Making sense of churn in semiconductor chips

This year, the mood has changed. Market leader Intel cut its financial outlook for this financial year, even as its revenues dropped in the latest quarter. Micron Technology said it would reduce production. The change is reflected in financial markets. Shares of major semiconductor players have plummeted, and the Philadelphia Stock Exchange Semiconductor Index, an index of 30 semiconductor companies, has dropped 24% this year, against a 13.6% fall in the S&P 500 index.

The semiconductor business has been prone to booms and busts throughout history. The cycle is typically driven by supply-side changes. It’s a capital-intensive business, with long gestation periods. Manufacturing capacity gets added in chunks, while demand picks up slower. This leads to a build-up of inventory, which is typically followed by a downturn.

That build-up of inventories is one reason for the current negative outlook, but this time is different. One, while there is a build-up of inventories in some segments (mobile phones and computers), there are shortages in others (automotive industry). Two, there are significant capacity expansion projects in the pipeline driven in part by geopolitical concerns.

Post-pandemic glut

In 2020, the pandemic made working from home the new normal, boosting demand for computers and smartphones. The market for used devices thrived as manufacturers struggled to keep up. This, in turn, boosted demand for semiconductor chips, an essential component in electronic devices. However, in 2022, demand for both computers and smartphones dropped due to the economic slowdown in key markets, including the US, and Russia’s invasion of Ukraine, among other factors.

While smartphone shipments dropped by 8.7% globally in the second quarter of 2022, over the corresponding period of 2021, shipments of personal computers dropped by 15%. “What started out as a supply-constrained industry earlier this year has turned into a demand-constrained market,” Nabila Popal, research director of IDC’s Worldwide Tracker team, said in a statement. In addition, expecting the shortage to continue, companies hoarded chips during boom time. This would impact fresh orders till the chips are used up.

Sectoral differences

However, what’s true of mobile phones and computers is not true of some other segments, which continue to face shortages. Like smartphones and personal computers, automotive sales are dropping, but the latter is partly still being shaped by supply constraints. In the US, automotive sales in the first half of 2022 is estimated to drop by 17% compared to the same period last year, according to Cox Automotive.

India’s top carmaker Maruti Suzuki lost sales of 270,000 cars in unmet bookings during 2021-22, its chairman R.C. Bhargava informed shareholders in the company’s recent annual report. The coexistence of shortage in one segment and oversupply in another is hard to resolve. The equipment and processes that are used to make one type of chip cannot be readily switched to make other types of processes. Many in the industry expect constraints to ease later this year.

Capacity expansion

Beyond that, capacity is set to grow significantly. Global chipmakers, including TSMC, the largest foundry, plan to invest billions of dollars to expand capacity. The glut in the mobile segment appears only to have delayed these investments. For example, TSMC has trimmed its spending plans for 2022 from $44 billion to $40 billion, but intends to spend the balance in the next fiscal.

Besides, there is a global race among countries to build their domestic semiconductor industry. The new CHIPS and Science Act in the US includes $52 billion in subsidies for the semiconductor industry. Last year, the Indian government cleared a ₹76,000-crore scheme to boost domestic semiconductor production. It’s not clear if these schemes would achieve their goals in a short timeframe. However, their rationale is that demand for semiconductors will continue to rise. Despite regular downturns, the expectation is that demand would catch up.

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