The financial downturn and global recession has hit the semiconductor industry hard. Orders for microchips were almost non-existent at the end of 2008 as computers and mobile phones languished unsold on retailers’ shelves.
According to the Semiconductor Industry Association, global semiconductor sales fell 2.8 percent last year and are expected to fall a further 21.5 percent to $195.6 billion this year.

The semiconductor industry is used to severe cycles. It has seen six significant cycles since the 1970s caused by recessions and oversupply. The last one, when the dotcom bubble burst in 2001, saw sales plunge 45 percent. But this time, it’s different. Strategic issues, such as soaring development costs and the intensifying need to innovate, have combined with the effects of the global recession and are unleashing forces that will reshape the entire industry.

One of the traditional driving forces of the semiconductor industry – computer sales – has been slowing over the past several years. Shipments of computers in 2009 are estimated to decline once again by 6 percent. This decline in computer sales is forcing chip companies like Intel to look elsewhere for growth, such as mobile chips.

As chips become smaller and smaller, development and production costs soar. The tools to make such tiny chips would be too expensive for companies to recover their costs over the lifetime of production. Intel estimates that only companies with about $9 billion in annual revenues can afford to be in the business of building new fabs. That would leave only Intel, Samsung, Toshina, Texas Instruments and STMicroelectronics.

The high development cost of new, smaller chips is thinning the “herd” of chip companies that can survive. Many companies have closed their manufacturing facilities and have outsourced manufacturing to Asian foundries. The fourteen chipmakers who were in the game at 90 nanometer have been reduced to nine at the current 45 nanometer level. Only two – Intel and Samsung – have firm plans for 22 nanometer factories.

The very largest chip companies may also need to experiment with new materials and work at the nanoscale – manipulating chips at the atomic level – in order to survive.

President of the Semiconductor Industry Association, George Scalise, said “We are now facing the research dilemma. Will the semiconductor industry lead the transition to the era of nanotechnology – or will we go the way of the vacuum tube manufacturers?” None of the companies that made vacuum tubes for the first computers in the 1940s and 1950s survived the switch to the silicon age.

Here are some of the companies that investors who want to own semiconductor stocks should be looking at:

Intel (NASDAQ: INTC), ARM Holdings (NASDAQ: ARMH), STMicroelectronics (NYSE: STM), and Texas Instruments (NYSE: TXN).

There are also two broad-based semiconductor ETFs for true believers in the sector:

SPDR S&P Semiconductor ETF (NYSE:XSD) and iShares S&P North American Technology Semiconductor Index Fund (NYSE: IGW).