Semiconductor shortage in 2021

If 2020 has taught us anything it’s that overreliance on outsourcing was a bad idea.

Aug 18, 2021

For almost 80 years now, ever since the Second World War, outsourcing was used to focus companies to their true target by reducing and controlling operating costs, It also enabled small companies to access world-class capabilities which gave birth to Tertiary Industries, especially the service industry. But there’s an issue, Never in the history of the world did so many produce so little of lasting value. Some of the biggest companies on the planet own nothing and produce nothing but still generate value by connecting owners of capital or information with users whose information on their use of said service is then sold to advertising companies.

In 2005, according to preliminary statistics compiled by the Bureau of Labor Statistics and published in Establishment Data Historical Employment (2005), workers who provided services (111.5 million) outnumbered workers who produced goods (22.1 million) by a ratio of five to one.1

It is then not surprising that we can go from an overabundance of food to “most serious food shortages that this country(UK) has seen in over 75 years“2 when a wrench was thrown into our well Oiled system.

Today, no global currency has true value behind it except the value others are willing to give it. This is all and good as Fiat currencies have no restriction on growth but also have no bottom to fall to. This growth spurt has also introduced a myriad of issues chief among that capital investments, that could take years to generate a return, have been put aside in favor of short turn gains and that is a mistake that the current global crisis has brought to the forefront. Countries that have an overreliance on the service-based industry will have a hard time coping with ongoing global shortages amidst the global pandemic.

Outsourcing is just one of the business tools but it became a catch-all. In the case of factories, it enabled companies to forgo large capital investments in manufacturing in exchange for a somewhat longer supply chain and longer lead time. And, up to 2020 outsourcing has thus fueled the world economy by juggling those two components and managing risks.

Combined with the effects of lockdowns due to the pandemic and blockage of the Suez canal alongside Just in Time warehousing strategies, users of outsourced manufacturing have suffered a major blow with many companies losing in a single year in sales as much as it would take them to build the factory itself. This has begun to feel itself in increased cost that the end-user is paying for products and services.3 I

It is estimated that the automotive industry alone will lose $61 billion in revenue4 from the semiconductor shortage this year. This estimate was later revised to $110 billion, almost doubling prior estimates.5

The first lesson automakers are learning, Wakefield (AlixPartners) said, is they are no longer “the 800-pound gorilla” in supplier relations, especially with chipmakers who also serve tech giants that pay higher prices for more advanced semiconductors for mobile phones, laptops and video games.

As the world transitions to electric vehicles, the demand for semiconductor parts will only go up. BMW production costs alone could rise by $1.2B due to raw material price increase in 2021 alone.6 In April BMW was forced to temporarily shut down due to a global computer chip shortage while it waits for more supplies. As did Jaguar Land Rover, and Nissan.

The automotive industry is important as an economic health indicator as it incorporates a variety of different supply chains from all over the world. From farmers that provide feeds to farms that provide leather for cars interiors, raw ore for smelters that produce steel and aluminum, price of electricity, and oil price is infused in a myriad of synthetic parts like tires, paints, plastics. Just imagine how many supply chains the automotive industry is relying on. And if one stops others are halted as the Just in Time warehousing strategy doesn’t allow large amounts of raw materials to be stored on site. So while the semiconductor shortage is resolved all other providers of goods and services, not just the carmakers, are losing money, compounding the economic loss. The automotive industry can be looked at as the BigMac index for the world economy. Not perfect but at the same time more realistic as fewer statistical tools are used on it to prepare it.

As of May 2021 the list of shortages in the US; computer chips, used cars and rental cars, Gas, plastics and palm oil, homes and vacation houses, lumber, household products like toilet paper and tampons, furniture, chicken, bacon and hot dogs, imported foods like cheese, coffee, and olive oil, chlorine, corn and medical Oxygen.7

It is said these shortages are just shortages that are hitting the reopening economy as production ramp-up again and that could be true if one or two or three supply issues occur but that is predicated on the idea that all those shortages exist in a vacuum, not relying on one another, and are not interconnected.

Semiconductor shortage is one of the most significant as it influences many aspects of modern life. Shortage of chips creates a shortage of parts in the automotive industry that then cant produce cars, trucks which most supply chains rely on for the end of line delivery. This, in turn, increases the cost of used cars driving the price of transportation and delivery of goods, and so on it goes. It’s a vicious circle that once it happens is hard to control. And all of these drive inflation which for the US is at the level of the 2008 financial crisis. Where that crisis was more or less constrained to financial institutions this one is far more reaching on the fundamental level of the supply chain. In 2008 prices did increase for a short time while production capacity was stable and as soon as confidence in the system was restored it was back to business as usual. But now, with demand high, inflation high, production capacity low, and shortages of raw materials all over the place there is nothing to spend money on which further decreases the currency and drives inflation.

Creating and maintaining a large manufacturing base is time, capital, and labor-intensive but has also proved to become an extremely lucrative business. As more and more businesses started to outsource their operations the recipients of that outsourced work began to grow and some like TSMC (Taiwan Semiconductor manufacturer) began, by design or not, to monopolize the market where they were the recipients of most outsourced semiconductor contracts. Buyers began to have little choice where to buy their chips from. Currently, only TSMC and Samsung in South Korea successfully operate 7nm process plants which are necessary for many modern logic semiconductors, such as processors in consumer electronics, laptops, and data centers.8 That has resulted in a predictable bottleneck and with little help from hindsight we can say it could have been fixed easily prior to 2020 as money was thrown all over the place in the EU for massive multi-billion Euro projects for building financial centers or gentrifying old city centers9 and none in any large scale manufacturing. Instead, the EU opted to outsource the “dirty industry” to the East. One of those dirty industries was semiconductor manufacturing which is anything but dirty.

In December 2020, 19 European Union member states signed off the “European initiative on processors and semiconductor technologies” in a bid to re-establish the EU as a global powerhouse in the semiconductor industry. The joint declaration aims to enhance cooperation and increase investment in equipment and materials, design, and advanced manufacturing and packaging, pledging EUR 145 billion in support.10

The fear is that it’s a little too late. By some accounts, the current shortage will last well into 2023.11 And it will become worse before it gets any better as world economies start to reopen increasing the demand even further. China, the worlds leading market when it comes to outsourced manufacturing has increased its domestic semiconductor investments by 407% annually12 but with strained relationships with the West and historically poor quality of manufactured goods combined with fears of embedded spying hardware13 will see that investment of little help to alleviate chip shortages in the West. This is especially true when looking at the next big wireless broadband technology, 5G, where even before the global pandemic Huawei, the leading Chinese technology company was at odds with most of the Western partners due to that exact fear.14

An additional complication is Chinas ambition to take back Taiwan. A source for the majority of the world’s semiconductors. China has been ramping up rhetoric as a disaster in Afganistan unfolds that it will retake15 the island without any repercussions just like the taliban did in Afganistan. Situation unimaginable a week ago.

It will take years if not decades until the semiconductor production capacity of the EU or US for that matter, is increased but also the knowledge base of the EU has been decimated by outsourcing. Just to train engineers in chip design will take a generation.

Europe’s Achilles heel is the lack of fabless companies that design chips. Once Europe’s chip design prowess is rejuvenated, the region will be in a much stronger position to think about how best to invest in its manufacturing capabilities.16

Barn Lab

Discussion about this post