Consequences of the semiconductors shortage

Synopsis While Microchip normally lets customers cancel a chip order within 90 days of delivery, it
began offering shipment priority to clients that signed contracts for 12 months of orders
that couldn’t be revoked or rescheduled.

SAN FRANCISCO: Since 1989, Microchip Technology has operated in an
unglamorous backwater of the electronics industry, making chips called
microcontrollers that add computing power to cars, industrial equipment and
many other products.

Now a global chip shortage has elevated the company’s profile. Demand for
Microchip’s products is running more than 50% higher than it can supply.
That has put the company, based in Chandler, Arizona, in an unfamiliar
position of power, which it began wielding this year.
While Microchip normally lets customers cancel a chip order within 90 days
of delivery, it began offering shipment priority to clients that signed contracts
for 12 months of orders that couldn’t be revoked or rescheduled. These
commitments reduced the chances that orders would evaporate when the
scarcity ended, giving Microchip more confidence to safely hire workers and
buy costly equipment to increase production “It gives us the ability to not hold back,” said Ganesh Moorthy, president and
CEO of Microchip, which Thursday reported that profit in the latest quarter
tripled and that sales rose 26% to $1.65 billion.
Such contracts are just one example of how the $500 billion chip industry is
changing because of the silicon shortage, with many of the shifts likely to
outlive the pandemic-fueled dearth. The lack of the tiny components — which
has pinched makers of cars, game consoles, medical devices and many other
goods — has been a stark reminder of the foundational nature of chips, which
act as the brains of computers and other products.
Chief among the changes is a long-term shift in market power from chip
buyers to sellers, particularly those that own factories that make the
semiconductors. The most visible beneficiaries have been giant chip
manufacturers like Taiwan Semiconductor Manufacturing Co., which offer
services called foundries that build chips for other companies.
But the shortage has also sharply bolstered the influence of lesser-known chip
makers such as Microchip, NXP Semiconductors, STMicroelectronics,
Onsemi and Infineon, which design and sell thousands of chip varieties to
thousands of customers. These companies, which build many products in their own aging factories, now are increasingly able to choose which customers get how many of their scarce chips.
Many are favoring buyers who act more like partners, by taking steps like
signing long-term purchase commitments or investing to help chip makers
increase production. Above all, the chip makers are asking clients to share
more information earlier about which chips they will need, which helps guide
decisions about how to lift manufacturing.
“That visibility is what we need,” said Hassane El-Khoury, CEO of chip maker
Onsemi, a company previously known as ON Semiconductor.
Many of the chip makers said they were using their new power with restraint,
helping customers avoid problems like factory shutdowns and raising prices
modestly. That’s because gouging customers, they said, could cause bad blood
that would hurt sales when shortages end.
Even so, the power shift has been unmistakable. “Today there is no leverage”
for buyers, said Mark Adams, CEO of Smart Global Holdings, a major user of
memory chips.
Marvell Technology, a Silicon Valley company that designs chips and
outsources the manufacturing, has experienced the change in power. While it
used to give foundries estimates of its chip production needs for 12 months, it
began providing them with five-year forecasts starting in April.
“You need a really good story,” said Matt Murphy, Marvell’s CEO. “Ultimately
the supply chain is going to allocate to who they think are going to be the
winners.”
It’s a substantial change in psychology for a mature industry where growth
has generally been slow. Many chip makers for years sold largely
interchangeable products and often struggled to keep their factories running
profitably, particularly if sales slumped for items like personal computers and
smartphones that drove most chip demand.
But the components are essential for more products now, one of many signs
that rapid growth may linger. In the third quarter, total chip sales surged
nearly 28% to $144.8 billion, the Semiconductor Industry Association said.
Years of industry consolidation has also wrung out excess manufacturing
capacity and left fewer suppliers selling exclusive kinds of chips. So buyers
that could once place and cancel orders with little notice — and play one chip
maker off another to get lower prices — have less muscle.
One effect of these changes was to make chip factories more valuable,
including some older ones owned by foundries. That’s because new
manufacturing processes have become so costly that some chip designers
aren’t shifting to the most advanced factories to make their products. The
result has been a demand crunch for less-expensive production lines that are
5-10 years old.
So some foundries, in a major strategy shift, are beginning to put more money
into older production technology. TSMC recently said it would build such a
plant in Japan. Samsung Electronics, a key foundry rival, has also said it was
considering a new “legacy” factory.

But those investments will take several years to pay off. And they won’t
address issues affecting chips like microcontrollers, which are a microcosm for
the supply chain squeeze.
Microcontrollers combine the ability to make calculations with built-in
memory to store programs and data, often adding features that only come
from specialized factories. And the number of applications is skyrocketing,
from brake and engine systems in cars to security cameras, credit cards,
electric scooters and drones.
“We’ve probably sold more microcontrollers in the past year than the past
decade,” said Marc Barnhill, chief trading officer at Smith, a chip distributor
based in Houston. The wait to receive some popular microcontrollers now stretches to more than a year, he said, and prices for the products have leapt
20-fold among traders that buy and sell chips.
Amid the turmoil, companies that design or use chips have responded with
new tactics. Some designers are adapting their products to be made in
different factories with more manufacturing capacity, said Shiv Tasker, a
global vice president engaged in that practice for the consultancy Capgemini.
And customers that once bought chips based on price and performance also
are thinking more about availability.
Consider BrightAI, a startup developing devices and software to help
businesses connect equipment and other devices to the internet. Alex
Hawkinson, its co-founder, said it redesigned one circuit board four times in
six months to adapt to different chips. The company also transferred some
designers to China to revise products more quickly with components obtained
there, he said.
Bigger chip users like automakers have started talking directly with
manufacturers, rather than following the typical practice of working through
subcontractors. Last month, General Motors forged a deal with the chip maker
Wolfspeed to ensure a share of the semiconductors coming from a new factory
that makes energy-efficient components for electric vehicles.
While the chip industry’s power shift has aided Microchip, it has also come
with its own headaches. Moorthy said the company had managed to produce
more chips in its three main factories in Arizona and Oregon, as well as get
more from foundry partners. But demand is growing faster than what it can
produce.
“We are falling farther behind,” he said.
Expanding Microchip’s own plants isn’t easy. For one thing, the company has
always relied heavily on buying used manufacturing equipment, but “that
whole thing has dried up,” Moorthy said.
Acquiring new gear can take 12-18 months and costs more, he said. While the
long-term purchase agreements have provided more stability to make such
investments, Microchip and others also hope Congress approves a $52 billion
funding package, which is expected to include grants to subsidize more U.S.
chip production.
“Are we counting on it to run our business? No,” said Moorthy. “Would it help
some of our investment choices? Absolutely.”