Microchip Supply Chains: The Changing Global Landscape
Key Takeaways:
From smartphones to defence, microchips shape modern life. However, the supply chains that ensure their availability are undergoing a radical shift.
Vulnerabilities highlighted by the pandemic and rising geopolitical tensions with China have prompted ‘de-risking’ policies from the US and EU which aim to pull microchip manufacturing closer to home.
The evolving microchip industry presents significant opportunity for big tech firms to innovate, fuelled by subsidies and incentives, with potential benefits extending to consumer technology and vehicle manufacturing.
While not an immediate transformation, global businesses should prepare supply chain contingency plans and expect increased costs for microchips produced in the Western world.
The inner workings of the devices we use daily, from mobile phones to computers, often go unnoticed. Rarely do we consider the intricate components guiding missiles, powering satellites for internet connectivity, or enabling vehicles to cover vast distances with ease and comfort. Yet, the driving force behind these overlooked aspects of modern life is the widespread presence of advanced semiconductors (or microchips). These facilitate intricate computing on a microscopic scale, playing an indispensable role in nearly every facet of modern life. The production of these high-tech semiconductors relies on historic global supply chains, concentrated among specialised regions and companies. However, this global chain is swiftly evolving. Geopolitical tensions have spurred the US and EU to pursue 'de-risking' and 'decoupling' policies from supply chains linked with China, resulting in strategic measures like export controls and targeted investments in alternative inputs. This political shift is driving significant changes, compelling businesses directly involved in the microchip industry and those reliant on their products to navigate a complex and fast-moving landscape of microchip supply chains.
Microchips: Then vs Now
Microchips have advanced dramatically since their inception in 1958, beginning with basic structures made of germanium and gold wiring with a single tiny switch called a transistor, to today's silicon chips, some containing up to 50 billion transistors. This remarkable growth aligns with 'Moore's Law,' a prediction made by Gordon Moore, co-founder of Intel, forecasting that the number of transistors on a chip would double approximately every two years. By the end of the 20th century, companies from the US, Japan, and Taiwan led the way in microchip technology. These microchips became essential components in both military equipment and everyday consumer devices, fundamentally shaping the global economy and our daily lives.
During this time, the semiconductor supply chain was divided between companies that design microchips (called fabless companies) and those that manufacture them (known as foundries). In semiconductor manufacturing, 'fabs' are the sophisticated facilities where silicon wafers, the basis of chips, are made. Operating these high-output fabrication plants requires substantial expertise and capital, which favoured the split in the supply chain. The largest and most influential foundry is TSMC (Taiwan Semiconductor Manufacturing Company), established in 1987. Currently, TSMC produces over 90% of sophisticated chips found in smartphones, computers, and military equipment. While this separation between design and manufacturing largely persists, some major companies like Intel and Samsung have chosen integrated operations, handling both aspects of the supply chain. This model has become more popular in recent years to address increased market volatility, driven by factors like the COVID-19 pandemic, tensions between the US and China, and concerns about Taiwan's security.
Current Status of the Global Microchip Supply Chain
Consider the iPhone 13 or 14 you might be using now. Its powerful A15 Bionic chip, housing 15 billion transistors, was conceived at Apple's headquarters in Silicon Valley, California. Once designed, the blueprint travels across the Pacific to Taiwan. There, TSMC transforms raw silicon, sourced from sand and rocks, into wafer discs of nearly pure silicon. These wafers are then etched using intricate lithography machines from ASML in the Netherlands to create microscopic chip designs. Each 300mm wafer can produce hundreds of A15-sized chips. Following various treatments and quality checks, the individual chips are separated from the wafer and prepared for shipment to assembly lines. Traditionally, this assembly process occurred in Foxconn factories in China. However, due to geopolitical concerns and supply chain disruptions, this final assembly stage, much like microchip manufacturing, is gradually diversifying. Factories in countries like India or Vietnam are increasingly playing a role in iPhone assembly, marking a shift from the previous reliance on China.
The dispersed microchip supply chain proved vulnerable to significant disruptions during the early stages of COVID-19 in 2020, with lockdowns in key manufacturing hubs like China and Taiwan causing substantial production setbacks. This underscored the critical need for businesses to fortify their supply chain resilience. Fabless companies, reliant on these global supply chains, faced challenges accessing essential links, leading to shortages, inflated prices, and economic slowdowns across various sectors, from vehicle manufacturing to consumer tech. To mitigate such risks, businesses should proactively diversify their supply chains, establishing backup suppliers, ensuring manufacturing flexibility, and strategising for contingencies. Investing in contingency planning, exploring alternative suppliers, and adopting flexible manufacturing strategies is essential to minimise the impact of future geopolitical disruptions. This disruption not only emphasised the importance of secure supply chains to the public but also prompted governments worldwide to safeguard their critical industries from potential future shocks.
Geopolitical rivalry between the US and China is a key driver behind the Western movement to 'de-risk' global trade and innovation. This trend stems from the growing significance of military capabilities in an era dominated by AI, Unmanned Aerial Vehicles (UAVs), and the development of hypersonic weapons. When it was discovered that a Chinese defence firm utilised American software on a TSMC chip to guide their advanced hypersonic missiles, the US swiftly enforced a range of sanctions to prevent the export of sophisticated US-designed chips to China. These measures, aimed at curbing China's competitiveness in AI and military technology, have strained diplomatic relations and further fuelled a technological arms race between the US and its 'near-peer competitors'. While these restrictions will undoubtedly limit business collaboration with China, the immense demand for technological advancement in US defence offers significant opportunities for tech companies specialising in AI, Machine Learning, Quantum Computing, Directed Energy, Hypersonics, and other emerging technological fields.
As we approach 2024, the global microchip supply chain remains largely dependent on the traditional model, primarily centred on Taiwan and South Korea for the production of advanced chips. Yet, this reliance is undergoing a notable transformation. The US CHIPS and Science Act of August 2022 aims to re-shore a significant portion of the semiconductor supply chain to the US through generous subsidies and tax incentives. Following suit, the EU introduced its own Chips Act in September 2023, echoing the US approach by emphasising vulnerability to geopolitical disruptions and aiming to enhance regional economic output. Naturally, these legislative nudges towards supply chain diversification have pushed China to intensify its domestic innovation and manufacturing capability amidst sanctions and competition with the US.
The United States
The Biden administration has committed $52.7 billion to bolster the US' foundries, R&D, and related job sectors, aiming to mitigate potential risks from future geopolitical upheavals and enhance competitiveness against China. This substantial pledge offers significant opportunities for large-scale manufacturing and construction businesses, offering them a 25% investment tax credit. It will also foster employment growth and regional development, exemplified by TSMC's $40 billion investment in two semiconductor fabrication plants in Arizona.
However, US investments encounter hurdles in the form of bureaucratic processes and higher costs compared to operations in Taiwan. The relative absence of low-cost skilled labour, compared to that seen in Asian regions, will require investment in training programs and an increased demand for STEM-educated workers in order to meet operational needs. Consequently, while these operations will spur economic activity in hosting regions, the costs of fortifying semiconductor supply chain security will lead to temporarily higher chip prices until US chip production reaches optimum output. This initiative, coupled with the US 'Inflation Reduction Act', aligns with the broader national strategy to position the US as a dominant global economic hub and curtail Chinese growth. It involves substantial domestic incentives, grants, and global measures like sanctions and diplomatic pressure on allies and trade partners.
China
Despite its substantial reliance on more sophisticated US chips, China is not powerless in the ongoing microchip trade conflict. In response to September's export restrictions on advanced lithography machines from ASML, China implemented controls on its own exports of critical minerals such as Gallium and Germanium. These minerals, primarily sourced from China and vital for cutting-edge microchip parts, will likely lead to immediate material shortages, market disruptions, and long-term price hikes. Addressing these constraints will demand significant investment and enhanced productivity from producers in the US and Europe. An illustration of this trend is seen in NEO Performance Materials, which recently expanded its operations in Estonia to manufacture rare earth products essential for meeting European demand. This changing landscape offers businesses dealing with critical minerals and rare earth elements a unique opportunity to leverage the incentives and new markets introduced by the US and EU.
Recognising the impact of lithography machine restrictions, the Chinese leadership is investing heavily in R&D, collaborating with companies like the Semiconductor International Manufacturing Corporation (SMIC). This strategic move has already proven successful, evident in Huawei's Mate60 smartphone which utilises an advanced SMIC chip, effectively countering US sanctions. On a broader scale, these sanctions have spurred China to fast-track its technological development under its ‘Made in China 2025’ initiative, setting the stage for a modern Cold War centred around competition in semiconductor advancements. This rivalry, akin to the Space Race and Arms Race of the 20th century, marks a pivotal moment in the global technological landscape.
For businesses dependent on the existing microchip supply chain, the impending microchip arms race between the US and China signifies a likely surge in semiconductor innovation. However, it also carries the potential to reshape supply chains, intensify market competition, and impact pricing dynamics. The heightened geopolitical tensions may lead to trade disputes and disruptions in technology and goods flow. To navigate this evolving landscape, businesses should anticipate shifts in market dynamics, reconsider supply chain strategies, and remain vigilant in identifying and addressing intellectual property protection concerns.
The European Union
Aside from ASML, Europe’s current impact in the global microchip supply chain is dwarfed by the likes of TSMC, Intel and Samsung. The European Chips Act (ECA), alongside other government incentives, aims to increase Europe’s share of global semiconductor manufacturing from 10% to 20% over the next decade. Traditionally, Europe’s semiconductor input has been focused on R&D, with most of the manufacturing taking place in Asia. The vulnerabilities of this structure have been highlighted by severe semiconductor shortages related to the Covid-19 pandemic and the Russo-Ukrainian conflict. The shifting US attitude towards China, part of the wider trend of de-risking, has presented the EU with the opportunity to seize a larger share of the semiconductor manufacturing supply chain. The ECA is reallocating €43 billion in investments, in conjunction with regulatory benefits, to make Europe a more attractive environment to base semiconductor manufacturing.
In addition to EU funding, the German government has identified semiconductor manufacturing as a potential means to address its current swathe of deindustrialisation, allocating approximately €20 billion in subsidies to companies able to open fabrication plants in the country. TSMC, in collaboration with Bosch, NXP and Infineon, Germany’s largest chip manufacturer, has already struck a deal with the German government to receive €5 billion in subsidies towards the construction of its new fabrication plant in Dresden, expected to come online in 2027. The allocation of these subsidies has been limited to multinational corporations and consortiums promising large foundries which can attract and develop skilled labour in the countries and regions hosting them. However, this model of capital allocation limits the opportunity for small businesses to gain market access outside of R&D and small-scale innovation.
Implications for Businesses and Future Trends
The evolving semiconductor landscape presents diverse opportunities and risks across all sectors reliant on this technology, which in the present day encompasses almost every facet of the global economy. Companies in rare earth elements and critical minerals production could benefit from government incentives aimed at securing semiconductor supply chains, yet future geopolitical disruptions may cause market upheavals and increased costs for companies reliant on energy and materials imports. The intensified competition in semiconductor advancements is expected to drive rapid technological innovations, notably in AI, machine learning, and quantum computing. Yet associated geopolitical tensions may introduce market volatility, affecting sectors involved in producing hardware and funding for these domains. This volatility could also lead to shortages and inflated prices in the consumer electronics sector. Therefore, companies in these sectors would be wise to explore alternative supply chain strategies as an imperative. Automotive companies are poised to gain from innovations in vehicle technology driven by semiconductors, namely self-driving cars and advanced electric vehicles. However, future disruptions in semiconductor supply could still lead to production delays, affecting vital vehicle electronics and automation systems. Similarly, the finance sector, benefiting from semiconductor-driven innovations in fintech and cybersecurity, also faces risks due to supply chain disruptions. These disruptions may cause price fluctuations and impede access to crucial tech infrastructure, potentially impacting digital services and transactions.
The changing landscape of the global economy, marked by the unravelling of established structures, underscores the necessity for businesses to fortify their supply chains. With the trends of re-shoring and near-shoring shaping a more multipolar world, the competitive innovation between the US and China will significantly influence trade and investment patterns. Businesses aligning with these major powers or strategically positioning themselves in geographic proximity (near-shoring) can attract lucrative partnerships and incentives. However, businesses not aligned with dominant powers risk losing preferred access to crucial investments. Nevertheless, their potential future access to both markets could offer a strategic advantage, highlighting the importance of securing resilient and adaptable supply chains in the evolving global environment.
