Deep Dives #1 / Geopolitics #2 | Chip shortages and a Quick Semiconductor Industry Primer
understanding why chip shortage is a thing.
Unless you have been living under a rock, you have read something about the semiconductor shortage. In this post, I’ll try and take a quick stab at the industry and how that evolution has led to the current state.
Some Background:
Chips are nothing but a large collection of Transistors. These can be combined in various ways to create logic gates and these in turn underpin the processing pathways that a chip has.
The production of chips is a fairly standard process. However, technology has evolved to make the chips smaller, more power efficient. A great primer, straight from the source can be found here, on Intel’s site. Here is also a great video from the Knowledge Project.
When you hear about 14nm, 10nm, 7nm processes, it refers to the size of the transistors on the chips. So while conceptually a 7nm transistor is half the size of a 14nm transistor, the performance of the chips will not be a factor of 2. The benefits really accrue in terms of power consumption and on-board capability.
And a lot of this innovation is being driven by the Mobile and IoT markets. Your phone today has more power than the Cray Supercomputer and the ILLIAC IV. You can design stealth fighters and simulate nuclear tests on that thing.
Here are a few important terms before we dive into the business side of things:
Fab– a company that builds the chips. Also sometimes called a foundry but I have seen that term used more for companies that create the silicon wafers. I could be wrong.
Fabless – a Company that will design the chip, and leave the actual production to a TSMC or SMIC e.g. Nvidia chips are made by TSMC.
IDM – Integrated Design Manufacturer – Intel, Samsung, NXP. They both design and manufacture their own chips.
EUV – Extreme Ultraviolet Lithography – Newer Tech. I’ll leave Wikipedia to explain what it is and how it differs from immersion lithography. Basically – these machines are expensive, there are only about 5 companies that make them, there isn’t enough of these machines, and they cost a bomb.
The really important ones here are Fabs, Fabless and IDMs.
There are other players that deal with EDA (automating the design of the chips), ATE (automated testing, failure rate of chips is very high) and OSATs (outsourced assemblers), but they are not a constraint (at the moment) so we will deal with them if they become relevant at a later date.
Now, let’s get to the business side of things:
Semiconductors is an extremely capex intensive industry. In 2019, the industry spent almost $85bn in capex. Each progressive improvement needs a ton of additional capex, running into billions.
You can’t just scale up production on a whim. So, to optimize, manufacturers will often build excess capacity that they hope will get utilized over time than to have a shortage.
This is a textbook cyclical industry and has 3 key trends:
Continued consolidation (Nvidia just bought out ARM)
Wider divide between Fabs and Fabless players. New IDMs are going to be very rare.
Increasing Lack of meaningful manufacturing capacity outside of Asia.
IDMs are market leaders and complex animals. Ones I can think of are Intel, Samsung and NXP. These guys have high margins, market share and staying power (aka deep pockets), but they are most affected by the capex cycle. As an example, Intel is moving to a 10nm process and its margins have dragged. It’s incredibly hard to begin again from scratch every 5 years or so s technology changes. It is hard to see another IDM coming up anytime soon and scaling to the levels of Intel and Samsung.
Fabless Players come in all shape and sizes e.g. Nvidia and Apple – these guys design the chips and let TSMCs of the world make them.
Let’s come to the other capex intensive segment – Fabs. TSMC is the largest player with a crushing market share and a corner on the EUV tech. it owns half of all the EUV machines in the world. Another outcome of this is that the industry has only a few players left. In 2001, there were ~30 or so fabs. That number went down to 5 in 2018. The industry is now an effective oligopoly where the weak ones have been acquired or are dead. New fab capacity is coming up in China (4 new fabs) but it’s not easy to get the industry off the ground.
The machines also have a very complex environment but very quickly – ASML is the only maker of EUV machines in the world; Applied material is the market leader in the prev. gen. tech; other big players are Tokyo Electron and LAM Research. LAM is a leader in etching and depositing machines and given the fact that the EUV tech overlaps this step – is also facing significant pressure.
Wait a minute, weren’t you going to talk about the shortage?
Now, with all this context and heavy concentration of global semiconductor industry in the hands of ~15 companies, here is what has happened and is happening:
With 5G model launches scheduled – Smartphone makers placed huge orders for chips. These are extremely profitable, large accounts and no one wants to piss them off, so these went to the front of the queue.
Huawei also placed extremely large orders because couldn’t buy more chips thanks to the trade sanctions.
Covid 19 rolled around and poked the entire global supply chain in the eye.
WFH led to a spike in the consumption of chips by cloud infra providers.
Thanks to Covid – industries like auto shut down production. As they didn’t place fresh orders for chips, the fabs took what orders were available and started executing on those – yep – mobiles and cloud infra.
So from defence to Laptop SSDs to batteries – everyone else has a shortage of chips.
This supply squeeze will likely continue into 2022.
If you have questions, send them to me. I’ll try my best to answer them or get an expert to answer them for you.