Why The Chips Are Down: Navigating the Global Chip Shortages and Beyond
The supply chain bottlenecks we're experiencing across the globe start with components. Rather, they start with component shortages. Of all the component shortages we’ve seen in recent years, by far the most severe has been for certain semiconductors, or chips. The current global chip shortage rivals only a few of the past imbalanced markets. However, it's unique in the breadth of product families feeling the gap in supply and demand.
Global semiconductor shortages are not ending yet, but there are some mixed signals ahead for 2023. Based on market data and conversations with our customers, we expect the market for components like analog, microcontrollers, FPGA and discretes to be constrained well into 2023; lead times for basic semiconductors still extend past 40 weeks, on average, and high-end components are in excess of 52 weeks.
However, we anticipate some relief could come in the back half of 2023. As the global economy has cooled down, demand in consumer markets has softened significantly — allowing suppliers to fulfill orders from other markets and begin clearing component backlogs. Combined, these factors spurred Gartner to project that the global semiconductor revenue will decline 3.6% in 2023.
Still, a few segments are still fueling high demand for specific chips: the Internet of Things (IoT), 5G and automotive, especially the electrification of the automotive industry. Now, instead of managing shortages in every area, chip suppliers are monitoring and reviewing their inventories to ensure they have the right product mix to meet demand where it’s peaking and avoid potential excess of chips from industries where demand is falling.
Like most unpleasant things in our lives over the past two years, there is a single underlying cause of the global semiconductor shortage that is now prolonging and exacerbating it: COVID-19. The demand caused by the pandemic is straining capacity at all points of the supply chain, starting with component suppliers.
What's Behind the Ongoing Global Chip Shortage?
The COVID-19 pandemic kickstarted the chip shortage, and its long-reaching effects — including virus outbreaks, labor challenges and geopolitical uncertainties — have fueled it. Each link of the global supply chain continues to be extremely disrupted. Unfortunately, there are no signs of recovery in the near term.
This is because the pandemic also spurred a snap back in growth and demand so remarkable and unpredictable that supply chains will struggle to keep up until that demand falls to a more manageable level or more capacity and component supply chain issues are resolved. All commodities initially saw demand drop precipitously with the onset of COVID-19 and the shutdown of factories. Then, the massive consumer spending we saw after the pandemic's initial shocks had settled created a V-shaped recovery of the global economy, spurring an extraordinary need for semiconductors.
Now that the formerly white-hot economy has turned sluggish, we are facing chip shortages, still-lengthy lead times from analog suppliers and huge price increases. Risk has been elevated to unparalleled levels all along the semiconductor supply chain.
Impacts from this sustained demand are primarily being felt at wafer foundries. Wafer starts are the main constraint within the chip supply chain. Even the world's largest chip maker, TSMC — which controls 28% of global semiconductor manufacturing capacity — is experiencing ongoing shortages. To ramp up chip production, manufacturers including Texas Instruments, Intel and TSMC are investing billions of dollars into the construction of new fabs. However, this is not a complete fix in itself; these new facilities have started coming online, and openings will ramp in 2023 and beyond. But these fabs were planned when demand was high across the board. Semiconductor manufacturers must now be wary of the risk of overcapacity if demand continues to weaken and balance their supply accordingly.
International governments have also joined the push to increase chip capacity. In July 2022, the United States Senate and House of Representatives passed the CHIPS Act, which includes about $52 billion in government subsidies for research and production of semiconductors in the U.S. The bill also provides chip plants with tax credits worth about $24 billion, with the goal of spurring U.S. chip manufacturing to alleviate some of the supply chain issues hampering the country's automotive and consumer electronics industries, among others.
The European Union is planning a “Chips Act” of its own to increase the production of semiconductors within Europe, while South Korea has committed $450 billion to its own industry, and the Japanese government is partnering with TSMC and Sony to open a new fab by the end of 2024.
Beyond wafer foundries, wire bonding, substrates, materials and testing are all seeing shortages or delays. In China, continuous COVID-19 outbreaks have impacted the supply of raw materials and assembly and testing. Further, the invasion of Ukraine has increased the prices and limited the supply of raw materials used in semiconductor production, causing turmoil throughout key markets for the industry.
Despite these challenges, lead times are beginning to stabilize and even decline in some cases. As of early 2023, lead times for most standard semiconductors average 26 to 52 weeks, showing steady improvement throughout the back half of 2022. Later this year, we could see average lead times for most non-automotive chips drop to below 35 weeks — still far longer than average pre-pandemic lead times.
Automotive-grade and high-end semiconductors like microcontrollers (MCUs) and chipsets remained heavily constrained. Most of these high-end components are in allocation, with average lead times averaging 52 to 78 weeks.
This new era of slowing growth and adjusting market demands has also seen new waves of price increases. Raw materials, wafer fabrication, logistics and labor have all become more expensive than ever. In turn, semiconductor suppliers are being forced to pass their costs on to their customers to help stabilize the supply chain. TSMC — again, the world's largest foundry supplier of 300mm wafers and the most advanced process nodes — is expected to raise prices between 3% and 6% in 2023 after a 10% increase for high-end semiconductors and by 20% for less advanced chips in August 2021.
Prices for basic chips will likely be flat or slightly up depending on the manufacturer. High-end chip manufacturers anticipate additional hikes of approximately 5% to 15% for their components.
Having already taken blows from 2021 and 2022's uncertainties, the markets that rely most heavily on chips — including automotive, 5G and the IoT and smartphones — are braced for more unknowns.
How Have Chip Shortages Impacted Markets?
The automotive industry has likely been impacted the most by the chip shortage. Depending on its level of connectivity, the average car can have more than 100 chips on board, with many vehicles requiring thousands of semiconductors to control safety features, the electrical and powertrain systems, infotainment, connectivity, and more.
As a TSMC spokesperson told Time, the roots of the industry's current chip challenges date back to 2018. Everything was becoming connected, from packaging to refrigerators, and smartphone demand was skyrocketing, but demand for cars was soft. To meet the need, semiconductor manufacturers began allocating more supply of now-critical automotive components like MCUs to other industries. This became a huge problem when car demand jumped unexpectedly in the last quarter of 2020 and continued through the first half of 2021 thanks to low interest rates and consumers having more expendable income than they anticipated.
By the spring of 2021, ramifications of the chip shortage had become clear to the auto industry. Factories have been forced to cut production or even close down temporarily due to parts disruptions. Putting more pressure on this limited supply of chips is the growing number of electric vehicle mandates being issued by governments around the world. Industry experts and auto makers have expressed concern that a prolonged chip drought could delay the rollout of these new vehicles, particularly in the United States. The analyst firm AutoForecast Solutions anticipate OEMs will face a production shortfall of three million vehicles in 2023 due to a lack of chips — a hurdle, no doubt, but an improvement of 2022’s 4.5 million and 2021’s 10.5 million lost vehicles.
Automotive chip shortages are also driving up the price of new cars. The average price of a new car hit record highs throughout 2021 and 2022, coming in at $46,382 in December 2022; the average price was $40,000 at the end of 2020. According to J.D. Power, while the number of new cars actually decreased 2.8% year-over-year between December 2021 and 2022 — due to a combination of supply constraints and a drop in demand caused by inflation and growing interest rates — consumer spend on new vehicles was only down 0.3% in the same period.
All told, despite the high prices, it's believed the chip shortage and economic pressures like higher interest rates have brought automotive OEMs their lowest sales total since 2011 — with many individual brands continuing to bring in lower-than-expected quarterly results and adjusting their 2023 financial targets as a result.
The chip shortage is also slowing IoT projects — including the implementation of IoT modules that use 5G networks. Demand for cellular IoT chipsets and modules had been surging as companies worked to implement 5G technologies, but supply chain disruptions delayed shipments and hampered the industry’s growth. The number of global IoT connections grew just 8% in 2021, compared to a 25% annual growth pre-pandemic. This slowed growth could further delay the long-awaited conversion from 4G to 5G.
Additionally, as the raw materials needed for semiconductors continue to be limited in supply, they will likely be first allocated to the high-end chips used in products like cars, rather than the simpler microcontrollers and sensors used in IoT devices. A report from Forrester on IoT in 2022 predicts that it will take longer for the IoT market to regain the supply of chips needed to meet demand.
The full effects of the shortages have yet to be seen on 5G's rollout. However, a number of telecommunications companies warned the F.C.C. in June 2021 that a lack of chips could have significant impacts on the deployment of 5G connections.
So far, industries have dealt with the chip shortage in mostly short-term ways. The automotive industry has turned to on-the-fly decisions like cutting high-tech features from new car models. Meanwhile, the smartphone industry was able to ride out the early stages of the shortage by using semiconductors they had stockpiled at the beginning of the pandemic.
The industry did eventually run into supply issues, but it now faces the complete opposite problem; there are too many memory chips available and too little demand for the new smartphones that require those components. A recent Nikkei analyst survey found this oversupply of semiconductors for phones, PCs and other consumer electronics will likely last until fall 2023.
We're seeing these mixed signals — with shortages of critical chips in one area and unforeseen component oversupply in others— throughout the global supply chain. Making it through this, or any, moment of uncertainty starts with a resilient supply chain strategy built on visibility, predictability and communication.
How to Navigate the Global Chip Shortage
Perhaps the only thing that can be said with certainty about the global chip shortages is that no one is certain when they will end. If demand holds as expected based on market data and conversations with our customers, we expect the semiconductor market to be tight well into 2023.
There's no easy way to get around a short supply of semiconductors and rising costs when every company is in the same boat. However, there's a big difference between a leaky kayak and a powerboat that is capable of navigating rocky waters. Every original equipment manufacturer (OEM) can take a series of steps to ensure they're in the best position possible as chip shortages persist:
Alignment: Your company's product design teams should stay aligned with your suppliers' technology roadmaps and capital investment plans to increase your chances of getting necessary components when you require them.
Supplier qualification: For common products, have multiple approved suppliers and continue to add to that list as suppliers grow their capabilities and offerings. Review and consider suppliers' global footprints as part of the qualification process to mitigate risks that might arise from having suppliers concentrated in a particular region.
Visibility: Provide as much visibility as you can to your suppliers so they can plan their product capacity and any potential longer-term capital investments. With some suppliers looking for 12 to 24 months of visibility, as soon as it's feasible, place long-term orders through the end of 2023 and even into 2024 to enable better visibility for wafer and capacity planning.
Increase lead times in planning systems and additional buffered inventories: With lead times increasing for most commodities, update your planning systems to reflect those delays accordingly. Pull-ins and support for unscheduled orders will be very difficult.
Both short-term and long-term strategies are necessary to withstand the challenges posed by the semiconductor shortage. This is not the only ongoing component shortage, and it certainly won't be the last.
The pandemic has thrown the global supply chain into disarray. But the challenges of the past few years have also revealed its deep interconnectedness and thus emphasized the critical importance of strong supplier relationships and a prepared, resilient supply chain and procurement strategy. Wherever the chips fall this time around, it's always prudent to have a plan.