If the pandemic had a partner in crime, it must be the global chip shortage. The duo has hit established economic systems world-wide, and made several organisations scale back production and rework their manufacturing and supply chain processes.
Toyota Corporation on Tuesday apologised to its suppliers and customers a third time in less than two months for delaying making new vehicles and changing production plans for the June ending quarter. On March 17, the Japanese automaker said it is pressing the brakes on production targets to rework a plan that will not max out factory capacity, push employees to their limits, and make do through overtime work. A month later, the Japanese automaker cut its global production target for the period between April and June by 1,00,000 to 7,50,000 vehicles in May. And then again, on May 24, it said ,“Due to the impact of semiconductor shortages, we have adjusted our production plan by tens of thousands of units globally from the number provided to our suppliers at the beginning of the year.”
CEOs of AMD, Nvidia and Intel have said at different forums last year that the chip situation will remain tight for the rest of 2022.
Genesis of shortage
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. People switched to work from home, children connected to schools through laptops, and get-togethers happened over video calls. This shift led to a surge in demand for laptops and tablets. The stay-at-home rules also made several people pick up console-based gaming. This demand was driven by console hardware, and subscription-based mobile games. Each of these devices were in high demand and are run on thumbnail-sized semiconductors, performing various functions on a single device.
Manufacturers produce them as 200mm or 300mm wafers. These are further split into lots of tiny chips. While the larger wafers are expensive and mostly used for advanced equipment, the devices that were in high demand needed smaller diameter wafers. But the manufacturing equipment needed to make them 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 consumer demand for low-end products, coupled with large orders from tech firms chocked chip makers whose factories were also closed during lockdowns. As the industry gradually tried to pull itself out of the supply crunch, and logistical complexities have exacerbated the problem.
THE GIST
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.
High consumer demand for low-end products, coupled with large orders from tech firms chocked chip makers whose factories were also closed during lockdowns.
When the pandemic began, carmakers stopped requesting chips from suppliers due to low demand for new vehicles. 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.
The lockdown has had a domino effect on global supply chains. Separately, Russia’s invasion of Ukraine has strained exports of essential commodities used to make chip sets. Moscow supplies rare materials like palladium, and Kyiv sells rare gases to make semiconductor fab lasers. This combination is required to build chipsets that power a range of devices, from automobiles to smartphones.
Intricate networks
About a decade and half back, semiconductors barely drew attention from large companies that have now come to rely on the thumbnail-sized semiconductor piece. During this period, firms developed a system to make chip sets. The system was made by interconnecting several parts of the world to make a single device. It is what we now call as the global supply chain. While it is hard to pinpoint when this system was developed, its roots go back to the time when companies began cutting up their businesses into smaller parts and outsourcing them to places where land, labour or capital was cheap.
Semiconductor-making firms applied this knowledge to their industry. The process to make a chip was divided into front-end and back-end parts. Wafer fabrication and probe are generally referred to as front-end operations, and assembly and test as back-end operations. The front and back-end processes were further broken down into micro units, and were spread out across the globe, creating a global chip-making ecosystem. This 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 semiconductor-based product could cross international borders about 70 times before finally making it to the end customer. Wafer fabrication is the most globally dispersed, with 39 countries directly involved in the supply chain and 34 involved in allied activity. They provide services like photolithography, etching and cleaning. Designing happens across 12 countries; product testing and manufacturing each are done across 25 countries.
That’s a complex, interconnected ecosystem with its own ebb and flow. The industry faced its share of glut and shortage in the past decade as consumer preferences shifted from one electronic fad to another. And this time, around the shortage in the system coincided with the pandemic. It also came at a time when the semiconductor supply chain’s chief strength became its weakness.
Strength becomes weakness
Developed during the World War II era, Just-In-Time (JIT) was used by Japanese companies that lacked resources and space to rebuild factories by carefully using what they had in the leanest way as possible.
Taiichi Ohno, the father of Toyota Production System, later conceptualised JIT and the Kanban technique to create an efficient production system for automobiles. Most companies, including chip makers, used JIT to run their supply chains smoothly and efficiently. JIT lets firms take inputs from suppliers only when they are needed. It helps them cut inventory storage cost, shorten production cycles and free up cash flow for other investment activities.
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. 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. 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.
Intel CEO Pat Gelsinger, in an interview to Bloomberg TV at Davos, Switzerland, said, “The supply and demand will balance out only in 2024.” He also 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. Together, these two 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.
Perhaps semiconductor-hungry firms may see light at the end of the tunnel when the shift in chip production capacities show up more prominently in the West.
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