Fabless Company: What It Is, How It Works, Example

The term “fabless company” refers to a company that designs and markets semiconductors while outsourcing that hardware's fabrication (or fab) to a third-party partner, who produces them in foundries. The term is commonly used for advanced chip designers, who hold the intellectual property (IP) for the chips they sell. Famous examples include Apple (AAPL), Nvidia (NVDA), and Qualcomm (QCOM).

How Fabless Companies Work

Fabless companies emerged once companies that developed the IP for new chip designs and other forms of advanced hardware found it less costly to outsource that work to foundries who happened to have productive capacity and difficulty entering the market. As a result, fabricating the hardware in-house through a vertically integrated supply chain proved less economical than using that capital for research and development and contracting with manufacturers in Taiwan, China, and other countries where workers tend to be paid less for their labor.

For this reason, many successful companies have chosen to subcontract the fabrication of their hardware to dedicated manufacturing firms. These companies are often located in countries with lower labor costs, where local fabricators have built up considerable experience and expertise in this specialized manufacturing.

The Taiwan Semiconductor Manufacturing Company (TSM) is the largest producer of semiconductors for other firms, controlling about 30% of the global market with almost $76 billion in revenues in 2022. But companies with foundries subcontract some of this work as well: ASML, the Dutch semiconductor company, makes tools used by TSM and other chipmakers, and it has been a pioneer in extreme ultraviolet lithography, the advanced method of printing intricate patterns onto semiconductor materials.

Today, the cost of developing a new factory to compete with an established player such as TSM could cost upward of $10 billion. When combined with the relatively low operational costs of the established foundries, this barrier to entry creates a significant incentive for fabless companies to continue outsourcing their manufacturing process. Indeed, MarketLine, the business intelligence and market research firm, notes that it doesn't expect to see new entrants in this sector soon, given the costs involved.

Fabless Company Example

Since the U.S. CHIPS Act was passed in June 2020 and updated in 2022, which provided massive support for domestic semiconductor production, dozens of American firms have announced plans to increase manufacturing capacity in the U.S. The U.S. was already home to some of the most successful fabless companies in the world, many of which are internationally dominant in their respective markets. For example, Qualcomm is a $100 billion fabless company with a vast portfolio of IP related to semiconductors, particularly those geared toward mobile phones. Its revenues, which reached almost $45 billion as of fiscal year 2022, are largely derived from the royalty streams earned on its IP licensing agreements.

Nvidia is another prominent example of a successful American firm employing the fabless business model. A specialist in graphics processing unit technology, the company now holds IP in areas such as mobile phone central processing units, motherboard chipsets, hardware and software for professional graphics visualization applications, and various software products for commercial and consumer-facing applications. Like all fabless companies, Nvidia's business model largely relies on revenues from its IP portfolio and alliances with highly sophisticated manufacturing partners.

The Bottom Line

The growth and popularity of fabless companies underscore the numerous benefits they offer. These companies have proven to be nimble and cost-effective, as they eliminate the need for expensive manufacturing infrastructure. They are able to focus their resources on design and innovation, leading to rapid advancements in technology. The fabless model also allows for greater flexibility, as these companies can swiftly adapt to market changes and trends. Furthermore, by outsourcing production, they can leverage the expertise and scale of dedicated manufacturing firms, ensuring high-quality output and timely delivery. This strategic approach has made them an increasingly dominant force in the tech industry, shaping the future of hardware innovation.