposable income abroad creates new customers for the home business, thus at the end everybody may benefit from it. This is a more positive scenario, probably true in the long run, but the lag between the disappearance of an activity and its replacement with another comes with a significant social cost.

Also we have seen offshoring displace industries entirely, and the intellectual-content of the displaced industry keeps increasing: there is virtually no textile industry in Europe and in the US, and UK’s manufacturing industry is trailing in Europe. The usual response to these displacements is that more lucrative activities replace those that moved abroad. London has long promoted the dismantlement of its manufacturing industry via offshoring as a chance to move to a service and finance fueled economy, which produces a higher added-value. But with the recent economic downturn driven by the finance industry, one cannot help though but question the soundness of that claim.

At the end, software outsourcing is here to stay: there is too much to gain for the home companies and the host countries, and the low cost of the infrastructure makes it flexible and easy to extend. On Sand Hill it is common to hear VCs asking “What is your Indian strategy?”. Some startups in the Bay Area even start from day one will a full software development team established in India, with just the executives, sales and support located in the US. Needless to say, these companies could not thrive or even get started without outsourcing part of their software development. Since they eventually contribute to the high-tech industry, one should endorse the long-term benefit.

Does that mean that being a SW/HW engineer in the Silicon Valley has become a high-risk job? Software innovation still relies on individuals with bright ideas for technology and products, thus these individuals will always be in high demand. But it has certainly become much harder for the general-purpose software developer. The Silicon Valley has benefited from a unique highly-educated engineer pool, entrepreneurs, and VC money. As long as these three components remain, there is no threat in sight. But if more and more VCs and entrepreneurs start to establish themselves in India, we will see a very serious competitor to the crown of software kingdom. Software outsourcing will not kill the Silicon Valley. Lack of innovation will.