By Daniel Newman
The global chip shortage came as sudden news to many investors in industries that rely on the tiny, yet ubiquitous, electronic product.
The delay, which is affecting products from cars to smartphones, has been looming for some time. Playing a pivotal role has been a series of external forces, including trade restrictions, offshoring and the global Covid-19 pandemic.
With the vast majority of chip production for U.S. and global technology original equipment manufacturers (OEMs) now being done in Asia by the likes of Taiwan Semiconductor Manufacturing (NYS:TSM) , Samsung and United Microelectronics (NYS:UMC) , we are currently experiencing the potential downside to a fabless ecosystem with minimal onshore production capabilities. Global technology leaders Apple (NAS:AAPL) , AMD (NAS:AMD) , Sony and Qualcomm (NAS:QCOM) represent a sampling of the companies that referenced the shortage in recent weeks.
Despite discussion about the shortage, it still feels like most people don’t know what happened. And while our strained relationship with China certainly played a role, there was no more significant catalyst than Covid-19 coupled with wildly inaccurate forecasts tied to the unknowns of a sustained global pandemic.
When Covid-19 hit China, it caused the first wave of supply constraints. Factories shuttered to deal with the pandemic, producing a slowdown in manufacturing that would lead to a drop in items that would require chips. As the pandemic moved from China to across the world, the issue went from one of limited sales capacity for chip-dependent industries to one of potentially halted demand. This is where the deepest wounds of the shortage originated.
In the early days of the global pandemic, we saw unprecedented demand for PCs, cameras, keyboards and displays. People who had PCs realized they needed better versions, and multi-person households could no longer share devices. This growing demand led to over 10% growth in the PC space for 2020, and surging demand in the fourth quarter reached 25.4%.
In itself, that caused a chip crunch as demand didn’t just peak for a short period to help people work and learn remotely, but the need stayed high with expectations that it would continue for at least a few more quarters.
Covid-19 didn’t only drive demand for PCs; it fundamentally changed our behavior. It halted going out to eat, attending a ballgame or going to the movies. This behavioral shift moved dollars from venues to home entertainment. People in droves were buying smart TVs, streaming services and gaming consoles. Like PCs, all of these are dependent on volumes of chips — and this demand wasn’t expected, and therefore wasn’t forecasted.
Tablets had their strongest demand since 2015, with over 160 million units sold in 2020. For Chromebooks, over 11 million units were sold versus less than 4 million a year earlier. Smart televisions flew out the door, up from less than 4 million units in the fourth quarter of 2019 to nearly 5 million units a year later.
Coupled with this demand came a complete miss from economists and demand planners across sectors.
The first was the mobile (smartphone) industry. With the rising demand for PCs early on in the pandemic came a narrative of stifled demand for smartphones. With all of us locked down at home, we were supposed to see material decreases in mobile devices’ demand. While forecasters were right in the early onset of the pandemic, it was business as usual for the smartphone industry by the third quarter.
By the fourth quarter, demand had surged to nearly pre-pandemic levels, down by only 2%, according to Canalys data. The 5G cycle, including the introduction of Apple’s 5G variant, further spurred demand.
The supply constraints for smartphone chips were evident in recent earnings results such as Qualcomm’s, which said sales were restrained by a lack of semiconductor supply. This theme was echoed among chipmakers including Intel (NAS:INTC) , AMD, Nvidia (NAS:NVDA) and Micron Technology (NAS:MU) .
The second big forecasting miss came in the automotive industry. Shutdowns due to Covid-19 in factories, coupled with expected economic strains, led automakers to cut forecasts for production and vehicle demand. And while the estimates for decreased automotive sales look to be around 15% year over year for 2020, much like the smartphone space, the demand for new vehicles has surged into the close of 2020, leaving many automakers, including GM (NYS:GM) , Ford (NYS:F) and Honda (NYS:HMC) , short on the chips required to produce cars.
For 2021, forecasts are expecting growth of demand for new vehicles to jump around 10%. This wave of demand further stresses the semiconductor industry as a new vehicle can have upward of 50 chips, with hybrid models often requiring two times the number of semiconductors as traditional vehicles.
In both cases, smartphone makers and automotive manufacturers heeded warnings of massive downtrends in demand. So they cut their semiconductor forecasts. And in a fabless world, where access to chips is entirely dependent on manufacturing facilities that handle the global demand for chips, those cuts led to gaping holes in supply.
Some may not understand that as soon as a smartphone or auto maker cuts its orders, the foundries move on to the next order, filling demand for the next in line, putting the original manufacturer at the back of the line. In what is perceived as an on-demand world, this industry has a queue, which means those who cut orders are left waiting.
Only some companies stockpiled
Some companies were more proactive than others. Recently, Toyota (NYS:TM) said capacity would be unscathed by the semiconductor shortage. The company identified the opportunity to stockpile excess chips during the original pullback, which it will use to handle current increases in volume.
Huawei, amid a global regulatory battle, most notably with the U.S., has taken a multi-year proactive approach to stockpiling the essential chips it was dependent on the U.S. for. While we increasingly hear about Huawei’s challenges, including the massive opportunity to disrupt the 200 million-plus mobile devices sold by the company annually, the situation could have been even worse had it not been holding on to key components.
On a temporary basis, almost every business dependent on semiconductors is being adversely affected by the shortage. Excellent results for smartphone and PC makers could have been better if supply were available. The increase in demand for vehicles is also a positive sign of the recovery and stimulus at work, but lacking unit availability is likely to limit results for the next few quarters, and in some cases could impact jobs, which would come at a difficult moment in the global economic environment.
Biden’s 100-day review
The Biden administration is set to probe the semiconductor shortage to identify opportunities to improve both short- and long-term demand. The expected period for this review of the industry is around 100 days. Based on the expectation that demand should settle to a more normalized level, much of the industry seems to feel the most impactful period of the shortage could subside by mid-year.
While I don’t believe the administration’s involvement will have any short-term impact, we have hit a pivotal moment to reflect on how to address this shortage to prevent recurrences and protect the national interest.
The most likely course of stabilization will be a focus on onshoring greater chipmaking capacity. This effort could be accelerated with grants and tax incentives to encourage experienced global foundries to expand domestic capacity. Taiwan Semi is already expanding in Arizona, but it will require more significant resources to prevent further supply issues.
The good news is that over the past two decades, government investments in semiconductor manufacturing have been fruitful in yielding strong economic growth that comes from the ecosystem of semiconductors, including materials, manufacturing, distribution, R&D and more.
In terms of the national security implications, this issue has been somewhat conflated with the current shortage. Still, this situation also deserves attention from the administration, and bringing manufacturing back to the U.S. would vastly improve security interests. With Samsung’s proximity to North Korea, and Taiwan Semi sitting right on top of China, there would be greater stability in having increased physical security via domestic manufacturing.
A perfect storm of global macro environmental circumstances has led us to the substantial shortage in semiconductors plaguing industries and leaving consumers in a lurch while also driving up prices for certain components.
The situation will largely subside with normalized demand, but given the industry’s expectation of 8.4% growth in 2021, there are still challenges ahead.
With cloud, mobile, software, artificial intelligence (AI), electric vehicles (EV) and remote work just a few of the forces that won’t be slowed in the coming years, the demand for chips, materials, software, OEMs and peripherals will all but certainly continue to grow. That means opportunities for strong earnings and revenue performance, but only if we can build the infrastructure to keep up.
Daniel Newman is the principal analyst at , which provides or has provided research, analysis, advising, and/or consulting to Nvidia, Intel, Salesforce, IBM, Microsoft, Amazon, Oracle and dozens of companies in the tech and digital industries. Neither he nor his firm holds any equity positions with any companies cited. Follow him on Twitter @danielnewmanUV.