As Moore's Law dies, the chip giants seek fresh prey

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(Bloomberg) -- After a five-year, $240 billion acquisition spree, there’s a suspicion that the nature of deal-making in the semiconductor industry may be starting to change.

The chipmakers are increasingly interested in snapping up their software cousins as they try to differentiate themselves from rivals. On Sunday, Bloomberg News reported that Arm, the British chip designer owned by SoftBank Group Corp., had reached a $600 million deal to acquire Treasure Data, a startup that specializes in making sense of big data.

This seems a long way from Arm’s core business of designing underlying semiconductor technology, which customers can then license and adapt to their own needs. But as research and development spending increases, Arm and other chip companies are trying to squeeze more profit out of every chip that’s made with their intellectual property. Offering additional software and services is a fast way to do that.

While Arm’s software revenue rose by about a quarter in the three months through March, it still accounted for just 8 percent of the $461 million in total sales. For now, Treasure Data works on pulling out consumer data for the advertising industry. Yet Arm would no doubt like to integrate the technology into its own products to help them monitor web-connected devices in the so-called “Internet of Things,” for instance in factories or cars.

This push beyond hardware is motivating some bigger deals too. Broadcom Inc. is spending $18 billion on CA Inc., a maker of software for computer networks and cloud computing. It’s harder to find much overlap with its core business, as my colleagues Brooke Sutherland and Shira Ovide have pointed out, but it’s theoretically at least a push to find a new revenue source.

A core problem for the industry is the rising cost of chip research and development. It’s becoming more difficult to keep innovating at the same pace (as shown by the demise of Moore’s Law, which foresaw a doubling of transistors on a chip every two years.) The industry has managed so far to offset rising R&D costs through a spate of takeovers that cut the number of competitors in the market, giving the chipmakers more pricing power.

That’s meant that, while R&D costs in the Philadelphia Stock Exchange Semiconductor Index rose 12.5 percent in the past year alone, its constituent members have consistently succeeded in boosting their gross profit margin.

There are probably still a few big chip hardware deals to be done, but there’s only so much consolidating an industry can do to protect profit. Another advantage of buying software makers, beyond the extra service revenue, is that it can also help the R&D process, according to Themis Prodromakis, a professor of nanotechnology and electronic materials at the University of Southampton in England.

As it becomes trickier to squeeze better performance out of chips, the game is increasingly about fine-tuning them for their ultimate application — which demands deeper knowledge of the software that will be used. Rather than constantly making chips smaller, it might be more cost-effective to spend that R&D money on priming them for the Internet of Things.

That could herald a surge in deals from semiconductor firms seeking artificial intelligence and big data software expertise. Arm’s purchase isn’t the only Treasure out there.

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