Semiconductors are now an integral part in a diverse array of products from humble toasters and tumble driers, to cars and highly sophisticated military equipment. Not only that, but they are also an intrinsic part of the factories that produce these products.
During the global pandemic, there have been winners and losers in the race to secure supply of this diminutive part, during which, the automotive industry has definitely been shunted into the slow lane
A global shortage of semiconductors became apparent during the first quarter of 2021 with some experts expecting it to last beyond 2022 and into 2023. Semiconductor sales revenue has seen an increase of between 7.3 – 10.8%1 since 2019 and is expected to reach $522 billion in 2021. Once manufactured, 90% of output is immediately utilised, meaning stocks are minimal and the industry can’t easily satisfy sudden and significant shifts in demand. The hub of manufacturing is in Asia after the US and other manufacturers moved their production off shore to cut costs. The world is now totally dependent for supply on countries such as Taiwan, South Korea, Malaysia and China. China is forecast to dominate global semiconductor production by 2030 if its current expansion and development continues. Not only will China’s own output increase but it will have significant influence over other Asian producers due to its physical proximity to them.
A number of factors contributed to the current situation quite aside from the fact that the product can take up to 16 weeks to manufacture, requires a highly skilled workforce, sophisticated machinery, clinically clean production environment and a lot of water! One of the most obvious factors was the impact of Covid 19. It caused a fall in demand for new cars in February 2020 as a result of lockdown; this had the effect that demand from the auto industry for semiconductors fell drastically, but luckily for the chip manufactures the increase in demand for IT products to assist the millions of people now working from home, more than absorbed the excess.
However, unluckily for the auto industry, once car sales picked up and manufacturers tried to reorder to their old levels, the supply of microchips had been reallocated and the manufacturers couldn’t increase production levels sufficiently to satisfy both sets of customers. Some astute auto manufacturers read the marketplace and realising a shortage was on the horizon started to increase their stocks, making a bad situation worse.
Around the same time, the trading relationship between America and China was going through a decidedly rough patch and the American trading restrictions on Chinese manufactured goods exacerbated the situation.
Many manufacturers advocate a JIT (just in time) manufacturing approach which works exceptionally well when all products are in good supply but if the supply of even just one component is adversely affected, the consequences are felt throughout the whole supply chain. Add to this the roll out of 5G and the worst drought in Taiwanese history seemingly everything, including nature, conspired against a plentiful supply of semiconductors.
Consequences for the Auto industry
The auto industry didn’t really stand a chance resurrecting its old supply agreements; the IT sector includes some big companies (consider the likes of Apple, Samsung and Microsoft) that require higher volumes and as such are more attractive to chip manufacturers.
In order to adapt to the shortage of semiconductors, manufacturers revisited their product portfolios to assess which were the priority lines and models and focussed production on them. The specification of the models was also revised and features dependent on semiconductors, for example, reversing systems and satnavs, were no longer included. Other companies desperate to get hold of any chip, agreed to take a higher specification chip even though the majority of its capacity would never be utilised. Some car manufacturers were forced into even more drastic measures; Ford, Volkswagen and Jaguar Land Rover reduced their levels of production, laid off staff and closed production lines.
Further evidence of a slow-down in car manufacturing can be seen by the increase in used car prices; forced up by car hire companies such as Hertz, who would normally by new cars in bulk, but instead have turned to auctions to find low mileage used cars for their fleets. Private purchasers who would normally replace their car regularly with one straight out of the showroom, have also had to look at used cars if they are determined to have a change.
How to mitigate
As the issue regarding supply would appear to be something manufacturers will have to contend with for some time to come, there are a couple of tactics that may help things along. If possible, manufacturers should search out new chip suppliers but this comes with its own problems; some chips contain protected intellectual property of the manufacturer and may require lengthy licensing if sent to another manufacturer; if the supplier is new to the manufacturing of a specific chip format there may be a delay whilst the factory is correctly re-tooled and equipment and raw materials purchased; and there is always the issue of quality, can the same levels be achieved by the new supplier. If the manufacturer can change supplier to one that is more local, keeping the business within the immediate locality will help that community to thrive and develop.
If the manufacturer is to stick with the same chip supplier, fostering stronger trading relationships may improve the security of future orders. This could include paying a premium for low volume orders; investing in the supplier’s operations in some way; or making longer term commitments regarding volume ie placing orders for 2022 to enable the supplier to buy in raw materials or make investments in their own processes with the confidence that the order will be honoured. Smaller companies could form simple associations and bundle together their smaller volume orders into more significant ones.
What the future holds
Governments across the globe are quickly coming to the realisation that having their own semiconductor manufacturing industry is a good step to take to support and protect their industry as a whole. The required capital investment is huge but already some countries are striking up agreements between government and private equity companies to get manufacturing sites established.
The auto industry has been particularly badly hit first by the effects of the numerous Covid lockdowns and the resulting fall in demand for their products and secondly by the semiconductor shortage. A resolution doesn’t seem to be likely to happen soon, so we as consumers need to accept that product delays are to be expected.