The semiconductor shortage

It all began with a relatively minor bump in consumer demand brought on by the pandemic. First, consumer spending tanked. Then, a few months later, demand for all kinds of chip-heavy gadgets rose unexpectedly as people set up home offices or sought out electronic diversions. 

The companies that build those devices then sent a wave of semiconductor orders rippling up the supply chain, which quickly overwhelmed the few chip foundries that manufacture virtually all of the world’s computer chips. Shortages ensued.

$440 billion: Semiconductor sales in 2020, up 7% from 2019

12%: Global semiconductor supply produced by the US, down from 37% three decades ago

$60.6 billion: Estimated losses in revenue for the automotive industry as a result of the global chip shortage

6: New semiconductor factories built globally in 2019, four of them in China

$28 billion: Amount Taiwan Semiconductor Manufacturing Co. (TSMC) will spend this year on developing chips and expanding plant capacity

543 billion: Chips imported by China in 2020

3: Boeing 747s needed to transport a disassembled, crated EUV, a state-of-the-art chip-making machines that uses extreme ultraviolet light

$120 million: Cost of an EUV

The semiconductor shortfall shows the stunning ubiquity of the chip today, and a single Dutch company sits at the very heart of this $439 billion industry. ASML assembles photolithography machines, which etch circuit patterns onto chip wafers using low-wavelength light. Other companies make such machines too, but ASML controls more than 60% of the market; in 2019, its revenue was 11.8 billion euros ($13.2 billion).

Another biggie: Taiwan Semiconductor Manufacturing Co. (TSMC). The world’s largest contract chipmaker pioneered the independent chip foundry model, i.e. focusing solely on manufacturing chips based on others’ designs.

The same forces that snarled the supply chain for chips are the ones that also led to desperate shortages of toilet paper and bicycles. It’s an economic phenomenon called “the bullwhip effect.”

The phrase was coined by a professor researching why the supply chain for diapers experiences wild swings in order volumes even though consumers buy diapers at a relatively constant rate. Turns out even small changes in demand for diapers triggered larger changes in retailers’ wholesale orders, which set off even bigger swings in manufacturers’ demand for the materials to manufacture diapers. Sort of like a cowboy cracking a bullwhip, small motion can have big impacts.

“What happens is, supply gets tight, prices go up, and then everybody says, ‘Oh, let’s build another factory.’ But another factory takes two years to build. Just when the new factories come online, there’s all this excess supply and then prices collapse and no one wants to build another factory for a while.” —Harvard Business School professor Willy Shih

The obvious reaction to any shortage is to simply make more of whatever is in short supply. Indeed, semiconductor manufacturers have already announced investments in foundry expansions and new factories that will increase supply. But those projects won’t be completely finished until the end of 2022 at the earliest. And the dynamic Shih describes can create a disastrous cycle for the industry.

Want to test the bullwhip effect for yourself? Try the “beer game.” 

1. Each of four players represents a company in the supply chain for six-packs.

2. Every week, the retailer places an order with the wholesaler, who places an order with the distributor, who places an order with the brewery. 

3. Every company has to make decisions about how much beer to order from its supplier based on incomplete information about what’s happening in the market. 

4. “Equilibrium” is achieved when each player reaches a target inventory (no hoarding!) and orders the same amount of beer each week for four consecutive weeks. 

(You can try out a version of the game by yourself or with friends.)

Which of the following does not use semiconductor chips?

🚗  The first generation Tesla Roadster, produced in 2008

☀️  An LED tanning-bed lamp

💳  Debit cards

👟  Nike Vaporfly shoes

🎸  Audience wristbands at Coachella

_{(Answer: Nike Vaporfly Shoes remain—for now—chip-free.)}