The semiconductor industry's chicken-and-egg problem
Demand, as seen by billings and as an indicator for trends in the global semiconductor industry, have risen and fallen with the industry’s cyclicality, growing as much as 60 per cent on a monthly basis and then dropping as low as 20 per cent
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Automakers have a shortage of chips. But the chipmakers have a shortage of the machines that make them
A global shortage of semiconductor chips is ravaging supply chains and hasn't shown signs of abating. Don't be surprised if it lasts another year.
Carmakers from Ford Motor Co. to General Motors Co. and Toyota Motor Corp. have cut production because of it. Several continue to idle assembly lines across the world. US senators are now urging the White House to help auto production. Taiwanese companies, some of the largest makers of the sought-after parts, have pledged to boost production.
But the challenge runs deeper - and speaks to a constant imbalance in the industry.
A miscalculation of demand by multibillion-dollar industries is just one side of the story. The other is supply. Estimates for when the sudden shortfall will bounce back range from the next few months to four quarters, depending on how long it takes to make the chips carmakers and other consumer electronics companies need.
That's where the real bottleneck is: the machines that make the chips. While a chip can take as long as three months to manufacture, the chip-making equipment can take a lot longer.
A handful of machine manufacturers, with a grip on 80 per cent of the market, have effectively run a global supply shortage for the better part of the last two decades. Demand, as seen by billings and as an indicator for trends in the global semiconductor industry, have risen and fallen with the industry's cyclicality, growing as much as 60 per cent on a monthly basis and then dropping as low as 20 per cent.
But there's another factor: delivery. Between 2005 and 2017, Japanese semiconductor equipment makers' so-called book-to-bill ratio, which measures the value of orders received for every dollar of products billed, was on average, 1.04. That indicates that orders typically piled up faster than they were shipped out. By 2015, this trend was accelerating.
As the orders continued to outnumber sales, manufacturers across the world stopped disclosing them in 2017, according to the North American industry association and other available data.
That year, on an earnings call, Gary E Dickerson, the chief executive of Applied Materials Inc., which holds around 18 per cent of the market, noted that orders exceeded an all-time high in the first quarter. The company's book-to-bill ratio had been 1.6 or 1.7, Robert J Halliday, then chief financial officer said on the same call."It was a big number, so that's going to trend down over time," he said, noting that it would 'stay positive for a while.' By the end of 2017, it had come down to 1.11. Halliday said Applied Materials still had a 'large and broad-based' backlog of orders.
However, in 2018, sales started slowing across the semiconductor equipment industry. End-user demand patterns changed: Chipmakers were eyeing artificial intelligence, 5G and the Internet of Things. The run-of-the-mill product-segments like servers and personal computers were weakening. Equipment manufacturers hadn't planned for this. Their customers pulled back faster than expected.
As Daniel J Durn, the current chief financial officer of Applied Materials said in December 2020 at the Barclays Global Technology and Telecommunications Conference, referring to the slowdown in 2018, "when we entered the downturn, what we saw [was] our customer dialling back capacity deployment," referring to chipmakers. He noted that was "the first time" they saw such "disciplined behaviour."
The discipline may have gone too far. For the $60 billion-plus semiconductor production equipment industry, gauging demand has always been tricky. The rapid advances in chip design and technology - along with consumers' whims - have often left the less-nimble machine makers playing catchup in a volatile market. It's tough to keep up. The range of machines - from those that etch to others that make silicon wafers – can quickly become obsolete as technology evolves.
A big part of the challenge is managing production and inventory properly. As a result, capital outlays are volatile, as is the portion of sales spent on research and development. Returns on invested capital went from 19.5 per cent in 2017 to 29 per cent the following year.
Looking at what the equipment makers are expecting now indicates how much of a shortfall there is. Billings for semiconductor production equipment were up 17 per cent in 2020 from a year earlier, according to Sanford Bernstein analysts, based on industry data. The biggest Japanese supplier and bellwether Tokyo Electron Ltd. boosted its outlook for 2021. It now expects new equipment sales based on orders they're receiving to be up 23 per cent from the previous year. Whether chipmakers get their equipment in time is another issue altogether.
And so the industry will be back to where it was - a state of severe imbalance. For those waiting for chips, don't hold your breath. (Bloomberg)
