Stress testing the global electronic components supply network
The responses from commercial organisations and governments following the COVID-19 pandemic and the current levels of vaccination scepticism on the part of our European neighbours has been met with a curious mixture of relief and concern from many people for whom the ultimate outcome could be critical. Even after the UK rollout of the various inoculations many people will still fall ill and some will unfortunately die. This puts the loss of revenue occasioned by the current supply problems in the electronics industry into perspective - unwelcome, unpleasant but not life threatening. In this article Adam Fletcher, Chairman of the Electronic Components Supply Network (ecsn) has reviewed how the semiconductor market copes with imbalance in supply and demand and suggests some likely outcomes in the current situation.
Let me start by sharing some good news with you. After many years of lobbying by industry most global governments have finally come to realise that semiconductor IP and manufacturing technologies are strategically important to the stability and growth of their economies. This was confirmed by the unprecedented direct inter-government negotiations particularly with Taiwan, conducted in an effort to speed the delivery of the semiconductor products needed by their own domestic automotive manufacturers.
Unfortunately, semiconductor manufacturing is typically an 18-week process and the commercial semiconductor foundries involved are doing their best to meet competing demands from many large customers in a fair and orderly manner but the current supply problems in the global semiconductor market are limiting production at some of the largest automotive manufacturers.
Ten years after
The manufacturer authorised distributors that comprise ecsn’s afdec membership and the customers they serve are currently operating well despite this challenging demand and supply environment. It’s nothing new: Ten years ago, the earthquake and tsunami on Japan’s eastern seaboard resulted in an almost instantaneous hiatus in the supply of specialty chemicals, compounds and components essential to the global electronic components supply network, triggering an exponential rise in semiconductor manufacturer lead-times.
Automotive manufacturers who buy the components they require JIT direct from manufacturers suffered significant disruption, but most global customers were - and are - supported by manufacturer authorised distributors and to a great degree were protected by twelve-weeks (average) inventory buffers and sophisticated inventory management practices.
Large Tier 1 organisations suffered the most from the disaster in Japan in March 2011 but simply don’t seem to have learned their lesson. They have apparently taken only minimal measures in the intervening years to improve their resilience to unexpected and disastrous supply chain disruptions. In 2020/1 they again found themselves caught out, this time by global Covid lockdowns and the trade war between the US and China.
This ongoing spat is primarily about the understandable need for US technologists to regain international legal control of their intellectual property required for the manufacture of advanced semiconductors and systems. In the mid-to-long term an international legal agreement that mutually and fully respects and licences the rights of IP owners could prove to be in the best interests of Chinese technology companies too, who may well have IP of their own to protect. China will continue to be a leading manufacturer, but the US will remain dominant in technology markets. Only by receiving the licencing revenue they’re entitled to can the US continue to invest and help power global economic growth.
Asia-Pac dominate semiconductor manufacturing
Many industry analysts have voiced their concern about the increasing dominance of semiconductor manufacturing in Asia-Pac where just four semiconductor foundries are responsible for 60% of the global output, and a multitude of test and packaging suppliers support the technology ecosystem. Forty years ago, US and European owned semiconductor manufacturers established outsourced operations in Asia-Pac countries to exploit their ‘low-cost economies’ and bolster their own profitability. It’s interesting to witness how such decisions may come to be regretted over time…!
The economics of operating a semiconductor foundry are extremely demanding. To be viable the foundry must constantly operate above 70% of capacity to generate a reasonable return on investment for shareholders and enabling the depreciation of this expensive asset over a short operating life. Over the last ten years in an uncertain global economic environment only incremental investment has been made in foundry capacity, where the return on investment could and has now been fully justified.
The US was successful in attracting TSMC (the world’s largest semiconductor foundry) into investing in a new foundry in Arizona and Intel has just announced its intention to invest $20B in two new semiconductor foundries in Chandler, also in Arizona, where they already have existing manufacturing facilities.
These announcements suggest that Europe will continue to fall behind in a critical manufacturing technology area, despite the fact that ‘the’ leading-edge semiconductor manufacturing equipment supplier is today based in Europe…! In the past the EU has offered financial incentives to semiconductor manufacturers to encourage collaboration, but at the time the terms were not found to be acceptable. In recent years some older legacy semiconductor manufacturing capacity in Europe has been removed forcing customers to migrate their designs to alternative legacy fabs or newer technologies, which have proved to be both expensive and difficult to do.
The capacity for the US and European countries to manufacture semiconductors for military applications is also extremely limited. Both economies are seeking to increase their capability locally and are now providing significant financial incentives to larger semiconductor foundries and manufacturers to increase inward investment. The European Commission’s aim of Europe supplying 20% of the global semiconductor market looks naïve at best.
The reality is that even with massive investment in existing European semiconductor manufacturing or with inward investment by an established Asia-Pac semiconductor foundry, it will take at least a decade to make significant progress and establish the full ecosystem required to support the entire semiconductor manufacturing process.
Strong demand and overshoot
Commercial pressures within the semiconductor industry will eventually compel the changes and investment required but in the short-term no amount of individual Government meddling will make much difference. Governments should determine solid long-term industrial strategies and policies including international collaboration, aligned with good legislation, regulation and if required, modest financial stimulation, and then let the market resolve short-term supply issues.
There is no doubt that the current strong demand for semiconductors is exceeding industry capacity and if demand remains at the current level, which looks likely, it will take a year or two to catch up. The extremely competitive nature of the semiconductor market, the need to keep foundries operating at high levels of capacity, the scramble to maintain or grow market share and the imperative to meet customer demand could drive the market back to equilibrium fairly quickly, but the more likely outcome is that total capacity will exceed demand as it has in previous cycles. An overshoot will inevitably lead to excess capacity, which will drive prices down and undermine the investment – at least until the cycle starts over once again.
On that basis I continue to urge all organisations in our industry to engage effectively both up and down their supply network. Sharing business intelligence honestly with your supply network partners can make a very effective contribution to the performance of your organisation and to the partners who also rely on your success…
Let’s hope the all governments allow the COVID-19 vaccine makers to focus their efforts on manufacturing and supplying their products to commercial terms and that politicians will then have a mandate to share the vaccine wisely based on real clinical need.