If you order a new top of the line sedan in Europe or North America these days, you might find there is a long waiting time unless it is a less popular model whose sales are doing poorly. The sudden car shortage has nothing to do with the spread of South African or Brazilian strain of the pandemic. The reason why automakers cannot make enough cars and why some plants of General Motors, Daimler, Ford, Toyota and Nissan are now idle is an acute shortage of semiconductors which power functions from brakes to emissions controls. “Electrification of vehicles is increasing the content of power chips ten-fold in every car,” notes Pierre Ferragu, an analyst for NewStreet Research in New York.
Moreover, the value of chips inside every car — over US$1,000 ($1,335) for Tesla’s new Model Y — has been steadily growing as the auto industry transitions initially towards semi autonomous and eventually self-driving technology. There is also a growing demand for chips that enable more infotainment and connectivity in vehicles.
Auto sales worldwide, including light commercial vehicles, fell 14.5% to just 71 million vehicles last year. That led to 8.4% decline in sales of chips made for automobiles to just US$37 billion. This year, revenues from automotive chips are estimated to grow over 18%. So dire is the shortage of auto chips that the German and Japanese government have publicly lobbied Taipei officials as well as chip industry executives to prioritise the manufacturing of auto chips. Global semiconductor revenues grew 6.5% in 2020, according to US trade group Semiconductor Industry Association. Tech research group IDC estimates that the worldwide chip market would grow 7.7% this year.
Ferragu believes demand for power chips used by EVs could grow at least 20% this year which is not reflected in those conservative global chip revenue forecasts. If vaccination is speeded up and the reopening of economies is ahead of anticipation, demand for cars this year is likely to increase way off the charts. The biggest beneficiary of the global chip shortage, particularly those used in cars, is the world’s largest maker of customised chips, Taiwan Semiconductor Manufacturing Co or TSMC, which is also the No.1 manufacturer of chips used in automobiles.
Auto chips made up for just 3% of TSMC’s total sales of US$46.8 billion last year, while chips for smartphones accounted for 48% of the sales and high performance chips used in central processors, graphics processors and AI accelerators make up over 33% of total sales. Chips used in Internet of Things (IoT) and consumer electronics products made up rest of its sales. The Taiwanese foundry operator is also hugely profitable. Net profits in 2020 soared to NT$517.89 billion ($24.7 billion), up 50% over the previous year.
It isn’t just Tesla or Mercedes Benz cars, these days it is hard to find any consumer technology hardware or, for that matter, high-end industrial technology hardware that does not have a TSMC-made chip inside — whether it is a Microsoft X-Box Series game console or Apple iPad or MacBook Pro or a military drone or commercial jetliner made by Boeing or Airbus. Indeed, TSMC now manufactures about half of all the world’s chips, as measured by their dollar value.
What makes TSMC special
TSMC’s biggest customer is Apple which design its own chips like iPhone’s A14 processor chip as well as power-management chips but also buys chips designed by others like communications chip firms like Qualcomm and Broadcom, all of which are manufactured by TSMC. Morgan Stanley estimates TSMC generates between US$30 and US$40 of revenue from every Apple iPhone. And, oh by the way, the latest 5G iPhone 12 uses 35% more chips compared the previous generation of 4G phones.
With a market capitalisation of US$575 billion, TSMC is now the 10th largest listed company in the world by market value, and the third biggest in Asia behind Tencent Holdings and Alibaba Group Holdings. The low-key global chip manufacturing powerhouse is actually more valuable than well-known corporate entities like Warren Buffett’s Berkshire Hathaway, credit card giant Visa International, top bank JP Morgan Chase and retailing behemoth Walmart. Because of its key position at the apex of chip manufacturing at a time when chip demand is exploding, TSMC’s stock has nearly tripled from its March lows and is up 4.5 times since early 2017. Not even tech leaders like Facebook, Apple, Amazon, Netflix and Google, or the so-called FAANG stocks, can match the surge of the Taiwanese chip maker.
What exactly does TSMC do and what makes it so special? Think of it as a contract manufacturer of chips designed by Apple, graphic chip designer Nvidia, gaming chips and processor designer Advanced Micro Devices Inc or AMD, Qualcomm and others chip design firms who do not have their own semiconductor fabrication facilities or fabs. Because sophisticated chip plants or fabs are too expensive to build — costing anything from between US$5 billion and US$15 billion — and manufacturing intricate chips is a very precise process and difficult to scale, semiconductor design firms are happy to hire TSMC to make the chips for them. For its part, TSMC, which has tons of customers, can spread its cost and continuously invest in the most sophisticated technology as well R&D which makes it harder for competitors to keep up with it.
About a decade ago, there were half a dozen almost equally matched chip foundry operators including Taiwan’s United Microelectronics Corp or UMC, Singapore’s Chartered Semiconductors (since merged with Abu Dhabi-controlled GlobalFoundries) and China’s Semiconductor Manufacturing International Corp or SMIC. TSMC outgrew other foundries, aggressively taking market share just as foundries outgrew integrated manufacturing symbolised by players like Intel that design and manufacture their own chips. In recent years, TSMC has pulled so far ahead of its nearest competitors that it will take them at least four to five years to catch up.
Indeed, TSMC is now investing heavily to pull further ahead. Last month, the world biggest contract chip maker announced that this year it would invest between US$25 billion and US$28 billion on capex which will help it build advanced chips. No chip company, excluding perhaps South Korea’s Samsung Electronics, has the balance sheet to splurge so much on expanding capacity and investing in more advanced chips. Over the next few years, expansion in US will be a key priority. TSMC, which already has a foundry in Washington state, will later this year start building US$12 billion new foundry in Arizona.
Mehdi Hosseini, chip analyst for Susquehanna Financial Group in San Francisco told The Edge in a recent interview that he believes TSMC is overspending on capex because it fears Samsung is about to splurge big on its own foundry business. In April 2019, Samsung, predominantly a manufacturer of memory chips, announced that it will invest up to US$110 billion by 2030 to strengthen its competitiveness in System LSI (Large-Scale Integration (LSI) and its own foundry business to help it reach its goal of becoming the world chip leader in 10 years. “TSMC is worried about Samsung,” Hosseini says.
Catching up in manufacturing
Ferragu disagrees. “TSMC has consistently achieved 45% return on assets,” he says. “The more TSMC invests, the better.” The way the NewStreet analyst sees it, as capital intensity increases, TSMC’s returns do not actually fade. More expensive manufacturing is also higher value manufacturing, he argues, and TSMC’s clients pay well for the additional costs which helps expand the giant foundry operator’s margins. Samsung or Chinese foundries like SMIC are unlikely to take much share from TSMC anytime soon. Samsung, as a foundry player, is irrelevant, because it is 30 times smaller than TSMC and he argues China could take over a decade to catch-up with the leading-edge chip manufacturing, if ever. Even when Chinese chip makers finally do catch up with TSMC in cutting-edge semiconductors, they will more likely be limited to the domestic market rather than global market where TSMC dominates.
Founded in 1987 by a mainland China-born, US citizen Morris Chang, an MIT graduate who spent 25 years at chipmaker Texas Instrument as an executive, TSMC grew into behemoth by outspending and outsmarting rivals and building deep relationships with chip firms that had great designs but found the custom manufacturing part of the business a bit daunting. Indeed, making thing to order has long been the way Taiwan has always done things. Giant global electronics contract manufacturer Hon Hai Precision or Foxconn which makes iPhones and iPads for Apple, networking gear for Cisco, laptops for HP, is based in Taiwan.
As it formulated its industrial policy in the 1970s and 1980s, the government of Taiwan focused on developing capital and knowledge-intensive high-tech sectors. Among the key sectors identified by Industrial Technology Research Institute, or ITRI, the body formed remake Taiwan’s manufacturing sector, was semiconductors. The other was petrochemicals and plastics. ITRI hired Chang as its president and as a veteran chip industry insider, Chang identified customised semiconductor manufacturing. The primary competitive edge of Taiwan’s semiconductor industry of which TSMC is the most visible icon, is “speed, cost, flexibility and quality, enabled by policy, public infrastructure, vertical disintegration, entrepreneurship, and human capital”, notes Chi-Tai Wang, a Taiwan-based tech industry researcher.
The key to becoming a successful contract manufacturer is the ability to make things cheaper and more efficiently than your clients can do themselves. An important part of a foundry’s cost is it huge annual capital expenditures. The tens of billions of dollars that an owner of a fab spends on new equipment and facilities is depreciated fairly quickly so only a player which can run its factories at full capacity all year round can afford to keep spending more and move to the next level. In a foundry’s case, that next level is the next smaller node. The chips for Apple’s iPhone 12 were based on 5nm node. Samsung is currently on 7nm node while Intel is 10nm nodes. TSMC expects to move to even smaller 3nm node later this year.
TSMC’s focus has been to be the “Switzerland of chips”. It makes chips for whoever needs them. Yet, as the US-China Tech War began to heat up over the past two years, the Taiwanese chip giant has been forced to take sides and throw in its lot with Washington. Before the US-China Tech War began, Huawei was its second-biggest customer behind Apple, accounting for over 16% of total revenues with mainland China as a whole making up just over 22% of the total capacity. At Washington’s insistence, TSMC stopped supplying to Huawei last July and Chinese customers now makes up just 6% of TSMC’s total revenues. Because its fabs were running at full capacity and there were plenty of customers waiting in the queue, TSMC quickly made up for the lost orders from Huawei. Indeed, with auto chips shortage there is still a long queue of customers waiting for TSMC to make their chips for them.
“TSMC’s key advantage is its pure-foundry business model,” Morgan Stanley noted a report two weeks ago. “By contrast, Samsung and Intel still have conflicts of interest with customers in end-markets.” With its strong execution capabilities in terms of production yield and process technology advancement, the US investment bank noted, TSMC can even gain market share from its leading-edge foundry peers. Its next big driver: Outsourcing opportunity from Intel which recently fired its CEO and is rethinking its entire business model.
Assif Shameen is a technology and business writer based in North America