Porter's Five Forces Analysis on Avago and Broadcom

PORTER’S FIVE FORCES ANALYSIS ON AVAGO AND BROADCOM

Buyer Power: Medium/High

There is a high concentration of customers in both Avago and Broadcom. Avago’s top ten direct customers collectively account for 57% of net revenue while Broadcom's top 5 customers contribute 42% of revenues. Most of the buyers are large OEMs with scale, manufacturing computers, smartphones, hard drives or creating network servers. Pricing for semiconductor products is generally standard and the buying decision is primarily based on the level of infrastructure, technology and support that a provider is able to offer OEMs. Given the level of competition and high concentration of buyers, buyers have 1) ability to influence product prices, 2) ability to play companies against each other, 3) ability to demand higher quality goods. This tends to intensify competition and lower operating margin for chip makers.

Mitigants:

(i) Long Standing Relationships: Avago and Broadcom have established long standings with OEMs and 3rd party manufacturers across multiple target markets. Many of its major customer relationships have been in place multiple years and have supplied multiple products during that time period;

(ii) Research and Development and Performance Differentiation: Avago and Broadcom have devoted a large amount of R&D spend (~$3Bn) to its product development, with a focus on rapidly introducing new, proprietary products. Many of its products have grown from internal research and development efforts and have provided Avago with a competitive advantage in certain target markets due to performance differentiation. This has led to building high value-add products for its customers, which is hard to replicate;

(iii) Highly Integrated Customer Relationship: Avago’s engineers are located near many of its top customers around the world. This enhances Avago’s customer reach and its visibility into new product opportunities and enables it to support its customers in each stage of their product development cycle, from early stages of production design through volume manufacturing and future growth. Avago and Broadcom have the scale to provide such deep and integrated customer support;

Supplier Power: Low/Medium

Avago’s manufacturing operations employ a wide variety of semiconductors, electromechanical components and assemblies and raw materials. Broadcom depends on multiple foundry subcontractors (~4 – 5 key foundries) located in Asia to manufacture a majority of its products. Both companies purchases materials from hundreds of suppliers on a global basis. This diffusion of risk over many companies allows the chip giant to keep the bargaining power of any one supplier to a minimum. These supply relationships are generally conducted on a purchase order basis, which benefits from economics of scale. Company’s long-term relationships with its suppliers allow them to proactively manage technology development and product discontinuance plans and to monitor suppliers' financial health. Given the size of both Avago and Broadcom, suppliers have relatively little negotiating power over them. We deemed this risk as low / medium.

Risk of Substitute Products: Low

The threat of substitutes in the semiconductors industry depends on the segment. While intellectual property protection (i.e. patents) might stop the threat of new substitute chips for a period of time, within a short period of time, companies start to produce similar products at lower prices. Copy-cat suppliers are a major problem for companies that spend millions/billions of dollars on the creation of a faster, more reliable chip. Copy-cat suppliers could reverse engineer the system and markets a similar product for a fraction of the price. However, we note that both Avago and Broadcom’s products are technologically advanced and require special expertise to construct according to customers’ needs. These products perform very specific tasks in a very rigid computer environment; therefore, there are not a lot of substitutes for it. They are also hard to counterfeit. Counterfeit products tend to not match the speed, size or reliability in comparison to the original products. Although there are growing trend of counterfeiting products, we deem this risk as low/medium.

In addition, our research shows that Graphene could be a potential substitute to Silicon, which is commonly used to create all the semiconductor chips. Discovery of a new material could lead to newer generation of microelectronic devices but we note that research is still in early stages. We believe silicon will still be use for another 15 year or more.

Threat of New Entrants: Low

In the early days of the semiconductors industry, design engineers with good ideas would often leave one company to start up another. As the industry matures, however, the cost of entry makes it painful or even impossible for all but the biggest players to keep up with state-of-the-art operations. Long established players have had a big advantage as the industry matures over the past few decades. However, things are changing and have caused some concerns in the industry. Semiconductor companies are forming alliances to spread out the costs of manufacturing. The appearance and success of "fabless" chip makers provide attractive outsourcing manufacturing options. Chip companies are emerging leaner and more efficient. Semiconductor industry is consolidating while OEMs are starting to look at acquiring chip makers for vertical integration.

Although the possibility of new entrants seems likely, we deem the risk as low based on the following factors:

(i) Large Capital Requirements: Old technologies are quickly replaced by new ideas through fast paced innovation, which require billions of dollars in R&D to replicate the process and technology. For example, Avago and Broadcom spent ~$3Bn of R&D annually. The cost of entry makes it painful or even impossible for all but the