The semiconductor supply crunch: what’s it about and what does it mean for you?

Microchips – or semiconductors – are used in the production of a huge range of products, from cars to computers, fridges and much more.

Right now, the world is facing an acute shortage which is wreaking havoc for many companies. At the same time, demand is peaking, leading to supply chain issues for a number of sectors.

Tesla’s Elon Musk recently likened the current semiconductor shortage to the great toilet paper drought at the start of the Covid crisis. “Our biggest challenge is supply chain, especially microcontroller chips. Never seen anything like it”, he said.

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In a sign that the world’s largest economy is getting increasingly worried about the supply chain issues related to microchips, US president Joe Biden this week announced he will establish a “supply-chain disruptions task force” to address supply chain shortage in a number of crucial fields.

So why is the world running short on semiconductor supply and who all does it affect? Here’s a broad summary of the story so far.

What are semiconductors and why are they important?

Semiconductors form the backbones of most modern electronic equipment. They are usually made of silicon and, as their name implies, they conduct an electrical charge more than an insulator, such as ceramic, but less than a true conductor such as metal.

Controlling their electrical conductivity means they can be used to switch or amplify electrical signals, and can be used to form integrated circuits, memory chips and microprocessors.

Any disruption in the supply of semiconductors could halt production across multiple industries worldwide. This is because the supply of chips cannot be easily increased or decreased at a stroke. Changing the production line can be a lengthy process and takes weeks or even months.

Why is there a shortage?

In the early days of the covid pandemic, staff at microchip production plants in China and globally were unable to work. And, as the world locked down, the lack of demand forced many microchip producers to shutter operations or operate at very low capacity.

But while Covid-19 lockdowns caused lower demand for some industries, others, such as laptop manufacturers, saw a surge in demand for products as much of the world moved to working from home. So demand for microchips bounced back faster than many producers anticipated, bringing us to where we are today.

On top of all that, a series of unfortunate events around the world worsened the situation. A fire broke out at a plant near Tokyo belonging to chip supplier Renesas; Texas suffered an unusually cold spell earlier this year; and Taiwan saw the worst droughts in its 56-year history.

Why are car producers so heavily affected by the chip shortage?

The car manufacturing industry is highly dependent on semiconductors. As Dan Hearsch, managing director in AlixPartners’ automotive and industrial practice points out, the automotive industry uses more chips than other sectors; chips are necessary for basic functions of vehicles, including power steering and brakes, to operate.

“There are up to 1,400 chips in a typical vehicle today, and that number is only going to increase as the industry continues its march toward electric vehicles, ever-more connected vehicles and, eventually, autonomous vehicles”, he says.

The chip shortage has forced some major vehicle-makers to leave some features out of the vehicles they produce. Nissan reportedly excluded navigation systems out of some of its completed vehicles, and Renault stopped offering an oversized digital screen behind its steering wheel, reports Bloomberg.

Both Ford and General Motors have warned of huge losses in the coming year due to supply chain issues. Ford expects the chip shortage to hammer its earnings by around $2.5bn in 2021, while General Motors is bracing for losses in the range of $1.5bn-$2bn. Consulting firm AlixPartners has warned the global chip shortage will reduce the global vehicle industry’s revenue by $110bn in 2021.

Apart from the automotive industry, all consumer technology industries are highly vulnerable to the shortage. Goldman Sachs expects it to have ripple effects across 169 industries in some way or another, reports Yahoo Finance.

When is the semiconductor shortage expected to end?

Most market watchers expect the shortage to persist at least until early next year. Flex, the world’s third-largest manufacturer, warned last weekend the shortage will last until at least mid-2022. Goldman Sachs was more upbeat, suggesting that the chip shortage will dissipate in the second half of 2021.

“Our analysts believe we’re probably in the worst period of that right now. That is, we’re seeing the biggest disruption downstream (in) industries like auto right now and that will gradually ease over the back half of the year,” Andrew Tilton, the bank’s chief Asia economist told CNBC this week.

Rising Covid cases in Asian countries such as South Korea, Vietnam and Taiwan could lead to further supply chain issues and worsen the shortage of chips. But Tilton doesn’t think the situation has caused a significant shortfall in production.

How will the shortage affect investors?

A shortage in semiconductors means many producers could pass on the cost of higher raw materials (due to scarcity) on to consumers, which may be inflationary.

But at the same time, the shortage also means chip producers could be more profitable than ever. Bank of America is recommending Qualcomm for its “high margin royalty business”, Analog Devices for its “diverse product lines”, and Qorvo for its “diverse 5G handset exposure with solid infra (infrastructure) portfolio,” reports CNBC.

Will there be a supply glut later on?

While most of the world is worried about a shortage of chips, the lead time – how long it takes to get a chip once ordered – may actually be a sign that a supply glut in microchips may follow.

Bloomberg reported in March that microchips are witnessing higher lead times. So there is the risk that the supply chain issues force companies to “over order” and also the risk that the world is left with too many microchips which may then result in the opposite story: a crash in the price of microchips. Time will tell.