Why Apple, Microsoft, and Others Will Take Chips In-House

Late last week, Oracle (ORCL) CEO Larry Ellison said that the company is in an acquisitions mood and that semiconductor companies might be a good fit. " Silicon is very important, software IP is very important," he said.

Oracle? Get into the chip business? Maybe it shouldn't be surprising. Two years ago, who would have seen the company buy Sun Microsystems? In industry, as in life, all things move on pendulum swings from one extreme to another. What we see now is a strong inclination for major hardware and operating system vendors -- Apple (AAPL), Microsoft (MSFT), and Oracle, as three examples -- to gain complete control over semiconductor design and production.

At one time, so-called vertical integration in semiconductors was common. Not only did more companies manufacture their own chips -- IBM (IBM) comes to mind -- but semiconductor designers had their own manufacturing plants.

That came to an end because of economics. Today, a semiconductor plant could easily cost $2 billion to build. In addition, manufacturing facilities depend on a steady stream of capital investment to stay atop improvements that can let a factory get more chips out of a single piece of silicon. While consumers have come to depend on the historic march of power and drop of cost for ever cheaper electronics devices, chip manufacturers have needed it to stay in business while remaining price competitive.

Most companies in the chip business are actually designers that either license intellectual property to others or pay a manufacturing facility (called a foundry) to make products on their behalf. Even Texas Instruments (TXN) started down this path a few years ago.

The industry has gone about as far as it could in that direction. There are only a handful of foundries, and the cost of pursuing new semiconductor designs has become astronomical. A couple of years ago, some experts told me that a single iteration of putting a chip design onto silicon, just to see if it works as intended, runs tens of millions of dollars.

At those costs, corporate customers want guarantees of return on the price of chips. Getting variants on what everyone else has little appeal. Look not just at Oracle, but at some other major tech companies and you see evidence that executives now think that again integrating semiconductor design or manufacturing could better suit their strategic plans. Apple already commissions its own chips for the iPad and iPhone 4. Microsoft obtained an ARM chip architecture license, so it can create its own semiconductors for mobile devices. IBM still has its own foundry. Oracle is looking at silicon investments. HP (HPQ) could easily afford one and has shown, by its acquisition of Palm, that it will move away from old assumptions and partnerships.

Although many acquisitions done in the tech realm have dubious value (look at much of what Google (GOOG) has bought, or HP's purchase of 3PAR), in this case I think executives have some rational arguments in their favor:

• At an in-house design center, your work is always a priority.
• Designers and the foundry focus on semiconductors that can best serve your products, rather than more general designs that could interest more than one client.
• The foundry can arrange its practices and processes around what best supports the chips you need.
• Delivery is more predictable.

Furthermore, some could reap additional benefits because of their strategic directions. For example, Apple has a strong interest in home and office automation and turning iOS devices into controllers. That would require a common framework to communicate with appliances. What better way than to sell chips with an iOS kernel to manufacturers to embed in their products?

Microsoft has an ARM license but says that it doesn't plan to make a phone using it. Given the competitive pressure from Google, Microsoft might decide to give away a mobile operating system and sell the chips that run it.

Having control and supply of silicon can be a way for hardware companies to further their own product designs and also have a lever to help push customers and markets where they want. Bundle software and hardware, save OEM customers time in design and implementation by providing tools, and a company can create an easily-protected market segment.

Related:

• Intel Tries To Shore Up Its Future By Chaining Its Chips
• Upgradeable Intel Chip Lands in a Cultural Mud Pit
• Microsoft Licenses ARM Architecture and Rocks the High Tech Industry
• Apple Eying Home Automation, Its Patents Reveal