Is the microchip shortage over? (Patreon)

[This is a transcript with links to references.]

Remember COVID? That pandemic we had back then? It did more than making homemade bread fashionable, it also showed us just how easily global supply networks can be disrupted. The Covid pandemic affected nearly every sector of our economies, but the impacts were particularly severe in the microchip industry. For three years now, the world has seen a microchip shortage that has affected the production of many consumer electronics. What happened? Is it over now? And what can we do to prevent it from happening again? That’s what we’ll talk about today.

First things first, what’s a microchip? Or microcrisp for our British audience.

A microchip is a thin slice of semiconducting material that holds electronic components such as transistors, diodes, capacitors, and so on. The little semiconducting plate is usually made of silicon and called a wafer. The components on the wafer are connected to each other either by thin metal wires, or by etchings on the surface of the chip. Microchips can do anything from basic logic operations to data processing and storage. They’re mini-computers, basically.

Microchips are often just referred to as “semiconductors” though strictly speaking that’s just the main material they’re fabricated from. But then, strictly speaking, peanuts aren’t nuts and French fries aren’t French, and I guess, strictly speaking no one speaks strictly anyway.

Microchips were first developed in the late 1950s, but they hit the market big time in the early 1980s, when mass-production became easy and cheap. Within a matter of years, every electronic device used them: TV’s, phones, clocks, toasters, you name it. Personal computers, portable music players, and digital cameras became first possible and eventually even affordable.

Today, microchips are everywhere. Whether that’s your kitchen, the ticket machine at the subway station, or that scary looking thing at your dentist’s office, it’s a safe bet that it’s using microchips. Simple devices like a digital thermometer may contain just one or a few microchips, but more complex devices, like smartphones, laptops, or TVs may contain dozens. Basically, the world now runs on microchips, lots of them.

And then, Covid happened. Governments around the world told people to stay at home, closed airports, and shut down all but the most essential factories. Supplies of many goods began to stutter and then came to a halt.

At the same time, many of us began to work from home and children were attending classes remotely. We all suddenly became zoom experts, and demand for consumer electronics skyrocketed. A new laptop, new TV, or maybe it’s time to get one of those bread-baking machines? I decided to buy a new video camera and put some work into my little YouTube channel and, well, here’s what happened next.

Computer sales increased from 267 million in 2019 to 302 million in 2020.And sales for their key ingredients, microchips, began to increase with it.

But that was only the first domino to fall in a series of unfortunate events. The next fell in July 2020. That was when the Nittobo factory in Fukushima, Japan, caught fire. At the time, Nittobo was the leading manufacturer of what’s called printed circuit boards. They’re used to support and connect electronic components, including microchips. The fire took several days to extinguish. Luckily no one was injured, but not only was part of the equipment destroyed, part of the inventory was affected, too. The factory was closed for months.

Then, in October 2020, another fire happened, this time in Nobeoka, Japan, at the AKM factory, a global supplier of microchips. The fire took three days to extinguish and destroyed the fifth floor of their building entirely. It put the factory out of commission for several months and it took several months more to fully recover their earlier production capacity.

And bad things kept happening. In February 2021, the winter storm Uri hit Texas. It was one of the worst winter storms on record for that region of the United States. Uri brought heavy snow and in some places temperatures dropped as low as minus 19 degrees.

A snow storm probably isn’t exactly the first thing that comes to your mind when you think of Texas, is it.Indeed, the Texan electrical grid was badly prepared for such extreme temperatures; it simply wasn’t designed for it. Valves, pipes, pressure regulators, and various instruments weren’t working properly and many power plants, especially those using natural gas, failed, or had to be shut down. Over 11 million people were left without electricity, some of them for days.

Texas is home to several semiconductor manufacturing plants, including some owned by Samsung, Infineon, and NXP Semiconductors. The power outages disrupted their operations and caused production delays. Besides the immediate effects, there were the secondary ones. The production of semiconductors requires plastics that the Texan plants received from other factories that were also affected. And so, while the microchip production could resume within a few days, operations were affected for weeks. Even though it was just a temporary hiccup, it caused another avalanche of backlogs.

The same month, an earthquake of magnitude 7 point 1 hit Tokyo, home to the microchip factory Renesas. Among other things, they produce 300 millimeter chips that are especially essential to the car industry. A month later, a fire broke out in the already battered factory. While it was extinguished after a few hours and there were no casualties, it damaged 600 square meters. The factory was offline for almost four months.

But the biggest disaster that affected microchip supply happened in Taiwan. The world’s biggest chip manufacturer, TSMC, is located there, and several other companies have factories in Taiwan too. In total, about 60 perent of the world’s microchips are produced in Taiwan. The number increases to 90 percent if you count the newest generations of microchips, which are smaller and use less energy. They require new production methods, most importantly extreme ultraviolet lithography .This method uses a chemical reaction triggered by ultraviolet light to create circuits on a silicon wafer. It’s faster and more precise than previous methods.

In early 2021, a drought took hold in Taiwan. Problem is, producing microchips requires water, most importantly to clean the wafers, both before and after the circuits have been imprinted. TSMC alone uses more than 150 thousand gallons per day, that’s enough to supply 600 US households. When the Taiwan water reservoirs had fallen to less than 20 percent capacity, the government restricted the factory’s access to water. They had to slow down production and couldn’t cope with the demand. Briefly after this, TSMC raised prices by 10 percent for advanced microchips and 20 percent for older technologies.

The final major event worth mentioning is the fire in the ASML factory in Berlin, Germany. Before this fire, ASML was a relatively unknown Dutch corporation. But at that time, the ASML factory in Berlin was the only global manufacturer for the machines that are used for the previously mentioned ultraviolet lithography. Yes, that’s right, there was only that one factory, worldwide, and all major semiconductor manufacturers like TSMC, Samsung, and Intel relied on them.

The fire broke out on January 3, 2022, and spread over about 200 square meters, including some of the production sites of the lithography machines. The company said that the fire would not affect production, but it nevertheless got everyone worried about the global dependence on this one supplier.

On top of this series of unfortunate events, there were, and are, political tensions. For starters, the Russian invasion of Ukraine made everyone worried that China might invade Taiwan. And while that hasn’t happened so far, it drove home the point that strongly depending on Taiwan for global microchip supply is risky.

Then there is the American-Chinese trade war. The trade war began in 2018 when President Trump imposed tariffs on Chinese goods. He was hoping to reduce the US trade deficit with China, arguing that China was using unfair trade practices. That’s what the Americans say anyway. The Chinese say that the US doesn’t like being outperformed. Be that as it may, China responded by imposing tariffs on US goods. It’s been going like this in several rounds of negotiations since then, with no end in sight.

Trouble is that the largest microchip manufacturer in China, SMIC, used to import critical chip components from the United States. Faced with the new export restrictions, they had to look elsewhere. This forced the Chinese corporation to find alternative sources for these components and trying to set up new supply chains caused more delay with chip production.

Biden has continued the trade policies installed by Trump despite the problems with microchip supply. He says it’ll help the US get ahead and develop self-sufficiency in the semiconductor market in the long term, which may or may not pan out.

Another reason for the microchip shortage is the small number of big semiconductor manufacturers which makes the production vulnerable to disruptions. More than 90 percent of microchips are currently produced in only 5 countries: Taiwan, China, Japan, South Korea, and the United States. . The four biggest companies hold 75 percent of the market.

It didn’t help that the microchip industry was already working at high capacity just when the pandemic hit. And on top of all of that were the cryptominers, who were looking for processing units for their mining operations, leading prices to skyrocket in early 2021.

All these factors multiplied and caused a massive shortage of microchip supply. When a manufacturer put in an order for microchips before 2020, it took about eight to twelve weeks until the order was fulfilled. At the peak of the shortage, the wait times ballooned to six to twelve months, which is long enough for some of us to make an entire human being.

In 2019 companies that produced or bought microchips on average stockpiled inventory for 40 days, but that went down to less than 5 days in 2021. In a situation like this, small fluctuations in the supply reduce the stockpile to zero and production has to stop entirely. The waiting time has decreased somewhat since its pandemic high, but it still hasn’t gone back to pre-pandemic levels.

The consequences were felt by all manufacturers who rely on microchips. According to Goldman Sachs, 169 industries were affected. The biggest impact was seen for consumer electronics, cars, and telecommunication.

Before the pandemic, the costs of consumer electronics had been trending down for several years. The microchip shortage did not reverse this trend, but it prevented products from getting cheaper. The situation relaxed in late 2021.

The car industry was heavily affected because modern vehicles use microchipsfor everything from engine control to safety features, infotainment systems, and even to direct energy to different parts of the vehicle. The car industry accounts for roughly 9 percent of chip demand worldwide and the shortage forced many automakers to temporarily halt production. Estimates say that the car industry lost a whopping 110 billion in sales.

Do you remember the nearly empty auto dealer lots in 2021? This was a by-product of the shortage. And because new cars weren’t coming by, the value of used cars increased by as much as 45 percent by mid 2021 in many markets. The microchip inventory issues started to improve through late 2022 and in the first quarter of 2023, and with that the production of new car inventory has also started to recover.

The telecommunications sector needs microchips not just for phones but also for the infrastructure of cable and wireless networks. Without microchips, there’d be no routers, transmitters, or signal processing.

The telecommunication industry was particularly badly hit because they need three different types of microchips in approximately the same share, rather than just one particular type. Manufacturers attempted to prevent shortages by putting in advance orders, but this inadvertently contributed to the shortage. While one manufacturer might work off a big order from one company first, they’d then have to wait for the other two chips because other companies got their big orders in first.

As a consequence of all that, prices increased for both consumers and businesses. Many telecommunications companies were forced to delay the launch of new products and reduce production of existing ones. Apple, Samsung, Huawei, and Nokia all faced delays with new products. Some companies decided to prioritize the production of high-end products, leaving lower-end and mid-range devices in short supply.

The shortage has also slowed down the rollout of 5G networks, because many of the necessary components, including base station chips and radio frequency chips, were in short supply.

The microchip shortage has much relaxed in 2022 but it isn’t quite over yet. Delivery times have gone back down and prices for consumer electrics are on the rebound. Though part of the reason that the situation is relaxing is decreased demand due to increased inflation rates.

But while the situation is better in 2023 and market analysts believe it’ll continue to improve, it’s still a bit chaotic. Some types of chips are now relatively abundant, while others become available every once in a while, and then those who need them try to grab them quickly.

Especially car makers and smartphone manufacturers are still struggling to receive sufficiently many microchips because their needs are so specific. For example, the auto industry uses older, larger chips, which many factories have started to move away from because they can make more money with the more advanced chips.

There are several lessons to take away from the shortage (a) The current supply chains are extremely vulnerable to interruptions because microchips come from only a few countries and often have to travel far to reach their destination. There are few new players entering the field because the costs to get started are high, between 1 and 20 billion dollars. (b) You don’t just have to worry about the production of microchips but also about the production of the machines required to produce the microchips, and (c) there are many different microchips, and it matters which one you’re talking about. Different industries have different needs.

Many nations have tried to learn from this and are taking steps to prevent such a shortage from happening again. In August 2022, President Biden signed the CHIPS Act, an initiative to eliminate the United States’ reliance on microchips from Asia and China. It’ll invest 50 billion dollars into domestic supply production. That includes 28 billion to produce memory and logic chips, and 11 billion for research and development.

The initiative has results already. Since the act was signed, more than 35 companies have announced plans to invest in manufacturing within the US. The company Micro is building a semiconductor plant in Idaho, and Samsung will spend 17 billion dollars on a new factory in Texas.

The European Union has learned its lesson, too. At the moment there is little microchip production in the EU, less than 10 percent of the global market. But the EU recently launched an initiative similar to that of the US. It’s imaginatively called, guess what, the Chips Act. The difference between the two is that in the US Chips act, CHIPS is an acronym standing for “Creating Helpful Incentives to Produce Semiconductors,” whereas in the EU it’s not.

The European Chips Act promises to invest 43 billion Euro into local microchip production facilities with the goal to increase the European share of the production to 20 percent by 2030. Part of the plan is to support research for next-generation chips and make it easier for startups to get off the ground.

And the Chinese, too, have made microchip independence a top national priority in its latest five-year plan. It’s a smart move because the market is expected to substantially grow in the coming years.

In summary, the microchip shortage isn’t quite over yet, but it looks like it’s going to mostly sort itself out by the end of year. Both the US and the EU governments have handed out money to increase domestic supply and hope it won’t happen again. Is this a good investment? Or should we instead remove trade barriers and let the market sort it out? Or maybe it wasn’t such a bad thing that people bought fewer cars and computers? What do you think? Let me know in the comments.

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