texas instruments mba pricing project

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Texas Instruments Pricing Project

Charles Laffiteau

July 29, 2009

Texas Instruments Pricing Project Charles Laffiteau

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Executive Summary: TI Pricing

Texas Instruments (TI) is a global leader in the semiconductor manufacturing

industry. Since they are used in so many products, semiconductors are viewed as

commodities, which results in vast competition. Manufacturers try persistently to

differentiate themselves so that they can sell their products at a premium and protect

themselves from the price wars that often result in commodity industries.

TI relies heavily on sales of semiconductors and in 1994 enjoyed total sales of

$10.3 billion. TI’s Semiconductor Group uses 90% of TI’s chipmaking capacity to

manufacture standardized chips that were considered commodity products. Differentiated

chips use the remaining 10% of TI’s capacity, but because there were no substitutes in the

market, TI was able to demand higher prices than it could for standard semiconductors.

TI uses both original equipment manufacturers (OEM) and electronics distributors

as their method of channel entry. Most medium to large sized OEMs purchase

semiconductors directly from manufacturers, such as TI, in order to negotiate lower

prices. Distributors could not provide much lower prices, but they were able to handle

other important details such as logistics, material flows, sales and servicing. These

services plus a wide variety of chips to choose from are attractive to smaller OEM’s.

By 1995, the electronics distribution industry’s consolidation left 7 or 8 powerful

competitors in control of the distribution market. This impacted the relationships between

semiconductor manufacturers and distributors, by placing increased buying power in the

hands of distributors and eroding the pricing power of semiconductor manufacturers.

Semiconductor prices often determined a distributor’s buying decisions, due to

the product’s commodity status. TI’s Semiconductor Group used forward pricing and

continuous price negotiations with distributors to determine the prices distributors would

pay. Forward pricing predicted semiconductor prices using the “product cost decreases

and yield improvements they would experience as their production volumes increased.”

To protect distributors, continuous price adjustments were also offered by semiconductor

manufacturers due to the price fluctuations caused by supply and demand in the market.

Distributors often held inventories and as the market price of semiconductors changed,

they would receive reimbursements from the manufacturer for any overvalued inventory.

Distributors had the advantage of being able to monitor semiconductor prices of

all major manufacturers by using their computer systems to continuously monitor the

prices of all chip manufacturers and then used this data to seek price matches.

John Szczsponik, director of North American Distribution of TI’s Semiconductor

Group, has noticed that the bigger distributors have become more active in the global

market, as they pursue sales in Europe and Asia. However, TI’s international distribution

channels were not subject to the same product manufacturing costs as its domestic

channels. Semiconductor production costs were higher in Europe than in North America

or Asia, and payment terms or schedules also differed. But international distributors

would often try to negotiate lower European prices comparable to North American or

Asian prices, without regard for the reasons why such differences existed.

These differences in regional prices pushed Arrow Electronics, the largest

semiconductor distributor in North America, to pressure chip manufacturers to set one

global price for each of their products. TI had to weigh the pros and cons of standardized

prices against the possibility that if they chose to continue their current pricing strategy,

the company also risked losing one of their largest distributors as an outlet for their chips.


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1. What are the reasons the semiconductor market is global? Why is it so difficult to

create a FSA or CSA? Are there any differential advantages?

The case mentioned that semiconductors were used in most, if not all, electronic

devices in a wide variety and large number of different industries. In addition to the well

known electronics giants such as Sony, Nokia and H-P, there are also hundreds of

thousands of small, medium and large companies worldwide that purchase

semiconductors and install them in their products before they are delivered to business

and consumer customers dispersed all over the world. TI’s customers include over 100

large electronics manufacturers, approximately 1,400 medium sized electronics

companies and more than 150,000 small electronics firms as customers. The electronics

manufacturing industry’s pervasiveness and the wide range of applications for the use of

semiconductors by customers worldwide attracted a lot of companies to enter this market

thus leading to the development of a truly global semiconductor market.

Of the many different kinds of firm specific advantages (FSAs) that exist, the one

that is probably most fitting for semiconductor companies is the knowledge based

advantage. However, this advantage has been difficult to maintain for several reasons.

First of all, semiconductors chips have become a price sensitive commodity item, hence

firms are not willing to invest in the large budget R&D projects required to develop new

ones. Secondly, there are so many US and Japanese companies competing in this market

with massive amounts of R&D resources (capital and labor), that no one company has

thus far been able to create a sustainable competitive advantage. These organizations are

complex entities such that the companies’ advantages in particular areas effectively

cancel each other out when you consider the company as a whole (i.e. one company

might be really good at designing the product but not as good at manufacturing it whereas

another company might be good at manufacturing chips but poor at designing them. Thus

at the corporate level their advantages and weaknesses cancel each other out.)

Regarding country specific advantages (CSAs), it is important to note that the

semiconductor industry does not use any special resource that is scarce or rare and only

available in certain countries. For example the factor conditions of the US do not favor it

over those of Japan’s. It is important to note that the semiconductor industry does require

a relatively skilled workforce, but human resources can easily flow between countries.

With the advent of more sophisticated educational institutes globally, this is no longer an

advantage for the US. Secondly as we mentioned earlier this is a truly global market with

customers all around the world, therefore the demand conditions are not very different

between countries. Hence it is difficult to create a CSA in the semiconductor industry.

There are several advantages to having differentiated products in the

semiconductor industry. Differentiated products have higher margins and are not

susceptible to price wars which are both significant advantages in an industry whose

products have a history of price volatility. Increased supplier bargaining power with

respect to distributors and OEMs is another plus since there are no substitute products

available. Finally with a differentiated product, that uses lower power or runs at a higher

speed, the company would gain market share when customers switched to TI’s chips

because of these features. Having more differentiated products would thus provide TI

with bigger margins and increase TI’s pricing power as well as its market share.


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2. What drives the need for global pricing? Any risk of gray markets? Any options

apart from global pricing?

With the increase in international distributors that sell globally, exposure to

semiconductor price fluctuations has become a prominent issue. Regional semiconductor

prices vary for the logical reason that there are differing costs of production in certain

regions. According to the case in the text, the cost of manufacturing semiconductors is

much higher in Europe than in North America or Asia1. Thus, prices from manufacturers

in Europe are higher than those from other regions. The issue of global pricing arose at as

an outgrowth of distributors’ ability to easily track the prices set by all semiconductor

manufacturers. Distributors used their price tracking data to negotiate lower prices from

different manufacturers for standardized chips because these were basically a commodity

product. Distributors then began pressuring manufacturers to set one global price in

order to lower their costs and also in an attempt to simplify the forecasting techniques

used to determine how many semiconductors distributors would need to purchase to meet

demand. Manufacturers on the other hand were hesitant to set one global price because of

the differing production costs in each country. They could not maximize their profits by

selling some semiconductors at prices lower than production costs in some regions. Also,

with a lower global price, manufacturers would not be as inclined to offer distributors

price adjustments (such as reimbursements on overvalued inventory) as they had before.

However, with standardized global pricing, the risk of gray markets developing

for some manufacturers’ semiconductor chips would be diminished. Gray markets

develop when “genuine branded goods are sold outside an authorized sales territory at

prices lower than those charged by authorized sales territories.”2 For example, if the same

product is priced at different levels in different markets, often the product is purchased in

the lower price market and then resold at the lower price in markets where the authorized

prices are higher.3 Without standardized global pricing, the semiconductor industry runs

the risk of gray markets developing in areas where semiconductors purchased in lower

cost regions such as the US or Asia, are resold in higher cost regions like the European

markets that quote higher prices for semiconductors. With standardized global pricing, it

would be much less likely for lower cost chips to be resold since all regions’ prices would

be the same. Semiconductor manufacturers, like TI, can try to prevent gray markets from

developing and continue to quote different regional prices by using different numbers on

semiconductors from each region. This would help distributors and manufacturers alike

distinguish TI chips sold legally in their markets from those available on the gray market.

TI has only a few pricing strategy options open to them. First, they can set a

standard price for all of their semiconductors. To remain profitable with this strategy,

however, they would have to raise the standard price enough so that their more expensive

production regions, such as Europe, can still achieve marginal profit over costs. This

1 Johny K. Johannson Global Marketing: Foreign Entry, Local Marketing & Global Management New

York: McGraw-Hill/Irwin (2006):603 2 Definition of Gray Market: Business Dictionary.com

http://www.businessdictionary.com/definition/gray-market.html 3 Jagdish Hiray. “All about Business and Management”

http://businessmanagement.wordpress.com/2007/07/13/gray-market/

http://www.businessdictionary.com/definition/gray-market.html



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option would satisfy distributors desire to obtain price simplification, but will also make

semiconductors on average more expensive. The second option would be for TI to keep

their pricing strategy as is, by pricing and numbering their semiconductors differently

depending on the region in which they were produced.

A third option would involve TI combining a global pricing strategy with their

current regional pricing. Since TI manufactures “standard” semiconductors and

“differentiated” semiconductors, TI could focus standard chip production in lower cost

regions in order to establish a profitable global price for chips. Standardized commodity

chips make up 90% of production, so the majority of TI’s chips would be bundled into

the standardized global price group. Differentiated semiconductors that command a

higher premium price could then be produced in more expensive regions. This strategy

would allow differentiated semiconductors that are more expensive to fabricate in Europe

to be priced at a premium that would account for Europe’s increased production costs.

3. Who has most power in the value chain from manufacturers through distributors

to customers?

The customer has the most power and the manufacturer has the least power in the

global semiconductor value chain because it is a “buyer driven global commodity chain”.

Buyer-driven commodity chains include “those industries in which large retailers, brand-

name merchandisers, and trading companies play the pivotal role in setting up

decentralized production networks in a variety of exporting countries, typically located in

the Third World.”4 Arrow has become the #1 market leader in semiconductor sales by

distributors largely through its superior logistics capabilities and through acquisitions,

(rather than organic growth) as has its largest competitor Avnet, which has the second

largest market share in the global semiconductor distributor market. But because large

semiconductor distributors like Arrow and Avnet have dealings with virtually all of the

semiconductor manufacturers, they also have access to the most up to date pricing

information for all of TI’s semiconductor competitors’ chips..

As Mr. Szczsponick of TI notes in the case study “through our negotiations with

distributors, we capture masses of data regarding the pricing levels of our competitors

and the market performance of our products. These data are critical to our ability to set

prices.”5 Given their ability to obtain semiconductor chips from a wide variety of

manufacturers and how critical distributors’ access to other manufacturers’ pricing and

product performance information is to manufacturers like TI, the distributor has more

leverage in setting prices for different types of chips than the manufacturer who actually

makes the semiconductor chips has. While the distributors depend on manufacturers to

provide them with products they can sell to their OEM customers, manufacturers are in a

weaker position relative to setting prices for their semiconductors because an unhappy

distributor can also steer its OEM customers to purchase chips made by TI’s competitors.

This loss of negotiating power in determining prices to ensure a higher return on

its semiconductor development and manufacturing investments explains why “Managers

4 Gary Geref. “Commodity Chains and Regional Divisions of Labor in East Asia.” In The Four Asian

Tigers: Economic Development and the Global Political Economy, edited by Eun Mee Kim. San Diego:

Academic Press (1998). 5 Johannson : 602


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at TI believed that higher returns were possible only by developing more successful

differentiated semiconductors.”6 Unlike standardized semiconductors, differentiated

semiconductors had capabilities that allowed manufacturers to set higher prices for them

because there were no readily available substitutes for them. So without the threat of chip

substitution in their corner, both distributors and OEM customers that use these chips in

their products have much less power in this segment of the semiconductor value chain.

In buyer-driven global commodity chains, power resides downstream from

manufacturing, in the hands of the retailers, brand-name firms, marketers, and advertisers

who “add value” to what otherwise would be just a toy, a shoe, a grape, or a spark plug.

Flexible specialization and the decentralization of suppliers have created new sources of

power for these downstream nodes, which control “the means of consumption” through

advertising, marketing, retailing, and brand-name product identification.7

Similar to the distributor (who can steer customers to a different manufacturer of

standardized chips) in global commodity value chains, the OEM customer (who provides

the end product for businesses and consumers) has more negotiating leverage than the

semiconductor manufacturer because they can always choose to purchase standardized

semiconductor chips from another manufacturer. These OEM customers also have more

power in this global commodity value chain than distributors, because they can also elect

to buy their chips from a different distributor, or in some cases negotiate the prices they

pay directly with the semiconductor manufacturer. Their ability to substitute other chips

coupled with their control of the production, marketing and retail distribution of their

products, gives the OEM customer the most leverage and power in this value chain.

4. How would you try to manage the global pricing process - by formalization of the

pricing process, economic controls, centralization, or informal persuasion? Any

other options?

TI’s distributors are pushing for a global pricing strategy that would allow them to

charge all their customers the same price regardless of where the product is being bought.

In order to analyze this question, we need to understand the nature of the semiconductor

industry and TI's specific role in it. As was mentioned in the case, most of the

semiconductor industry’s chips were considered commodity products. There was a high

level of standardization in the product (i.e. the product was not adapted to local needs)

and therefore a multi-country or regional marketing approach was not required. The price

differentials across the markets represented the difference in manufacturing costs and the

different price elasticities of the different customers. Furthermore, we can assume that

TI's strength of local resources in the global markets was relatively low. While TI’s level

of resources to manufacture the product was relatively high but the level of resources to

market, manage and negotiate prices with a multitude of smaller customers was low. This

was why price negotiation calls were referred back to Szczsponik's team at headquarters.

Based on the above analysis, we determined that because the level of marketing

standardization was high and the strength of local resources was low, of the 4 options

presented, the best option for TI was centralization. Centralization is where headquarters

6 Johannson : 600

7 Ken Conca “Consumption and Environment in a Global Economy Global Environmental Politics Vol. 1

Issue 3 (2001): 54


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sets limits for local prices (i.e. a range between a maximum and a minimum price.) This

options still gives distributors some leeway to set different prices based on country

differences (manufacturing costs etc.) With this approach, a price differential will still

exist between the countries as it does currently, but this price differential would be

reduced to a level such that it would not be profitable to buy the product in a lower price

country and ship it to the higher priced country to sell it. TI would also need to explain to

the distributors that the small price differential is primarily reflective of the difference in

manufacturing costs. Briefly looking at the other options, we felt economic controls

would not work because rationing the product would require a lot of resources to

constantly monitor and recalibrate the number of chips being made available in each

market. Formalization was already being used to an extent with their forward pricing

strategy and would not be helpful because the price differential was not due to different

strategies in planning and implementing pricing decisions but due to real manufacturing

cost differences. Finally informal coordination wasn’t needed since local autonomy in the

different markets is not as critical or important in this industry as it is in other industries.

Centralization is the best option if it is realistically implemented. However, it

remains questionable whether or not the price differential after centralization will be

reduced to a reasonable enough level that it would be acceptable to the distributor.

Therefore the centralization approach that we're recommending involves a significant

amount of internal reorganization. The case mentioned that TI sells standardized products

as well as a variety of differentiated premium products. TI should look all of these chips

costs and consider manufacturing the most price sensitive products in their lowest cost

countries and shift all the fabrication of the differentiated products to TI’s higher cost

plant locations. This reorganization would involve one time relocation costs of capital

(machinery possibly) and labor (people who were experts in these product.), but the long

term benefits are high. The benefits include a standardized global price for each type of

chip since most chips will be produced at one or two manufacturing plants. Secondly,

moving all the resources related to specific chips to one or two locations increases

collaboration and results in both a higher quality and lower cost product. TI can also

reduce the hassle associated with renegotiating prices with distributors. As mentioned

earlier, this approach requires a significant one time reorganization investment so TI

would have to do a detailed cost analysis to see if this also makes sense in the long run.

TI’s situation since 2007

The semiconductor industry actually consists of 2 parts: first designing the chips

and secondly manufacturing the chips. In order to compete more effectively on costs,

chip manufacturers are constantly working on the latest process node. A process node is

the blueprint for how to manufacture chips more efficiently since making them is a very

expensive process and quality semiconductor chip yields are extremely important. In

2007, TI announced that it would exit the process development race and outsource most

of its chip manufacturing to Taiwan Semiconductor Manufacturing Company (TSMC).8

8 Mark LaPedus Electronics Supply& Manufacturing http://maltiel-

consulting.com/Texas_Instruments_drop_digital_logic_process_development_go_fabless_maltiel_semicon

dcutor.htm

http://maltiel-consulting.com/Texas_Instruments_drop_digital_logic_process_development_go_fabless_maltiel_semicondcutor.htm




6

This was a major outsourcing move for one of the leading chip manufacturer to take in

the semiconductor industry that has since led many other chip producers to follow suit. TI

said that in the future it will focus on designing chips and fabricating differentiated chips,

leaving the manufacturing of standardized chips to TSMC and other foundries (factories).

In doing so, TI was merely following in the footsteps of many other former

manufacturers of high value computer, electronics and telecom equipment products who

began to sell their factories and outsource the manufacturing to more efficient ‘contract

manufacturers’ during the latter half of the 1990’s. Once companies like TSMC decided

to focus on fabricating rather than designing chips, they developed a competitive

manufacturing advantage over semiconductor companies that both designed and

fabricated their own chips. But this was a prescient decision by TI in another respect that

may have been anticipated by TI when it decided to focus on designing rather than

fabricating chips. While the global economic downturn has negatively impacted TI’s

sales and profits, TI’s standardized chip manufacturers are suffering even more serious

consequences. “Cheng Cheng-mount, a Taipei based economist with Citibank estimates

TSMC, the world’s biggest contract chipmaker, is running at 35% of capacity.” 9

TI is currently at parity with Toshiba as the #3 and #4 semiconductor designers

and or manufacturers in terms of both sales and market share, with each having roughly

$11.5 billion in 2008 sales & 4.3% market shares. TI’s sales and market share have been

in decline since 2006 when TI had sales revenue of $12.6 billion and a 4.8% share of the

global market for semiconductors. Most of this decline can be traced either to TI’s

decision to stop making standardized chips and or to the worldwide economic downturn

that has affected the entire semiconductor industry. Total semiconductor industry sales

revenue is projected to decline by another 19.6% in 2009 to US$199.2 billion. While

some recovery might begin slowly in the second half of 2009, it will probably be 2012

before semiconductor revenues again reach the levels achieved in 2007. “Declining

confidence levels, resulting from recent shocks and increased uncertainty about the

future, will lead to more conservative spending practices even after liquidity improves

and the economic recovery is well underway. Assuming that governments and central

banks around the world continue the aggressive fiscal and monetary actions that they

began to take in 2008 and that these actions are largely successful, growth in 2010 is

forecasted to be modest, at 11.8%, followed by 9.7% in 2011 and 8.8% in 2012.”10

Conclusions

The international marketing management learning experience that our team derived from

the TI case was a multi-faceted one involving the often conflicting business marketing

agendas of 2 separate companies that are also very dependent on each other. As a result,

this case study forced us to juggle the competing agendas of two different independent

companies that were both engaged in serving the needs of OEM customers in sometimes

overlapping segments of a single “buyer driven” global value chain, which included both

price sensitive commodity products and specialized custom products. This made the task

of developing a win-win solution for both companies an extremely difficult proposition.

9 The Economist “Mirror, mirror on the wall” (February 14,2009):52

10 Global Semiconductor Product Market Forecast - Help Wanted: Spenders and Lenders (Feb.2009)


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References

Conca, Ken “Consumption and Environment in a Global Economy Global Environmental

Politics Vol. 1 Issue 3 (2001): 53-71

Definition of Gray Market: Business Dictionary.com


The Economist “Mirror, mirror on the wall” (February 14, 2009):52-53

Geref., Gary. “Commodity Chains and Regional Divisions of Labor in East Asia.” In The

Four Asian Tigers: Economic Development and the Global Political Economy, edited by

Eun Mee Kim. San Diego: Academic Press (1998).

Global Semiconductor Product Market Forecast - Help Wanted: Spenders and Lenders (Feb.2009)

Hiray, Jagdish “All about Business and Management”


Johansson, Johny K. Global Marketing: Foreign Entry, Local Marketing & Global

Management New York: McGraw-Hill/Irwin (2006)

LaPedus, Mark Electronics Supply& Manufacturing article available at http://maltiel-

consulting.com/Texas_Instruments_drop_digital_logic_process_development_go_fabless

_maltiel_semicondcutor.htm




