The Real Cost of Making Chips

The silicon chip business has some unusual economic characteristics that you won't find in most other industries.

In most manufacturing businesses, if you sell more products you also have to buy more raw materials. If you're making boats and your orders increase, you have to purchase additional wood, brass, and fiberglass to build the boats you're selling. If you make TVs, you need to buy more cathode-ray tubes (or LCD or plasma displays) to put into the TVs. When sales go up, your materials costs go up. Pretty simple.

But the chip-making business doesn't work that way. Microprocessors, DRAMs, and other chips all contain silicon, copper, aluminum, and maybe a little gold or other trace elements but those ingredients aren't the most expensive part of the chip. Unlike other tangible goods, in the semiconductor business the raw materials are essentially free. Making more chips doesn't mean spending (much) more on raw materials.

No, the most expensive part of a silicon chip is the depreciation on the equipment used to make it, including the building. A semiconductor factory, or fab, is horrendously expensive to build and maintain, to the tune of $2 billion to $3 billion dollars in construction costs, plus tens of millions per year in maintenance. And the whole facility will be obsolete within three to five years. Ouch.

That means each and every chip coming out of the fab is burdened with the enormous overhead cost of that depreciation. That depreciation is actually the biggest cost for many chips, eclipsing the expensive raw materials that went into it. It's as if chip makers taped a $5 bill to each new microprocessor.

Making more chips doesn't raise the manufacturer's costs very much. In fact, greater volume effectively lowers costs because that crushing depreciation can now be spread over more chips. Same overhead; more units. That's a good thing for both producers (them) and consumers (us). In a sense, the first chip off the assembly line costs $2 billion; all the chips after that are free. Like real estate, the material is cheap but the space is expensive. You're paying for the acreage, not the dirt.

That's why chip makers are so fanatically focused on high-volume products. They want/need to amortize their overhead costs over as many units as possible. That's also one of the reasons chips are constantly getting smaller. It's not so that they'll use less silicon or copper, it's so that more of them will fit on a single wafer, thereby increasing the yield per wafer. Semiconductors are like pharmaceuticals: very high development costs and very low unit costs. The difference is, there are more Canadian chip companies.