Context

• The Japanese automaker, Toyota Corporation recently announced to slash the global production of motor vehicles due to the semiconductor shortage.
• The news comes as Samsung pledges to invest about $360 billion over the next five years to bolster chip production, along with other strategic sectors.

Revenue squeeze owing to chip shortage

• Car manufacturers were particularly badly hit due to lack of flexibility in the supply chain. For example, Volvo cited chip shortages for a 22.1 percent drop in sales of its vehicles in March 2022, when compared to the same period the previous year.
• Jaguar Land Rover, General Motors and others say they've also felt the squeeze this year.
• However the effects of chip shortage are also being felt by makers of computers and other kit, with Dell reporting that it is expecting the backlog to grow.
• Chipmaker TSMC warned in April that supply difficulties are likely to last through this year and into 2023.

Genesis of shortage

• Fall from peak: After reaching its peak in 2011, the laptop market growth slowed down with the rise of alternatives such as smartphones and tablets. Then, the pandemic hit.
• Pandemic: During the pandemic, people switched to work from home, and children connected to schools through laptops. This shift led to a surge in demand for laptops and tablets.
• Gaming spurt: The stay­at­home rules also made several people pick up console­based gaming.
• Boost in Semi-conductor manufacturing : Gaming demand was driven by console hardware, and subscription­based mobile games. Each of these devices were in high demand and are run on thumbnail­sized semiconductors, performing various functions on a single device.
• Scarcity of wafers: : Manufacturers produce semi-conductors as 200mm or 300mm wafers which are further split into lots of tiny chips. The manufacturing equipment needed to make smaller diameter wafers were in short supply even before the pandemic began. That’s because the industry was moving in the direction of 5G and advanced communication, which required expensive wafers.
• High demand for chips : High consumer demand for low­end products, coupled with large orders from tech firms chocked chip makers whose factories were also closed during lockdowns.
• Supply crunch of chips: Carmakers stopped requesting chips from suppliers due to low demand for new vehicles owing to Covid-19 pandemic. And now, as they ramp up production to meet consumer demand, chip makers are down on supply because they have cut deals with other industries.
• Logistic challenges: Logistical complexities have exacerbated the problem for chip-makers as lockdown has had a domino effect on global supply chains.
• Raw material shortage: Separately, Russia’s invasion of Ukraine has strained exports of essential commodities used to make chip sets. For instance, Moscow supplies rare materials like palladium, and Kyiv sells rare gases (like Neon) to make semiconductor fab lasers. This combination is required to build chipsets that power a range of devices, from automobiles to smartphones.

Intricate networks

• Chip Sets manufacturing: About a decade and half back, firms developed a system to make chip sets instead of thumbnail­sized semiconductor piece which have drawn attention of large companies in recent times.
• Inter-connected Process: The system was made by interconnecting several parts of the world to make a single device referred to as the global supply chain now. This was due to companies cutting up their businesses into smaller parts and outsourcing them to places where land, labour or capital was cheap.
• Segmenting chip making: Semiconductor making firms applied the global supply chain knowledge to their industry. Hence the process to make a chip was divided into front­end (wafer fabrication and probe) and back­end parts (assembly and testing).
• Global ecosystem: The front and back­end processes were further broken down into micro units, and were spread out across the globe, creating a global chip making ecosystem.
• Extensive chains: The global chip making ecosystem is so vast that each segment of the semiconductor manufacturing involves roughly 25 countries in the direct supply chain, and 23 countries in allied functions, according to a joint study by Global Semiconductor Alliance and Accenture.
  • The report estimates a semiconductor­based product could cross international borders about 70 times before finally making it to the end customer.
• Wafer trial: Wafer fabrication is the most globally dispersed, with 39 countries directly involved in the supply chain and 34 involved in allied activity, providing services like photolithography, etching and cleaning.
  • Similarly, designing happens across 12 countries, product testing and manufacturing each are done across 25 countries.

Strength becomes weakness

• Developed during the World War II era, Just­In­Time (JIT) and Kanban technique was conceptualized by Taiichi Ohno, the father of Toyota Production System.
• JIT was used by Japanese companies that lacked resources and space to rebuild factories and Kanban technique to run their supply chains smoothly and create an efficient production system for automobiles respectively.
• About JIT: JIT lets firms take inputs from suppliers only when they are needed which helps them cut inventory storage cost, shorten production cycles and free up cash flow for other investment activities.
• JIT backfired: This important aspect of supply chains back fired due to the pandemic, and the recent geopolitical events. When the pandemic began, carmakers stopped requesting chips from suppliers due to low demand for new vehicles.
  • As the geopolitical events in Central Europe and production shutdowns in China continue to add pressure to the already complicated semiconductor supply chain, the chip shortage tunnel only seems to be getting longer.
• Production impetus: Intel CEO recently pointed out that the European Chips Act (45 billion euros) and CHIPS for America Act ($52 billion) would incentivise fab makers to set up their units in these regions and balance.
• Balanced investments: Together, these two (U.S. and EU) will enable the semiconductor manufacturers to have equal investments in the East and West by 2030, from the current tally at 80% in Asia, and 20% in Europe and the U.S.

Conclusion

• Preferential treatment: The chip industry need to be given preferential treatment to ease the shortage more quickly.
• Address skilled labour shortage: While chip making process is among the most-automated, the high-tech equipment used at the facilities still requires skilled staff to operate it. For example, In Taiwan, a global powerhouse in chip making, the recruitment gap is at its highest level in more than six years.
  • Hence, New chip-making facilities, known as fabrication plants, or “fabs,” require thousands of Technicians (oversee and manage the manufacturing process), researchers (to innovate new types of chips).
• Knowledge hub: Innovation and education in high-tech sectors need to be promoted such as semiconductors, universities to start specialized semiconductor colleges in partnership with companies manufacturing chips etc.
• Boosting substrate production: A key concern of the global semiconductor shortage is the supply of so-called substrates, panels of resin embedded with wiring onto which central-processing units and other types of chips are attached. Hence there is need to boost investments and diversify this critical sector which presently is based mostly in Asia.
  • For instance, Intel Company has secured substrate capacity dedicated to Intel products and has embraced new ways of working with substrate suppliers to support their longer-term investments.
• Boost investments: Intel has pledged to make more than $100 billion in chip-factory investments over the coming years in the U.S. and Europe. Taiwan Semiconductor Manufacturing Co., Samsung Electronics Co. and others also have big expansion plans which can ease the pressure on global chip shortage.

Hence the semiconductor industry needs to be built for long-term growth and diversify its portfolio as it could generate annual revenue of $1 trillion by 2030, according to McKinsey.