What causes the shortage of chips affecting PS5, cars and more?

A shortage of chips that began when consumers filled up personal computers and other electronics during the Covid-19 pandemic now threatens to stifle car production around the world.

GM said on Tuesday it would extend production cuts in the U.S., Canada and Mexico until mid-March. They join a long list of major carmakers, including Ford, Honda and Fiat Chrysler, who have warned investors or delayed vehicle production due to the scarcity of chips.

But not only the automotive industry is struggling to get enough semiconductors to build their products. AMD and Qualcomm, which sell chips to most of the leading electronics companies, have noticed the shortfall in recent weeks. Sony blames the shortage of chips for making it so difficult to get a PlayStation 5 game console.

Chips are likely to have a shortage in the coming months as demand is still higher than ever before. The Semiconductor Industry Association said in December that chip sales worldwide would grow by 20.4% in 2021 compared to a total of $ 433 billion by 2020. It increased by 5.1% growth between 2019 and 2020 – a significant jump, given how large the absolute numbers are.

Semiconductors are in short supply due to strong demand for electronics, shifting business models in the semiconductor world that have created a bottleneck at outsourced disc factories, and the aftermath of the US trade war with China that began under former President Trump.

The Covid-19 pandemic has fueled demand for consumer electronics.

The first wave involved people buying computers, monitors, and other equipment to work remotely or go to school. Then, last fall, home gadgets like game consoles, TVs, smartphones and tablets started flying off the shelves.

Computer sales rose 4.8% in 2020 to 275 million units, with more than 10% growth over the holiday season, according to Gartner data. It reversed a years-long decline and is the highest annual growth in the computer market since 2010.

Other devices also sold well. The Consumer Tech Association, an American trading group, said that 2020 was the biggest year on record with nearly $ 442 billion in retail sales revenue, and that in 2021 it predicts a huge demand for game consoles, headphones and smart home products.

All of these devices contain a ton of chips – not just the central processor which can cost tens or hundreds of dollars, but also cheaper small chips to control the screen, power management or use a 5G modem.

“The current shortage of chips starts with the unprecedented demand for personal computers and peripherals as the entire world has worked from home and gone to school,” said Patrick Moorhead, founder of Moor Insights, a company that studies the semiconductor industry.

Giants in the electronics industry that reported record sales say it could have been even better if there was enough supply. Apple, which recently reported a quarterly $ 111 billion quarter, told analysts that they did not have enough supply of its new iPhones to meet demand. CEO Tim Cook told Reuters that “semiconductors are very strict.”

AMD CEO Lisa Su, who makes the processor at the core of Sony and Microsoft’s new consoles, said last month that he expects shortages at least in the first half of the year. “The industry does need to increase overall capacity levels,” Su said.

The shortfall highlights a structural change in the semiconductor industry. Many of the top semiconductor companies are now ‘fabulous’, which means they only design the chips and the technology in them. Other companies, known as foundries, have largely been contracted to make the chips.

The foundries are run by companies such as TSMC in Taiwan or Samsung in South Korea – and it seems that they have already made chips as fast as possible. If a company were to cut orders in the early days of the pandemic, they would have to be back in line.

Car manufacturers do not compete directly with high-tech companies for the same chip supply. Car chips are usually based on older chip manufacturing technologies and do not require the bleeding edge.

But the shortage is not just in the fastest chips, but in everything.

“The shortfall in the semiconductor industry is general,” said Cristiano Amon, the current CEO of Qualcomm, last month. “Not only leading nodes, but also legacy nodes,” which refers to the chip manufacturing technology.

Cars now contain numerous small chips, many of which perform functions such as power management. Cars also use many microcontrollers, which can control traditional motor tasks such as power steering, or the brain is at the heart of an information system. Car manufacturers also usually use ‘just-in-time’ production, which means they avoid storing extra parts.

“The problem is, even if the 10-cent chip is missing, you can’t sell your $ 30,000 car,” said Gartner semiconductor analyst Gaurav Gupta.

“If the chip that drives the switchboards in the car or brakes automatically is decelerated, so will the rest of the vehicle,” Bryce Johnstone, director of car segment marketing at disk designer Imagination Technologies, told CNBC earlier.

The automotive industry now realizes that this is a lower priority than the electronic businesses at the foundries. In 2020, only 3% of TSMC sales of chips were in the car, compared to 48% for smartphones.

Gupta said tech companies are the volume guys. They have higher margins. And they have never reduced their orders and have long-term contracts with the foundries. “Now that this car demand has peaked faster than the OEMs expected, cars can not get back in line.”

The foundries are aware of the matter. TSMC, which is considered the most advanced and important foundry, said it was trying to help the automotive companies, saying it would spend as much as $ 28 billion this year to increase its capacity.

“Although our capacity is fully utilized with demand in every sector, TSMC is redistributing our wafer capacity to support the global automotive industry,” TSMC said in a statement in January.

Car manufacturers also use motor vehicle chips, which are carefully “qualified” against industry standard binders to ensure their durability and reliability. “It’s harder for the industry to shift its production lines and supply chains elsewhere,” Trendforce, a semiconductor industry consulting group, wrote in a report last month.

Last year, the U.S. placed restrictions on Semiconductor Manufacturing International (SMIC), the largest foundry in China, which bans it from making advanced chips, making it much harder to sell its final products to companies with U.S. tires. Gupta said customers had to shift their orders to competitors like TSMC.

SMIC executives acknowledged that the U.S. move prevented them from using its full capacity when they said geopolitical factors would prevent it from taking advantage of “this year’s rare market opportunity”, citing the scarcity.

Some companies have also decided to stock up on essential chips before the U.S. deadline, which used up their production capacity last year. For example, Huawei has stored critical radio chips before sanctions, Bloomberg News reports.

The inventory was also driven by supply concerns, as Covid swept around the world. SK Hynix, a major maker of memory chips, said in July last year that sales were showing an increase in anxiety over IT supply chain in general.

Some companies that have stored chips are now reaping the rewards. Toyota said on Wednesday that it did not expect to reduce its production rate because it had stored four months of chips to make up for the shortfall. Toyota increased its profit forecast for the year by 54%.