Here's a warning to all of you technology investors out there: Beware the firms that are outsourcing their brains.
That was one of the take-home messages Clayton Christensen left for his audience at a recent presentation. I'll explain exactly what he meant by that in a second; but for individual investors, Christensen also singled out the only U.S. semiconductor company that wasn't zombifying itself: Intel (Nasdaq: INTC).
Outsourcing and the pursuit of profits
"The problem lies with the business schools," Christensen argues, which teach future business leaders to focus on percentages -- like profit margins -- above all else. By focusing on short-term gains, which improve profitability, many firms are outsourcing their brains in the long term.
Decades ago, semiconductor companies were vertically integrated -- meaning that they were in charge of everything from gathering the raw materials necessary to make their chips, fabricating the individual parts, and assembling the chips, to planning the design and marketing campaigns.
But over the past few decades, more and more companies have outsourced the bottom levels of this process -- the gathering of raw materials and fabrication of the chips -- to firms in Asia, namely companies like Taiwan Semiconductor (NYSE: TSM) and United Microelectronics (NYSE: UMC).
Nowadays, almost all chip makers embrace the "fab-less" tag. NVIDIA (Nasdaq: NVDA) has used Taiwan Semiconductor for years; AMD (NYSE: AMD) has been using United Microelectronics to make some of their chips since 2002.
Because these Asian firms are able to fabricate the chips at a cheaper cost than AMD or NVIDIA ever could, the American firms should be the long-term winners in such deals, right?
Not so fast!
It's here where Christensen sees a problem. As these foreign companies slowly take over more and more of the manufacturing processes, they are gaining a huge knowledge advantage over their American counterparts.
Contrary to popular opinion, he asserts, the plants at Taiwan Semiconductor or United Microelectronics aren't sweatshops solely focused on pouring out as many chips as possible. Instead, they are sophisticated organizations that -- though they aren't there yet -- could one day handle the design of the computer chips.
So while chip makers like NVIDIA and AMD are gaining an upper hand in the short term by cutting labor costs, they are trading away some pretty valuable assets -- like knowledge accumulated from entire fabrication process and the subsequent loss of innovation from that lack of critical knowledge.
Without innovations coming from their own people, NVIDIA, AMD, and their fab-less cohorts could soon realize that it's Taiwan Semiconductor and United Microelectronics that are designing their own chips, which have higher capacity and lower costs. In short order, that could spell doom for the U.S. semiconductor industry.
What's a Fool to do?
Actually, if Taiwan Semiconductor and United Microelectronics design superior chips at cheaper costs, it would spell doom for all but one U.S. chip maker. As I mentioned at the beginning, that chip maker would be Intel. The U.S. company has resisted the temptation to outsource its production process and to this day is the only major U.S. player that fabricates its products.
So while it may have been late to the game in designing chips for the mobile revolution, I'm pretty confident in Intel's future. With the stock currently offering a 3.5% dividend that accounts for only 32% of the company's profits, and trading with a PEG ratio under 1, I think Intel is a great long-term bet.
I own the stock myself and have given the company a thumbs-up on my own CAPS profile.
But if Intel isn't quite for you -- because it's so late to the mobile game -- I suggest you check out our special free report: "3 Hidden Winners of the iPhone, iPad, and Android Revolution." We all know who the big players are in the industry, but this report details the lesser-known and lower-priced companies that are poised to benefit from this revolution. Get your copy of the report today, absolutely free!
