As the world is becoming more interconnected, more automated and greener, each unit of GDP growth will contain a higher content of semiconductors. Integrated circuits are becoming a key component of the modern-day world. They have become more of a commodity and an important one. These tiny electronic circuits are used in products ranging from automotive, consumer electronics, wireless devices, industries, military & aerospace and computing. Semiconductors are so important that they can even be a threat to the national security at times. Hence big nations are gushing to make policies which will help them to manufacture these semiconductors in their own countries.
The industry is witnessing an acute mismatch of supply and demand. This shortage has been brewing since quite a time now and was first experienced in 2018. But the recent pandemic situation has escalated the gap. The increase in demand for PCs, laptops, smartphones and other electronics have grown unexpectedly because of the recent lockdowns and the employees shifting to work from home.
A steady rise in the semiconductors demand was seen since 2010 which faltered in 2019, which then grew by around 6% in 2020.
The supply shortage has forced the lead times for order completion to extend from 12 weeks in Jan 2020 to 15 weeks in Jan 2021.
Effects on Automobile Sector
Automobile companies are the first ones to be hit by this shortage of semiconductors. So much so that companies like General Motors, Volvo, Ford and Volkswagen had to cut down their productions and even shut down some of their plants entirely.
The automotive electronics which include displays and other in-car systems currently constitutes 40% of the car’s manufacturing cost and is poised to increase to 45% by 2030, according to a Deloitte report.
Though investors should not worry about their positions in automobile companies since the demand has just stretched out and not curtailed. For example, a consumer who wants to buy a four-wheeler will not go and buy a bicycle instead, he/she will probably delay the purchase by a few months. So, the sales and revenue of automobiles companies are going to be hit for few quarters (which they already are due to the second wave of covid-19) but will eventually climb back in the long term.
Semiconductor manufacturers or foundries have already increased the prices after the shortage was first experienced in 2018. The current shortage has inflated those prices more, which in turn has increased the cost of materials used for the end-product manufacturers. This inflation in prices shall lead to two things:
- It will eat up the margins of the manufactures which will reflect in their PAT numbers.
- The manufacturers will pass on the increase in cost to the customers thus increasing the product price.
Maruti, India’s ace car maker has recently increased the prices of most of its car models from April 16,2021 due to increase in their input cost. The automaker has said that it has raised the price of all its models by an average of 1.6% (on Delhi Ex-showroom price). Now to understand, the table shows what approximately will the new prices of different models look like.
|Model Name||Previous Price (Delhi Ex-showroom)||New Price (Delhi Ex-showroom)|
|Swift (Base LXI)||5.73 lakhs||5.82 lakhs|
|Swift (ZXI+ AMT)||8.27 lakhs||8.40 lakhs|
|Vitara Brezza (Base LXI)||7.39 lakhs||7.5 lakhs|
|Vitara Brezza (ZXI+ AMT)||11.2 lakhs||11.8 lakhs|
Source: Financial Express
*The prices in the above table are just for explanation purposes. The actual prices may or may not differ. *
The consumption of semiconductors by the auto makers is roughly around 8-9% of the total capacity of the foundries. The industry that contributes the highest to the consumption of these semiconductors is the computing industry – Smartphones, PCs, Laptops etc. The actual effect of the shortage will be felt when there will be shortage for these products and Apple is already feeling the heat.
(Foundries are contract manufacturers of silicone wafers which are then converted into designed integrated circuits and memory chips for fabless customers like Apple, General Motors, Microsoft, etc)
Over the last decade the production capacity of the chipmakers and the supply chain have been keeping up perfectly with the growing demand. In other words, customers are taking up the capacity as soon as it comes online indicating that demand is on par with the increase in the production resources. But the production of advance chips is dominated by top foundries.
The imbalance is evidently in the 200 mm wafers from which low-end chips are made which include power management chips, display ICs or other integrated circuits. These chips are majorly used in cars and other consumer electronics.
The automakers got hit first because of their poor inventory planning and underestimation of the consumption of vehicles. Thus, when the pandemic hit, they needed more of these chips due to unexpected surge in demand, which in turn led to sales opportunity loss.
- The most advanced and complex chips which are the logic chips that are used by Qualcomm, Apple, Nvidia and others that gives the devices their brains are not manufactured by these companies themselves. These fabless companies only design the chips which are then manufactured by foundries.
- Another key bottleneck is that there are only few foundries which can manufacture these advance semiconductors. Only these few foundries are technologically advanced to manufacture the chips efficiently and deliver them with shorter lead times. The four foundries which control the major global chip manufacturing are TSMC (Taiwan), Samsung, California based Global foundries Inc (controlled by Abu Dabi investment arm) and United Microelectronics Corp.
- Supply chain bottlenecks occur because these foundries produce for semiconductor designers which are then supplied to companies manufacturing consumer electronics and cars.
- Shin-Etsu chemical Co. and other chemical companies from Japan dominate the chemicals market which are used for producing semiconductors. They have the power to manipulate the prices of these chemicals.
- Netherlands-based ASML Holding NV owns a virtual monopoly on advanced photolithography equipment required to print patterns of cutting-edge chips onto the wafer.
- The making of chips cannot even start with access to the electronic design automation software which is dominated by U.S.’s Cadence Design Systems Inc. and Synopsys Inc.
So why can’t we just increase the production capacity?
Building new capacity for foundries takes time, a lot of time. For foundries to increase their capacity they require years to build the infrastructure for semiconductor fabrication facilities (2-3 years minimum). For that they require billions of dollars in capital expenditure. Even then the economics are so brutal that if your manufacturing expertise are lower even by a fraction, you lose to your competition. Moreover, these foundries also have to cope up with the advancement in technology and manufacturing processes and thus continuously keep their facilities updated.
The end goal of these foundries is to convert the silicone into a compact chip with millions of transistors etched on it which forms the basis of our circuitry which eventually gives our phones, PCs, washing machines, cars their essential capabilities. To achieve this goal foundries, have to incur a lot of costs to maintain their facilities clean. These facilities are cleaner than a surgery room in a hospital. Only few and essential personnel are allowed in these facilities with complete PPE kits and masks.
The Air inside these rooms is continuously filtered so that no dust particle sits on the wafer (or else the wafer becomes useless). Also, the manufacturing of semiconductors requires water in large amounts. And not just water, but purified water. The foundries have to build purifiers to make sure the water is purified according to their standards if the location or city or state does not provide the same quality of water.
Capital is the biggest entry barrier for the new entrants to start their own facilities. The industry is dominated by three companies Intel, TSMC and Samsung. TSMC dominates the smartphone market, while Intel has strengthened its roots in the computer industry. Samsung rules the memory chip markets. For a new player to just manufacture 50,000 chips will require at least $15 billion to set up the facility because the equipment used are heavy duty and most of it is automated or operated by robots.
How long will this shortage last?
The sudden surge in demand for semiconductors was not estimated. The pandemic led demand has put the buyers into unforeseen crisis. They are trying to accumulate more and more inventories of the chips they require to offset the uncertainties of the deliverables by the suppliers. This infact is pushing the prices up for semiconductors. Government and company officials are working to curb this crisis situation by pumping in more capital and introducing industry friendly policies. Foundries have allocated more Capex for capacity building to overcome this shortage.
TSMC will be putting in $63 billion to get its newest capacity online as early as possible. Samsung has pledged $151 billion by 2030 for producing non memory chips. While Intel on the other hand will be increasing its capacity by allocating $20 billion for its capital expenditure. Even with all these investments the shortage is there to persist because of the longer time frames required to build these infrastructures. The gap between supply and demand will be seen till the end of 2022, according to company officials at TSMC. This will keep the prices inflated for the chips and so the input costs.
For countries to achieve self-sufficiency in this sector becomes difficult with so many barriers to entry and so many bottlenecks. But these chips play a highly important role for the security of the nation, this is the reason why countries like United States of America and India are moving on a path to become self-sufficient in semiconductor manufacturing because in case of a trade war or even an actual war (where chips will be required for military purposes) this self-sufficiency/domestic manufacturing will play a vital role.
Therefore Joe Biden, President U.S.A has allocated $50 Billion in his new infrastructure bill of $1.7 Trillion, for the semiconductor manufacturing foundries to take control from TSMC, Samsung and few Chinese firms. This investment will help generate employment in the states and help evade the crisis of shortage of semiconductors.
India has now begun to move in the direction of self-sufficiency in the sector of electronics. Overall electronics and its building components have become the second highest category in which India is a net importer just after crude oil. MEITY (Ministry of electronics and Information Technology) had floated an EOI (Expression of Interest) for companies that are interested in setting up a semiconductor fabrication plant in India.
MEITY is looking for global players that could potentially be attracted like TSMC, Samsung, Intel, Texas Instruments, Fuji Electric, and Panasonic from Japan and other European players like ST Microelectronics and Infineon to form a consortium with Indian companies. The government is looking for a plant on three levels. On the first level it is seeking preliminary interest from integrated circuit design manufacturers/foundries or a consortium with an Indian company to set up a new fabrication plant or expand an existing one. This plant will use metal oxide technology which is the most advanced technology for making integrated circuits to produce processors and memory circuits. Initially the plant will start with a capacity of 30,000 wafer units per month and a wafer size of 300 mm.
On the next level the government seeks players with same qualifications to manufacture wafers of size 200 mm. On the third level, it is interested in Indian companies who want to acquire the semiconductor fabrication units in India.
The investors are taking time to make their decisions primarily because they feel that India does not have the required infrastructure yet (which includes clean water and continuous supply of electricity) nor does it have the domestic demand to attract multi billion dollars investments in fabrication plants and secondly many global players have increased the capacities in their own countries to meet the demand.
But the government is keen on making India a hub for electronics manufacturing and intends to continue with aggressive push in making a semiconductor plant and other high-tech areas. It will consider the investments and will take action to facilitate them. Government is looking for ways in which it can aid the companies to successfully run a plant. It is willing to support the companies by providing viability gap funding in form of equity or long-term interest free loans, tax incentives, or infrastructure support. METY has earmarked $5 billion fiscal support for domestic manufacturing of semiconductor and displays, IOT devices and wearables. This is a substantial amount considering government’s total fiscal support for turning India into electronics manufacturing hub is $25 billion.
Indian government’s push may make India an electronics manufacturing hub in the future but it cannot feed the hungry semiconductor markets for now as implementing these projects and getting the plant online would take years. Moreover, the other expansion projects by the global companies are still under process thus the shortage of the semiconductor is there to remain till the end of 2022. Hence, we will experience inflation in coming months in many products which use these electrical components. Economies are going to face inflation in many other categories as suddenly there is a shortage for food crops & timber (used in building real estate) and the bottlenecks in the supply chain have increased, semiconductor industry is first one to experience this inflation.
This is a guest post by Shalin Jain