Semiconductors Have Been Dubbed the “New Oil”
Semiconductor demand has been rising for decades but right now they’re in the news due to a painful supply shortage. The lead time to get the chips needed for everything from PlayStations to cars jumped by 6.5 days in January. That’s the longest lead time increase since data collection on chip supply chains started. Then they jumped by another 6 days in February.
This has alarm bells ringing in the industry, with many saying a supply deficit could easily last into 2022. What happened to bring us to the point where analysts are saying it could take until the end of the year for supply to grow and what will the future look like?
How Did We Get Here?
At the beginning of the global lockdowns, consumers stopped buying. With a few notable exceptions (toilet paper, of course) people were simply not spending until they had a better idea of what life was like during a global pandemic. That was bad news for many industries, but we’ll look at the automobile industry here. People weren’t buying cars. Why buy a car when you’re expected to stay home for at least the next couple months?
So, the car manufacturers limited or even canceled their existing orders from chip makers. With global demand plummeting, the chip makers slowed production. Then the COVID consumer spending on electronics kicked in. Hard.
Cars, phones, computers, routers, smart TVs, video game consoles – you name it. We bought them all and we bought them fast. So, naturally these auto manufacturers (and other manufacturers) made larger chip orders to try to get inventory out the door for consumers. But it was already too late. Supply was outstripped by demand almost immediately.
Now we’re stuck waiting. Some manufacturers are even building new chip plants to try to catch up. Intel is investing $20B to build two new chip plants in Arizona, for example. But to build a new plant and get the necessary equipment installed, it could take years. Intel’s plants are expected to begin pumping out chips in 2024.
We could see chip prices pushing higher for years to come if supply remains constrained while new plants get built to get more supply online.
In the meantime, the last year showed us a taste of what’s to come in terms of demand. Semiconductors have been dubbed the ‘new oil’ because they are in more of our products and because a disruption in their supply chain causes such a large impact. In fact, semiconductors are an input to 12% of US GDP today. That number has been climbing and will continue to climb.
Again, cars work as an example. The percentage of a car’s cost attributed to electronics (which include semiconductors) has increased from 18% in 2000 to 40% in 2020. Cars went from being machines to being electronics as EV demand surged. Now carmakers need to compete with hardware companies to secure their supply of new tech such as semiconductors.
Cars aren’t even the major revenue source for semiconductor companies. Computing and wireless communications equipment make up the lion’s share of revenue for these companies.
That’s the real opportunity. In 2020, we all started working from home. Most employees are happy to come into the office sometimes, maybe even most of the time. Nobody wants to give up their option to work from home on at least some days. With a hybrid office/home structure, every single home office is going to need computing and wireless communications equipment that operates at the high level needed to support commercial activity.
So, supply is constrained for years to come and demand will continue to grow. That alone will keep these businesses profitable and allow opportunities for margin expansion in the medium term. Is it a good long term investment, though?
To understand this, I like to think about the barriers to entry. If it’s difficult to start a new business in an industry, the rest of the strategic picture tends to fall into place.
In the case of semiconductors, the price tag for one of Intel’s new chip plants is $10B. The timeline to production is over two years. Startup costs in the billions of dollars and years before any revenue are something only very few people can afford. On top of that massive upfront cost, specialized knowledge and equipment is required. Currently there are only three firms capable of making the most advanced semiconductors. That makes the industry an oligopoly in at least these advanced products.
This industry will remain somewhat competitive but there’s no way it will become unprofitable in the long term. It feels like we’re on the verge of something special for this space.
Thank you for your loyal readership.
The Financial Star