How Government Regulation Hurts EDA
The EDA market experienced strong growth in 2006 and the early months of 2007. Even so, over the past half-decade EDA growth has generally lagged the rest of the software market. The EDA industry's compound annual growth rate (CAGR) since 2001 has been only 5.6 percent, far lower than the rest of the software business and decidedly lukewarm compared to other mature software segments, such as Customer Relationship Management, that have experienced consistently sharp growth, year after year.
Why does EDA, over the long term, appear to under-perform? One theory is that the "remixing" of tool licenses has reduced revenues by devaluing the price for premium EDA products. Another theory is that "free" EDA environments (such as those supplied with FPGAs) are depressing revenues, much as Linux has pressured Microsoft to keep server software prices low. While such factors may be relevant, there's another market dynamic that's suppressing the earning ability of EDA industry: government regulation.
EDA, of course, is not a highly regulated industry. However, recent regulatory priorities, both in the United States and Europe, have created a business climate that is peculiarly hostile to the unique conditions under which the EDA market operates. Even though government regulation is not targeted specifically at the EDA industry, the current climate has subtly made it more difficult for EDA firms to grow over the past half decade. And that's bad news for everyone in this business.
ZERO SUM SPENDING
Take, for example, the Restriction of Hazardous Substances Directive (aka RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE), both enacted earlier in this decade by the European Union. You'd think that such regulation would be essentially harmless from an EDA perspective, since it's focused almost entirely upon the manufacturing and post-manufacturing cycles, rather than the design chain. But you'd think wrong.
Because the European Union is such a large segment of the electronics market, semiconductor firms could not afford to ignore the directives and thus were forced to completely change the way they tracked the materials that went into their chips, as well as the products that came out of their factories. "We have thousands of suppliers, all of whom must now supply us with documentation and are subject to audit programs," explains Reed Content, senior manager for environment, health and safety (EHS) at AMD.
RoHS and WEEE were godsends for software companies that make Product Lifecycle Management (PLM) and Product Data Management (PDM) applications, according to Jon Gable, vice president of product management for the PLM vendor ENOVIA MatrixOne. "PLM allows you to handle the process by making materials compliance an integral part of the on-going design activity," he explains. The sudden success of the PLM sector would be of little interest to EDA executives if it weren't for one fact: semiconductor firms (just like other companies) have limited budgets for purchasing software.
While EDA software is obviously "mission critical" to a semiconductor firm, EDA must still compete for budget dollars with other types of "mission critical" software. So when government regulations mandate that money be spent on non-EDA software, it takes money off the table. Indeed, during the time when semiconductor companies were making RoHS-related PLM/PDM purchases, the proportion of money spent on EDA (versus the money spent on PLM/PDM) shrank. (See Graphic: Relative Spending on PLM/PDM vs. EDA). Of course the regulations also have the effect of shifting some of the EDA spending from tool to tool and from vendor to vendor, but the total amount spent remains the same.
Government regulation in the area of corporate governance has also had a negative impact on EDA over the past half decade. The Public Company Accounting Reform and Investor Protection Act of 2002 (aka Sarbanes-Oxley) has made it much more difficult for all small firms (not just EDA firms) to raise capital through an Initial Public Offering (IPO), according to Doug Brockway, managing director at Innovation Advisors, a banking firm that caters to small and mid-market technology firms. "Many software firms are unable or unwilling to spend a significant portion of their current capital on Sarbanes-Oxley compliance in order to prepare for an IPO," he says.
The cost of Sarbanes-Oxley compliance can reach as high as $1.5 million dollars a year, according to Andrew Yang, CEO of Apache Design Solutions, an EDA firm that recently went through the compliance process. In the case of Apache, the company had already grown large enough so that the cost of compliance wasn't burdensome but that's not true of all firms. "We had been doing audits anyway and spending money on internal controls," Yang explains, "But there's no question that Sarbanes-Oxley has made it more difficult for EDA firms to use IPO to raise capital in an earlier phase of development."
Sarbanes-Oxley damages the ability of smaller firms to compete in any marketplace. "Though Sarbanes-Oxley was intended to reign in excesses at the Enrons of the world, in effect it is making life more difficult for small to medium-sized firms," says John Greenagel, communications director at the Semiconductor Industry Association (SIA), an industry trade group. He also cites new tax rules for stock options as being major bad news for small firms which often lack the cash to compensate key employees through high salaries. "By requiring options to be treated as expenses, the government makes it more difficult for firms that aren't yet making a lot of money to remain viable and competitive," he explains.
Recent government regulation of corporate governance is particularly toxic for the EDA industry. With IPOs closed off as an exit strategy and stock options increasingly unavailable as incentive, the prospect of working in an EDA startup becomes less attractive. While the sluggish growth prior to 2006 might have many causes, government regulation certainly hasn't helped smaller EDA firms.
TOO LITTLE TOO LATE
Sometimes the problem isn't too much regulation, but not enough of the right kind. A perfect example of this is the regulation of Intellectual Property, specifically software, across international borders. For mainstream software firms, the software piracy problem is enormous, resulting in billions of dollars of lost revenue every year. "In some countries it's not unusual to find that nearly all the software used inside a company is pirated," says Keith Kupferschmid, senior vice president of intellectual property policy and enforcement at the Software and Information Industry Association.
The EDA industry tends to treat software piracy as a minor threat because most EDA tools require support services and customization in order to be useful. However, if there are a large number of engineers in a region who understand how to use a certain EDA tool, it creates a pool of knowledge that makes it unnecessary to resort to the vendor for advice. Since there are approximately five hundred small design firms in China alone (according to UMC CEO Jackson Hu), there's plenty of know-how to go around.
In fact, it's not difficult to find signs of EDA piracy, if you look carefully. Magma chairman Rajeev Madhavan cites websites in China that offer CDs containing entire EDA suites for a fraction of what a licensed version would cost. "They even promised to provide upgrades when they were released," he marvels. To make matters worse, one of the EDA industry's most important and growth-generating sectors, semiconductor IP, standard anti-piracy measures are extreemely difficult to enforce. While a mainstream software vendor can use the Internet to check for the validity of a piece of software, with semiconductor IP it's necessary to reverse-engineer the chip – a complex and expensive process.
Unfortunately, the main thrust of government regulation relative to software piracy has been focused on the problem as it exists internally inside the United States. "There are various bills pending in Congress that would increase criminal penalties so that software vendors wouldn't be forced to file civil lawsuits in order to pursue cases of criminal piracy," says Kupferschmid. On the international front, though, the U.S. government has trod more lightly, issuing protests rather than sanctions. While it's anybody's guess how much EDA revenue is lost each year, there's no question that even EDA's good years, like 2006, would be better if IP rights were enforced internationally.
Probably the biggest danger with government regulation is that the EDA industry, flush with recent industry revenue growth, might ignore the ongoing negative impact of misplaced or ill-considered government regulation. "Companies have to take this stuff seriously and lobby for the good of their industry," says the SIA's Greenagel. For an industry like EDA that has attracted some of the smartest people in high tech, figuring out a way to influence government policy for the good of the industry shouldn't prove too difficult.
GRAPHIC: RELATIVE SPENDING ON PLM/PDM vs EDA IN BILLIONS