Why $MU Is One of the Most Cyclical Businesses in the World?
$Micron Technology(MU)$ operates in the semiconductor memory industry, which has long been in a notoriously boom-and-bust cycle.
This cycle is driven by the incredibly strong demand elasticity of the memory industry.
When demand is high, prices rise rapidly as users of memory chips race to secure supply. This is exactly what we are seeing now. Memory is an input in the final product, which can’t be shipped without memory.
It takes years and costs $10-20B to build new fabs, so memory makers can’t quickly increase supply, further driving higher prices.
When prices are high, manufacturers look for ways to reduce memory requirements, reducing specs or changing designs.
Let’s not forget that high prices also incentivize suppliers to increase production. So, memory manufacturers all at the same time race to invest in capacity to increase supply. While it takes years for the additional supply to reach the market, it does at the same time.
Supply explodes, and pricing collapses.
The same factors that make increasing supply quickly difficult also make decreasing supply a non-starter. Once built, foundries must operate constantly, as the equipment that they spent billions on degrades while interest costs pile up.
In this industry, raw material input costs are a lower share of total costs than the depreciation of equipment.
Simply put, by shutting down foundries, memory makers will lose more money than by selling each chip at a loss.
Furthermore, Micron’s business is also complicated by the bullwhip effect!
It’s a supply chain phenomenon where small changes in consumer demand for end-products (like smartphones or PCs) result in increasingly larger swings in orders as one moves down the supply chain to the semiconductor manufacturers.
When Walmart runs out of 100 PCs, they make a large order to rebuild their inventory, thinking that strong sales will continue, they order 200 PCs.
When the distributor gets an order for 200 PCs from Walmart, they make an order for 400 PCs with the manufacturer.
The manufacturer receives an order for 400 PCs, so they call their suppliers to order enough chips for 600 PCs.
Chip manufacturers do the same and build capacity to produce chips for 800 PCs.
This growth in orders is seen not only as proof of current demand but as a signal towards future demand.
They do this because each party wants to have enough inventory to meet customer demand, as nobody wants to lose sales due to something “simple” like a lack of inventory.
But then, it takes Walmart much longer than they expected to sell 200 PCs, so they don’t make new orders next time. This creates a cascading series of events, the distributor doesn’t make new orders with the manufacturer, and the manufacturer doesn’t make purchases from the supplier.
The supplier already increased capacity to meet the demand, so they keep manufacturing, as not doing so is worse, supply explodes, and prices collapse. Lower prices increase demand, and the cycle begins again.
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