The Downturn’s Impact On Startups

The strong get stronger in a downturn for reasons that aren’t readily apparent at the outset of the slump.

First of all, contracts that are in place at the outset typically don’t get canceled—at least not at first, and frequently not at all. In the system-level design world, those contracts can last as long as 18 to 24 months. Even if the number of derivative chips is scaled back, or killed altogether, there’s a cost involved in that. More commonly, companies opt to skip a process node and live with what they have longer.

Second, many of the startup companies competing with large established players in the system-level design market are funded by private investors. Those investments are made in A, B and C rounds (there are multiple other names that mean the same thing), and the funding is often doled out over periods of two years or more.

Finally, it takes time for a slowdown to really sink in. No one knows how long a downturn will last when it begins, and they don’t know how long an upturn will last. The dot-com bubble exploded violently in 2001 largely because it went on entirely too long at an unrealistic growth pace. The current downturn is following roughly the same course, filled with uncertainty because of the effects of globalization. There was less inventory, but the supply chain is much more dispersed.

Corrections eventually lead to overreactions on the part of customers, which is where the real damage to small companies gets done. The customers of the customers who develop systems now are asking for more integrated solutions rather than just chips. They want it complete with software, integrated and fully tested IP, and it has to work within a power budget that extends well beyond the chip itself.

It’s becoming too complicated—as in time-consuming and expensive—to integrate IP blocks from different vendors. It’s also too expensive to integrate point tools, which individually may be best of breed. And it may be getting to expensive to integrate homegrown tools, despite the fact that the development on those tools is already depreciated.

All of these changes take time to unfold. Market shifts are measured in years rather than months. You don’t starting looking to save pennies at first. You start with those places where you can save dollars and the lowest-hanging, most visible opportunities. IDMs outsourcing their production to foundries was an easy choice. Skipping process nodes was another. But now the focus is shifting to tools.

The first signal that something was amiss was when exit strategies for startups migrated from IPOs to acquisitions by large companies. That dramatically weakened their leverage to cash out at a premium. The next step was a sharp reduction in VC capital flowing into the ESL tools market, because with no easy exit the return on investment was far riskier. Following that came a cut in the amount of money available to EDA and ESL startups, because there was no reason to fund massive infrastructure if the companies weren’t going public.

Finally, with investments now considered riskier, venture money is shifting to lower-cost geographies such as China where the amount of startup capital needed is even lower. While labor costs are rising, it still costs less to hire engineers in China than in the United States, and a half-dozen engineers in China led by a U.S.-trained manager is much less of a financial risk than trying to build a company in Silicon Valley. It’s also much cheaper for a large company to buy an offshore startup or their IP and integrate it into their tools suite.

Add all of this together and the strong become even stronger. Downturns work in their favor because it costs even less money to add new tools or expertise. It remains to be seen whether an uptick in the market, probably beginning in the second half of this year, reverses this trend. But just as it took time to get to this point, it will take months if not years to figure out if it’s reversible.

–Ed Sperling