Is Apple’s Custom Silicon Strategy Gaining Momentum?

by Trefis Team
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Shares of Dialog Semiconductor declined by about 35% after a report in Nikkei Asian Review indicated that its largest customer, Apple (NASDAQ:AAPL), could start using its own power management chips beginning as early as next year. Dialog currently designs these chips for Apple’s iPhone. While there hasn’t been an announcement or any concrete evidence that Apple is shifting to its own power management chips, there is clearly a lot at stake for Dialog, given that Apple accounted for about 74% of its sales in 2016. Moreover, there has been a trend of Apple increasingly designing its own chips. A few months ago, UK-based semiconductor company Imagination Technologies was sold to a private equity firm after Apple said it would stop using the company’s mobile graphics chips. In this note, we take a look at why Apple is increasingly focusing on its own components and what it could mean for the company going forward.

We have a $181 price estimate for Apple, which is slightly ahead of the market price.

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Apple Is Counting On Custom Silicon For Product Differentiation

Apple has been progressively using more self-designed silicon in its devices, cutting its dependence on third-party vendors, as it looks to improve the performance of its products via tighter integration. The company’s in-house chip design team currently develops its A-series application processors, the bionic neural engine chip that handles facial, image and speech recognition as well as the wireless chips used in its audio products such as Airpods and Beats headphones. While processing power has grown in recent years, the performance improvements to end users have been incremental, and somewhat indiscernible for mainstream customers. However, battery life remains an area where progress has been relatively stagnant for years. The power management chips on smartphones control charging, battery management, and the overall energy consumption of the device, and Apple could add value by integrating its proprietary hardware and software, which could allow phones to handle tasks more efficiently.

Keeping A Check On Component Costs 

Competition in the production of smartphone parts is also fairly limited, given the high barriers to entry both in terms of technology and investment. This shifting balance of power in the smartphone market from smartphone vendors to component producers is contributing to components becoming more expensive. For instance, Apple’s bill of material costs for its 2015 flagship iPhone 6S Plus came in at $231.50, compared to this year’s iPhone 8 Plus, which has components costs of about $288, according to IHS. The higher costs are also putting pressure on Apple’s gross margins, which are down by roughly 100 bps over the last two years. By designing its own chips, Apple could reduce costs to a certain extent, though it will still have to lean on foundry companies for manufacturing. Apple will reportedly use Taiwan’s TSMC to manufacture in-house power management chips, if it decides to do so. That said, power management chips do not account for a very large component of Apple’s costs. On Apple’s latest iPhone X, the power management ICs that include Dialog’s designed ICs and the wireless charging components by Broadcom cost about $14, accounting for less than 4% of the device’s total cost base. Accordingly, such a move would be unlikely to have a meaningful impact on the company’s margins in and of itself, but Apple’s recent moves do point to a broader shift from a strategic standpoint.

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