Microchips, do we have too many now?

Microchips

To those who have followed the news from the world of technology, it will seem that the microchip market has essentially gone mad in recent years. Production blockage linked to the pandemic, reconstruction of supply chains on a geopolitical basis, industrial reshoring of the major powers, and above all a global shortage of microchips globally. In the last three years, these have been some of the key elements of the public debate regarding one of the most important technologies for our economy.

Recently, however, another word has begun to appear in the vocabulary of semiconductors, which in the sector hadn't heard from him in a while. Excess, or surplus if you like. It seems that, within a few months, the situation has reversed and that today too many microchips are produced. What does all this mean? How did it happen that from one extreme we passed to the other? And how does it get out of it?

Japan's impossible project to dominate the microchip industry Rapidus is the new company Tokyo has decided to bet on to recover ground in the semiconductor market. But he has extremely ambitious goals. Maybe too much

A political factor?

In recent years the semiconductor market, the essential component with which microchips are produced, has experienced a remarkable expansion. Industry revenues in 2021 were about $600 billion, but some projections indicate that the industry will grow at a rate of 6-8% annually this decade to reach $1 trillion in 2030.

In the face of the expansion of this market, the developed countries have not stood idly by. China , the United States , Europe , South Korea , Japan , Taiwan , India : all have implemented plans to take a slice of that market, trying to attract investments and possibly produce locally the microchips required by their industries . Behind these measures (in some cases worth tens of billions) there is certainly an economic reason, but in many cases the motivation is mainly political: in fact, semiconductors are considered by all to be too strategic a technological resource for a country to be dependent on them. import . Many governments have therefore approved plans to bring production back within national borders, with a view to both economic and military security (given the military uses of certain types of microchips).

But contrary to what is believed he might think, this is not where the oversupply comes from. Of course, many countries have launched huge industrial plans to bring production back home, but in most cases these are recent investments that have not yet increased effective production capacity given that the plants are still under construction. The origin of the excess of microchips that we are seeing today is instead to be found on the demand side.

Does globalization of chips put Taiwan's future at risk? The doubling of the manufacturer Tsmc already certain in the United States and that ever closer in Japan. And then also the landing in Germany (and in Europe). Semiconductors made in Taiwan conquer the world. On the island, however, many are not happy with the choice

A complex market

Meanwhile, the first thing to clarify is that there is no generalized excess. What has begun to be observed since last autumn is a production surplus with respect to demand in some industrial sectors and in relation to some technical types, while in other sectors and for other types the market continues to be undersupplied. For example in the automotive sector, which usually uses microchips whose technology is already quite mature, a continuation of the current semiconductor shortage is expected. Electrification, which would increase the number of microchip components in a car from $500 to $1,600, is also a process that risks further exacerbating this shortage.

The glut of semiconductors that has been talked about since last autumn it concerns memory chips , both Nand and Dram . The sector is not new to the cyclical nature of the market, made up of phases of expansion and contraction, but the data on the current collapse are quite alarming for producers, who at the end of this phase could have lost more than 5 billion dollars according to some estimates.

Sanjay Mehrotra, the chief executive officer of Micron, said that “the industry is experiencing the most severe supply-demand imbalance in 13 years in the Dram and Nand [segment]. But some are even more radical in their judgment. In fact, the CEO of Lam Research argued in front of the shareholders that the memory chip market, whose total value is around 160 billion dollars, "is at levels we haven't seen for 25 years".

At the origin of the collapse in sales there is a substantial reduction in the demand for semiconductors by electronics companies, which are the main buyers of microchips. Smartphones, tablets and computers are electronic devices on which a large part of demand depends and all three sectors suffered substantial losses last year, according to Gartner: -16% for personal computers, -12% for tablets and - 11% for smartphones. This slump in sales then spilled over to semiconductor manufacturers, which received fewer and fewer orders. As evidence of this decline, the companies that produce machinery for manufacturing microchips have suffered losses reaching up to 50%.

This depression in demand is due to a combination of factors. First of all, as recalled by Alberto Prina Cerai, an analyst on critical materials, the "chip supercycle of the last two years" is coming to a close, in which the change in lifestyles forced by the pandemic (such as working from home or distance learning) has considerably expanded the demand for digital devices and, therefore, also for microchips. However, in 2022, with the fall of the restrictions imposed for the containment of the virus, demand decreased sharply, thus causing a deficit with respect to the increased production capacity. Added to this are the economic uncertainty created by the war in Ukraine and the negative effects of inflation on consumers, who, as observed during the Christmas period, considerably reduced their purchases of electronic devices, further depressing demand.

In addition to these sectors, the demand for semiconductors also drops for the data centers of the US and Chinese digital giants, whose investments have been held back due to the decline in revenues.

The excess supply with respect to demand then declines in various ways. The first, as we have just seen, is the cutting of orders from customers. The second is the accumulation of unsold microchips, which thus swell the producers' inventories. Between September and December, the companies that encountered sales problems increased dramatically and the data on inventories of the major producers grew to almost triple the data of 2020: according to Bloomberg , today these stocks are equivalent to approximately an entire quarter or quarter of sales. Finally, the third effect of the drop in demand is the collapse in prices, which has been visible in all the revenue reports published by the semiconductor companies. Also according to Bloomberg , Samsung Electronics and all the other manufacturers at the moment are losing money for every microchip they manufacture .

What happened to Intel's chip factory in Italy The CEO of the multinational Gelsinger said he is evaluating other options in addition to the Veneto to build the plant, while the government is pressing to secure the investment

What was the reaction and how to get out of it

The first reaction of the industry, which from the decline of the demand she had already noticed at the end of 2022, was to cut costs and reduce production. According to TrendForce today some semiconductor factories are running at a reduced regime equal to about 65-75% of their production capacities, in order to follow the drop in orders more closely. The fundamental problem is obviously that of how to dispose of warehouse stocks but for now the companies are adopting a series of cuts, some of which are defined as "extraordinary" by the actors involved. Memory chip companies are not only cutting expenses and reducing production line utilization, as Japan's Kioxia has done, they are also planning layoffs and deferring capital investments. Among these there are also giants such as the US Micron and the South Korean SK Hynix .

Given the enormous capital invested, it is difficult for these companies to adapt in an agile way to changes in demand. But while in the Dram segment the market is firmly in the hands of Samsung, SK Hynix and Micron with no major jolts on the horizon, in the Nand segment the competition is fiercer and the current imbalance of supply and demand could force the hand of some companies. In this situation, the companies in question are faced with a dilemma: reduce production to keep afloat but risk their share of the market, or sacrifice profits in order to consolidate their market position? The answer to this question depends a lot on how the technological balance will evolve between the more developed economies. To deal with this situation, some companies are looking for a mutual side such as Kioxia and the US Western Digital which are considering a merger. For many countries that depend on technology exports, South Korea in the first place, this is a crucial challenge which, in addition to the economic consequences, also has implications in terms of international politics.

How do you get out then? For now, the forecasts are not very encouraging for the whole of 2023, but towards the end of the year a timid rebalancing of the market should be glimpsed. As Prina Cerai said, the semiconductor industry will be "stimulated by the penetration of new technologies" which will in turn increase the demand for microchips. But the underlying problem remains and until consumers return to buy products that require semiconductors, the memory chip market will hardly recover. Also because if demand does not rise again, the imbalance could become even more radical after the inauguration of the large number of factories that should come into operation this year. “ Most of the new production capacities announced before or during 2022 will be operational in 2023. Approximately 18 in the United States, 20 in China, 14 new smelters in Taiwan, 12 between Japan and Southeast Asia, 3 in South Korea and 17 between Europe and the Middle East” recalls Prina Cerai.