Unfortunately, the only sure way to recognize the bottom of a market is in hindsight. When Gartner Data-quest detects indications of a few quarters of flat revenue or growth in a communications semiconductor market sector, we become increasingly confident that the nadir has come and gone. But the current state of the market remains uncertain because of inconsistent revenue patterns and various external factors.

Reports of customers' delaying acceptance of orders and instances of building inventories continue. Consequently, a company that experienced, for example, sequential growth during the most recent fourth and first quarters experienced declining billings in the second quarter. Anecdotally, we hear of suppliers' being whipsawed by alternating requests to hold back orders and then to fill orders quickly. Customers themselves face uncertainty and loathe holding inventory.

Inventory, spoken as an epithet, has been the catchword of the current semiconductor industry downturn. The downturn was triggered by the accumulation of inventory, and the upturn is being determined by the elimination-through consumption or disposition-of those inventories. The timing of the recovery of each sector depends on the severity of the inventory problem and the demand for end equipment. The latter also determines long-term growth prospects and is influenced by macroeconomic conditions.

Combined, the effects of inventory and demand for end equipment are yielding a two-stage recovery process for component suppliers. First, as inventories were worked off during the past several quarters, component shipments rose from their depressed levels to a level at which component shipments track end-equipment shipments. Second, when end equipment markets recover, they contribute to continued growth of component markets.

The market uncertainty appears to be due to a gap between the timing of the two stages and market instability as suppliers and customers try to gauge and adapt to demand. In general, the systematic inventory problems of 2000 have resolved themselves, but equipment markets are not growing at pre-bust rates. Any market dependent on telecommunications carrier capital spending will fare poorly until mid-2003. The general economic downturn, compounded by concerns about terrorism and instability in the Middle East as well as accounting scandals, is also depressing demand for equipment and delaying the second stage.

Gartner Dataquest expects approximately 415 million handsets to be manufactured this year and nearly 600 million to be manufactured in 2006. In addition to increased handset production, the chip industry will benefit from the transition to next-generation data-enabled phones, which have a greater semiconductor content.

The enterprise-networking sector is also on the recovery path. Here, three guiding indicators are economic conditions, IT managers' sentiment toward spending and Gigabit Ethernet adoption.

Gartner Dataquest's research shows that IT managers' sentiment toward spending turned positive in the first quarter of 2002. Gigabit Ethernet adoption is well under way. Major PC manufacturers are incorporating Gig-E in their business desktop systems, and suppliers of Gig-E switching silicon plan to ship aggressively priced products in 2003. Although end-equipment shipment growth is tepid, Gig-E buoys the sector because the value of Gig-E products is greater than Fast Ethernet products. A further contributor to the enterprise sector is the ultrahot wireless local-area-network market.

The status of the remote and Internet access sector is less clear. Reviewing several chip companies' financial statements, it appears that the sector hit bottom in the middle of 2001. Further indications are that inventories returned to normal levels during 2001, with possible cases of inventory glut continuing into early 2002.

The dramatically lower-than-expected June quarter for GlobespanVirata, however, highlights the instability and uncertainty in the market. Growth indicators in this sector include end-user adoption of high-speed Internet services and the status of a government-spurred initiative to deploy high-speed access technologies, such as fiber to the home or fiber to the neighborhood. The challenges in the market are numerous. Gartner Dataquest expects declining central-office port shipments in the short term. Also, the transceiver chip market has become more competitive with the launch of Broadcom's products and the acquisition of Alcatel's transceiver business.

Conditions in other sectors are less clear. Decreased carrier capital spending is affecting the public-networking and telecommunications sectors and the wireless infrastructure sector. Key indicators are economic conditions and carriers' capital-spending plans.

In the public-networking and telecommunications sectors, Gartner Dataquest expects WAN/MAN access to recover before core-transport networks. "Fatter pipes" to enterprises and other network users will necessitate upgrades of wide-area networks and metropolitan-area networks, which in turn will consume excess capacity in core-transport networks.

Factors that drive increases in WAN/MAN access bandwidth include competition, government intervention and new network services. Waning competition and profitability concerns provide little incentive to established carriers to deploy high-speed fiber in lieu of milking profits from existing copper-based networks. Further, many carriers carry tremendous debt and lack the financial wherewithal to invest. Adoption of new services will be slower than desired.

Government intervention, which is less likely in the United States than in other countries, could spur growth.

In summary, recovery in the communications semiconductor sectors will be protracted. In those sectors, the risk of a gap between the first recovery stage and the second is greatest. Sustained growth is a year away.

The accompanying figure depicts our forecast of the market for semiconductors for communications system use over the next eight quarters. In the worst case, demand for wired communications systems in aggregate declines significantly in 2002 compared with 2001, and cellular-handset production fails to reach our expectations in 2002 and subsequent years. In short, the second stage of recovery is delayed until 2003.

In the best-case scenario, demand for enterprise and access network systems improves in 2002. Then, in 2003 and 2004, there is a greater-than-expected upswing in demand for cellular handsets, particularly next-generation models, which have greater semiconductor content.

Joseph Byrne is Industry Analyst of Gartner Dataquest (San Jose, Calif.).

Worldwide Forecast for Communication ICs