February 3, 2004    Volume 11, No. 3

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$600 Million Over 10 Years For IBM's 'Trusted Foundry'
Chip Industry's Shift Overseas Elicits National Security Agency, Defense Department Response



BY RICHARD McCORMACK


The Department of Defense and the National Security Agency (NSA) have decided to take the first step in addressing a growing concern over the shift of semiconductor manufacturing capacity offshore. The two agencies are jointly funding a "Trusted Foundry" owned by IBM in Vermont to provide them with integrated circuits over the course of 10 years under a contract that is said to be worth up to $600 million. The deal was disclosed by Sen. Patrick Leahy (D-Vt.), but Leahy, IBM, DOD and NSA all said they could not comment on the project.

Sources in the government and the semiconductor industry say that NSA in particular was getting nervous about the sources of supply of advanced chips. The "take-or-pay" contract with IBM will provide the intelligence community and DOD weapons systems makers with access to state-of-the art semiconductors tailored for military and security applications.

The deal, say government and industry sources familiar with it, allows DOD and NSA to move away from the strategy of the 1990's of buying commercial off the shelf (COTS) technologies. This strategy was running its course because so many high-tech commercial products are now being produced offshore. "There is a problem with [commercial] industry not being able to meet the defense industry's needs and we have to be doing something different," says one DOD official.

Another government official says the deal with IBM, which had largely abandoned the defense contracting business, "is a shrewd place to start" because it provides DOD and NSA with access to IBM's $6-billion a year R&D facility and a foundry that deploys the latest semiconductor technologies.

"The commercial IC suppliers don't want their devices used outside their published tolerance range so that leaves aerospace and defense high and dry" in their need for chips, said one Washington defense industry official. "There has to be some middle ground and that's what we have to find."

The health of the U.S. high-tech industrial base has become a growing concern among those in the government who are dependent on advanced semiconductors for a new generation of weapons systems. New platforms being developed under DOD's "transformation" to a lighter, more agile warfighting force are built upon high-speed communication networks and the computational power necessary to process a dizzying amount of data from multiple battlefield sources and sensors. Such systems require the latest chips, which may not be available to DOD from U.S sources.

Those familiar with the IBM agreement talk about a tug of war within the Pentagon over disagreements concerning the health of the U.S. high-tech defense industrial base and whether or not something needs to be done. They say Suzanne Patrick, deputy undersecretary of defense for industrial policy, has dominated the debate by arguing that the U.S. defense industry has never been healthier.

"Suzanne Patrick points out how well we did in Iraq based on our striking technological superiority," says one military technology official. "But the segment of our national security that uses the highest technology is the intelligence community and they are in a constant war. That battle is engaged all the time."

Others in the defense technology community in Washington say that DOD and NSA have limited options in their struggle for access to leading-edge technologies. There is growing recognition that China has put in place an effective policy that is attracting the latest generation of semiconductor fabs. "China has taken a competitive move using straight industrial policy to capture this sector," says one government official. "They manipulate their currency; they've got the [14 percent] value added tax [on imported semiconductors]. They'll supply the plant for free if you put it in their industrial park. They have no income taxes. They'll supply a fully trained workforce that works at low cost."

DOD has few tools to counter these policies. It can't press China on the VAT -- that's the USTR's role. It can't forgive corporate business taxes or create high-tech industrial parks. Its only option is to develop dedicated relationships in specific technology sectors, such as the IBM Trusted Foundry.

But this will not be enough to address the growing hemorrhage of U.S. high tech manufacturing, say others. In prepared testimony before the House Small Business Committee last October, Thomas Hartwick, chairman of the DOD Advisory Group on Electron Devices, said "special arrangements with domestic chip manufactures are [a] band-aid solution that our government has put in place for the time being."

What is needed, Hartwick told the committee, is a "long-term national strategy to reverse the offshore trend." He called for "immediate government action" to address the offshore movement of manufacturing and said: "We desperately need a national strategy to maintain our leadership."

Hartwick told the committee that the structure of the U.S. high-tech industry is becoming unglued -- that innovation and design are losing their tie to prototype fabrication and manufacturing. The breakage of this link is resulting in inventions ending up "on the cutting room floor because they cannot be manufactured." In a few years, the manufacturing base in the United States may not exist to create the "mega-billion dollar industries like microelectromechanical systems or nanotechnologies," on which the defense industry will depend, Hartwick said.

Randy Isaac, vice president of strategic alliances in IBM's Technology Division, told a group assembled by the National Academy of Sciences last year for the release of its semiconductor report entitled "Securing the Future" that the United States semiconductor industry as it is currently structured "is at risk." Industry financials "are causing liquidations, consolidations and partnerships," he said. "Many companies are going fabless or fab-lite -- manufacturing is moving offshore to large-scale foundries." The United States, he said, "needs a new semiconductor partnership strategy plan."

The United States, Issac told the Capitol Hill briefing, has only 21 percent of the world's semiconductor manufacturing capacity and 25 percent at the leading edge, "and both shares are declining." R&D clusters comprised of universities, foundries, equipment makers, design service vendors and governments are forming in Shanghai and Beijing. "Design and integration capabilities will migrate with manufacturing capabilities and these realities represent a long-term trend difficult to reverse," said Isaac. "The resulting diminution of U.S. semiconductor manufacturing base has many implications including U.S. government inability to obtain needed chips reliably."

The only options for the government are to partner with U.S. industry or to rely on foreign suppliers for design and manufacture of specialized chips. "With the exit of leading-edge fabricators from the U.S. and the driving force they represent, U.S. semiconductor technology leadership degrades steadily until lost outright," Isaac concluded.

The IBM Trusted Foundry deal was spearheaded by NSA, say sources. There was a great deal of discussion within the Pentagon as to who would most benefit from the agreement. "The problem on the DOD side is how do you identify and prioritize who gets access to the fab," says one source. "Since nobody has had access to something like this before nobody knows what the real demand for specialized chips will be."


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