Buying and Selling

What is a semiconductor chip and why is there a global shortage?

In an industry reported to be the hardest hit, the automotive sector is running out of chips that help with things like in-car infotainment systems.

The global semiconductor supply shortage has been forecast since the third quarter of 2020 and has halted assembly lines around the world.

The long lead time for these tiny silicon chips has slowed production of everything, from smartphones and home appliances, to driver-assistance systems. Major carmakers have since announced significant reductions in their production, massively lowering expected revenue for the whole of 2021.

The challenge for the auto industry began during the early stages of the Covid-19 pandemic, where vehicle sales plummeted as much as 80 per cent in Europe, 70 per cent in China and nearly 50 percent in the United States. The lack of demand for new vehicles closed auto factories and sent home millions of workers, while orders for automotive semiconductors, used in a myriad of ways, including in fuel-pressure sensors, digital speedometers, and navigation displays — dropped off almost overnight.

What is a semiconductor?

A semiconductor, also known simply as a ‘chip’ - is a material product usually comprised of silicon. It conducts electricity more than an insulator, such as glass, but less than a pure conductor, such as copper or aluminium. Its conductivity and other properties can be altered with the introduction of impurities called ‘doping’ to meet the specific needs of the electronic component in which it resides.

Semiconductor devices can display a range of useful properties such as showing variable resistance, passing current more easily in one direction than the other, and reacting to light and heat. Their actual function includes the amplification of signals, switching and energy conversion, therefore, they find widespread use across many different industries.

How did the shortage come about?

In the first half of 2020, the auto industry faced a substantial drop in demand and, moreover, new vehicle sales grew in the second half of the year, and the uncertain sales outlook at the time meant that automakers didn’t meaningfully increase their semiconductor orders.

At the same time, driven by the shift to working from home and the need for increased connectivity, consumer demand significantly rose for items like personal computers, servers, and equipment for wired communications, all of which heavily depend on semiconductors.

Although production of these chips has increased year-on-year, the current demand outweighs the chips available and some companies ‘stockpiling’ may have also added to the problem. On the other hand, limited stock held by vehicle manufacturers running a tight ship by keeping a low inventory (to save money), as well as those who didn’t anticipate the magnitude of the supply chain disruption are now suffering.

Access to supply

The typical contracts for sourcing parts in the auto industry differ significantly from other industries, which are more often governed by long-term binding agreements (so-called take-or-pay deals) and provide semiconductor suppliers with purchase orders that go well beyond six to 12 months.

Amid an auto supply chain that is complex and often heavily outsourced, the chip sourcing commitment cycle for the auto industry tends to be shorter term, especially with respect to binding purchase commitments on the order of just a few weeks to a few months.

While the auto industry has had a good reputation for stable demand in the past, semiconductor manufacturers are now committed to more conventional, longer-term contracts from other fast acting industries.

Why can’t more chips just be made?

According to an article by Bloomberg published in May 2021, making chips is incredibly difficult and is getting tougher.

The more complicated answer is that it takes years to build semiconductor fabrication facilities and billions of dollars. Even then, the economics are so brutal that you can lose out if your manufacturing expertise is just a fraction behind the competition. This is why countries face such difficulty in achieving semiconductor self-sufficiency.

The vast majority of the world’s chips are made in China, while the USA is the second biggest producer. China has called chip independence a top national priority in its latest five-year plan, while US President Joe Biden (according to the same Bloomberg article) has vowed to build a secure American supply chain by reviving domestic manufacturing. Even the European Union is mulling measures to make its own chips.

Manufacturing a chip typically takes more than three months and involves giant factories, dust-free rooms, multi-million-dollar machines, molten tin and lasers. The end goal is to transform wafers of silicon—an element extracted from plain sand—into a network of billions of tiny switches called transistors that form the basis of the circuitry that will eventually give a phone, computer, car, washing machine or a satellite crucial capabilities.

There tends to be a great lead time in ordering chips. Even if there is supply available, an order today may not be dispatched for at least three months.  

Every vehicle manufacturer is affected

It seems no vehicle manufacturer is exempt, with reports of manufacturing plants halting production or having production volumes severely reduced, which is now creating storage issues for vehicles waiting on chip supply in order to be completed. 

Some carmakers are even leaving out high-end features as a result of the chip shortage. Nissan, for example, is reportedly leaving navigation systems out of cars that would normally have them.

It is also noted that vehicle shortages are impacting rental car firms who can no longer buy new cars but are instead sourcing low-mileage used vehicles to add to their fleet instead.

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