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Apple aims for more control, less cost as it accelerates in chip design

Apple Inc's decision to stop licensing graphics chips from Imagination Technologies Group Plc is the clearest example yet of the iPhone maker's determination to take greater control of the core technologies in its products - both to guard its hefty margins and to position it for future innovations, especially in so-called augmented reality. The strategy, analysts say, has already reduced Apple's dependence on critical outside suppliers like ARM Holdings Plc, now owned by SoftBank Group Corp. Apple once relied heavily on ARM to design the main processor for the iPhone, but it now licenses only the basic ARM architecture and designs most of the chip itself. More recently, when Apple bought the headphone company Beats Electronics, part of a $3 billion deal in 2014, it ripped out the existing, off-the-shelf communications chips and replaced them with its own custom-designed W1 Bluetooth chip."Apple clearly got rid of all the conventional suppliers and replaced about five chips with one," said Jim Morrison, vice president of TechInsights, a firm that examines the chips inside electronics devices."Today we do much more in-house development of fundamental technologies than we used to," Apple Chief Financial Officer Luca Maestri said at a February conference. "Think of the work we do on processors or sensors. We can push the envelope on innovation. We have better control over timing, over cost and over quality."Most vendors of consumer electronics products rely on outside suppliers for chip design and development, primarily because it is extremely expensive. That has created huge opportunities for companies like ARM, Qualcomm Inc and Nvidia Corp, which have developed core technologies for processing, communications and graphics that are used by scores of vendors.

Now, though, Apple is so big that it can economically create its own designs, or license small pieces of others' work and build on it. As with ARM and Qualcomm, the actual manufacturing of the chips is still contracted out to a semiconductor foundry, such as those run by Samsung Electronics and Taiwan Semiconductor Manufacturing Co Ltd. MOVE FAST, SAVE MONEY Bringing more of the design work in-house cuts complexity, people familiar with the processes say. Instead of managing one or more design teams and then a fabricator, Apple has only to manage the fabricator.

It may also help the company move faster - and save money - as it focuses on new technologies such as virtual and augmented reality. Apple CEO Tim Cook has indicated that Apple plans to integrate augmented reality into its products, which makes 3-D sensors and graphics chips like Imagination's especially important. Even before formally cutting off Imagination, Apple had given hints that it was preparing to design its own graphics processors. Specifically, it introduced a piece of its own code called Metal for app developers. App developers use Metal to make their apps talk to the graphics chip on the iPhone. By putting a piece of Apple-designed code between app developers and the phone's chip, Apple has made it possible to swap out the chip without interrupting how the developers work. That could also make it easier to bridge the gap for developers between the graphics chips on Apple's phones and its desktop computers, which currently require some separate coding.

“By promoting Metal instead of relying on other existing standards, Apple is not only able to control what graphics chip functionality is exposed at its own pace, but also blur the line for developers between coding for desktop and mobile GPUs," said Pius Uzamere, the founder of a virtual reality startup called Ether. Taking control of the iPhone's chips can also help Apple keep costs down, which is especially important as it gears up for a feature-laden new iPhone this fall. Timothy Arcuri of Cowen & Co said in a research note that he thinks the curved screens expected on the new phone could add as much as $50 in cost, for example. Shebly Seyrafi, an analyst at FBN Securities, estimates that the average price of an iPhone increased only 1 percent to $695 last quarter, while costs increased 8 percent to $420, resulting in an iPhone gross margin of 39.6 percent. That is down from the 44 percent average gross margin for iPhones in 2015, according to Seyrafi's estimates. Apple spends only $75 million a year on licensing fees for Imagination's chips. But licensing fees to chip designers, taken together, are a significant cost for the iPhone. Apple recently sued Qualcomm for $1 billion over licensing terms for its communications chips - which Apple would have trouble designing in-house because of patent issues.

U.S. factory activity cools slightly; trend remains bullish

A measure of U.S. manufacturing activity retreated from a 2-1/2-year high in March amid a decline in production and an inventory drawdown, but a surge in factory jobs indicated that the sector's energy-led recovery was gaining momentum. Other data on Monday showed construction spending rising to a near 11-year high in February, lifted by a jump in home building investment. The reports pointed to strong fundamentals despite signs of weak economic growth in the first quarter."The U.S. economic expansion remains on solid footing even taking into a account what is likely to be a pretty lackluster first-quarter growth profile," said Tom Porcelli, chief U.S.economist at RBC Markets in New York. The Institute for Supply Management (ISM) said its index of national factory activity fell to a reading of 57.2 last month from 57.7 in February, which was the highest since August 2014. A reading above 50 indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy. Seventeen of the 18 manufacturing industries reported growth and no industry reported a contraction. Comments from factories were mostly upbeat, with machinery manufacturers saying that business was up 10 percent to 15 percent. Transport equipment manufacturers, however, described the industry's outlook as "relatively flat." The manufacturing recovery is being driven by the energy sector as steady increases in crude oil prices boost drilling activity.

A report from energy services firm Baker Hughes on Friday showed U.S. drillers added 137 rigs in the first quarter, the most since the second quarter of 2011. That has fueled demand for machinery, resulting in business spending on equipment rising in the fourth quarter for the first time in a year. Manufacturing is also benefiting from a surge in business sentiment following President Donald Trump's pledge to pursue business-friendly policies, including cutting corporate taxes and deregulation. But after last month's failed attempt by Republicans in the U.S. House of Representatives to repeal the Obama administration's 2010 healthcare law, economists warn that Trump might struggle to implement his agenda. The dollar rose to a two-week high against a basket of currencies, while U.S. stocks fell after New York and other states challenged the Trump administration on grounds of illegally blocking energy efficiency standards. U.S. Treasuries rose.

HIRING PROSPECTS BRIGHTEN Last month, the ISM survey's production sub-index decreased 5.3 percentage points to 57.6. A gauge of manufacturing inventories contracted. While that weighed on the ISM index, it bodes well for future manufacturing activity. Though a measure of new orders fell last month, it remained near a more than three-year high. A gauge of factory employment jumped to its highest reading since June 2011. That would suggest another strong month of factory job gains in March. But sentiment indicators such as the ISM have been painting a more robust picture than the so-called hard data, which has suggested that the economy grew around a 1 percent annualized rate in the first quarter. Gross domestic product increased at a 2.1 percent pace in the fourth quarter.

"If manufacturers hire as many workers as the survey says they are planning to do, the nonfarm payroll jobs number on Friday could be a blowout," said Chris Rupkey, chief economist at MUFG Union Bank in New York. Manufacturers reported paying more for raw materials, further evidence that inflation pressures are building up. A report on Friday showed a key consumer inflation measure in February recorded its biggest annual gain in nearly five years. The ISM's prices index rose 2.5 percentage points in February to 70.5, the highest reading since May 2011, indicating higher raw materials prices for the 13th straight month. A separate report from the Commerce Department on Monday showed construction spending increased 0.8 percent to $1.19 trillion in February, the highest level since April 2006, after dropping 0.4 percent in January. Construction spending was boosted by outlays on private residential construction, which surged 1.8 percent to the highest level since July 2007. Spending on private nonresidential structures fell 0.3 percent."The trend in nonresidential construction spending has softened lately," said Daniel Silver, an economist at JPMorgan in New York. "Despite this weakening in the data, we still look for a strong increase in overall private nonresidential investment in the first quarter because of large gains in separate data related to activity in the energy sector."