In 2000, inventories held on the balance sheets of semiconductor vendors stood at an average of 43 percent of quarterly sales. With sales falling faster than inventory could be burned off, this ratio climbed to an unpalatable 70 percent by the third quarter of 2001. Today, the inventory-to-sales ratio stands at 47 percent. Are we out of the woods yet?

Before answering this question, I'd like to clear up one common misconception: namely, that excess inventory precipitated the recent collapse of the semiconductor industry. Instead, the root causes of the decline can be traced to simple supply-side and demand-side factors. On the supply side, excess levels of both semiconductor intellectual property and manufacturing capacity led to dramatic declines in average selling prices. On the demand size, gains in sales to consumers were not enough to counter weak enterprise and telecommunications carrier expenditure. Elevated inventory levels did make the downturn more severe, but they were more of an effect than a cause.

To determine whether inventory levels are still elevated, a few qualitative corrections to the 47 percent number must be made. Any analysis should include semiconductors held on the balance sheets of OEMs, CEMs and distributors-information that's notoriously hard to come by. But recent conversations with semiconductor vendors suggest that OEMs, CEMs and distributors are pushing inventory risk back on the balance sheets of chip makers. This means that semiconductor vendors should expect to hold higher inventories in order to deliver with very short lead time. Most of them welcome this change, since it puts them in closer touch with real demand.

That ICs quickly become obsolete and that IC manufacturing costs are falling improve the inventory picture. Those two factors mean that unit inventories are not as high as would be calculated using today's average selling prices.

To be sure, there are factors that make the inventory situation seem worse than it is. For example, a cluster of inventory write-offs occurred in late 2001. If these were just accounting tactics that did not actually remove physical inventory, then the inventory-to-sales ratio would suffer.

By any measure, inventory levels have improved dramatically since late 2001. Companies like PCTel, Qualcomm, PLX Technology, Broadcom, Xilinx and Oak Technology have done an outstanding job managing inventories recently. Let's hope the string of five consecutive quarters of semiconductor sales growth continues.

Jeremey Donovan (jeremey.donovan@gartner.com) is chief analyst at Gartner Dataquest.