What you'll learn:
- The turnaround from chip shortages to bloated inventories in multiple industry sectors.
- What are the main factors behind the turnaround?
- What industries are still struggling with shortages?
At the start of the year, the situation with the global chip shortage had become so dire that large industrial conglomerates were ripping scarce chips out of washing machines to plug them into industrial modules.
In a turn of events, there are now signs that the worst of the semiconductor drought is subsiding, according to multiple analysts. But rather than having solved the problem, chipmakers are facing a slump in demand due to the worsening state of the global economy. Economic fears and global inflation are taking a toll on consumer spending, leading to an inventory pile-up of processors and memory chips used in PCs. Lockdowns in China and fallout from Russia’s invasion of Ukraine also are denting the global economy.
As a result, shortages are alleviating across the board, and supply constraints caused by record demand for chips during the pandemic are less widespread, spelling relief for buyers that have withstood a protracted period of long lead times and inflated pricing.
Market watchers have said that while demand for chips is receding, it’s not yet enough to translate into the end of the broader chip shortages. Supply woes will continue for large swathes of the electronics industry into 2023, largely due to a dearth of less-advanced analog, power, and logic chips that are pinching the industrial, automotive, and other sectors.
According to a report from Susquehanna, average delivery times for chips declined by six days last month, the largest drop since 2016, further proof that demand for electronic devices is receding amid a rebalancing of inventories and market corrections. Lead times averaged 25.5 weeks in October, after peaking at 27.1 weeks in May.
While the end of the chip boom is bringing relief, lead times are still a long cry from pre-pandemic levels. The chip shortage will officially be over once average lead times fall to between 10 and 14 weeks, according to Susquehanna.
While major companies have been building more production capacity to counteract the chip drought, many still try to get through order backlogs totaling tens of billions of dollars built up during the pandemic.
“We have more backlog than we know what to do with at this point in time,” Microchip Technology CFO James Eric Bjornholt said on a quarterly call with analysts just this month. “And, so the factories are running harder than they have ever been before, with every piece of equipment that we have, to produce as much product as we can.”
Executives indicated it could take several more quarters for the company to resolve the “substantial” constraints affecting its supply of specialty chips.
A Surplus of Chips?
After racing to ramp up production capacity in recent years, chipmakers are now having to adjust to a new reality.
Chip giants from Intel and Micron to NVIDIA and Qualcomm are all feeling the pinch of plunging demand for chips, which is infecting most of the market for smartphones, personal computers, and other consumer goods. Executives have said the sudden swing in demand was driven by many of their customers having built up bloated inventories of CPUs, GPUs, and memory chips, the latest sign that demand is falling out of step with supply.
As demand slows, inventories are being cleaned out more slowly as well. As a result, electronics companies that have been at pains to replenish during the pandemic suddenly find themselves with a glut of components they must use before placing new orders.
AMD CEO Lisa Su said on a recent earnings call with analysts that it’s readying for a potential rebound in 2023. But everything depends on its customers getting through their bloated inventories. Other chip producers are adjusting, too, curtailing spending and even reducing factory output to keep costs in check.
The semiconductor industry is well-known for being cyclical. But the surge that started early in the pandemic was unlike anything the industry has seen in decades, inundating chipmakers and foundries alike with record demand.
The chip boom came with labor availability and cost issues, in addition to snags in supply chains and elevated logistics and raw material costs, which have loosened but still plague chip manufacturing operations. Although it already takes about three months to manufacture, package, test, and deliver the average chip to a customer, some companies are still warning buyers that they should place orders six months to a year (or more) in advance.
“What has happened is that the macroeconomic environment deteriorated, and we went from a period of supply shortages to demand declines,” said Qualcomm CFO Akash Palkhiwala on a November call with analysts. “It’s an unprecedented change over a short period of time.”
“Backside of the Cycle”
While supply and demand are coming back into balance in the consumer market, other sectors are not out of the woods yet. A scarcity of electronic components is still causing pain for automotive and industrial firms.
“We’re now on the backside of the cycle,” said Dale Ford, chief analyst at the Electronic Components Industry Association (ECIA). He added that given the complexity of the global chip industry, the recovery is happening slowly and unevenly.
“While all markets might not be declining like the consumer market, at least they’re not red hot the way they were. So, we have taken our foot off the accelerator in terms of demand,” said Ford. “We are not running as hard as we can to catch up to the market, plus, on the other hand, you have more production capacity that has come online in the last year and will continue to come online.”
While some have started feeling relief from parts shortages, many still struggle to get their hands on specific components. At issue is the fact that electronic devices can contain hundreds to thousands of parts with varying levels of availability. It only takes a single component—a so-called “golden screw”—on a bill of materials (BOM) being out of stock or on allocation to bring a production plant to a halt.
Analysts have said that disruptions due to pandemic-related restrictions or climate change mean that electronics engineers must regularly remove electronic components from their designs and execute spot buys to try to replace them with viable alternatives.
“We are facing a tricky demand environment,” said NXP CEO Kurt Sievers, adding that even as it adjusts to “demand destruction” in the consumer market, the company is already sold out in its core industrial and automotive businesses through the end of both 2022 and 2023.
Sievers explained that some of the worst supply shortages are affecting microcontrollers (MCUs), which are widely used in cars as well as in industrial and medical equipment. Even major automakers are still being affected by a deficiency of automotive-grade chips. Analysts warned that lead times for high-performance MCUs and other chips last as long as 60 weeks.
Richard Barnett, chief marketing officer of Supplyframe, a supply-chain services company that tracks the availability and pricing of electronic components, said the chip deficit could continue to impact automakers into the second half of 2023.
Old Chips, Old Problems
Electronics companies no longer have serious problems in sourcing more advanced chips, based on 16-nm or smaller nodes, that go in smartphones or other consumer goods, according to officials. But they’re still severely limited in their ability to procure analog, power, logic, sensors, and other “trailing-edge” chips based on 40-nm and older production technologies, such as 65 and 90 nm, that continue to derail new product designs.
Those chips became a severe supply-chain bottleneck for virtually every segment of the electronics industry starting last year, forcing everyone from automakers Ford and GM to semiconductor gear manufacturers like Applied Materials to fight over the same finite amount of capacity. The issues even affected leading consumer electronics companies like Apple and Sony.
Per Infineon CEO Jochen Hanebeck, the world also lacks a wide range of analog, mixed-signal, and power-management ICs, partly due to a shortage of production capacity at the 130-nm node. “This [node] is the sweet spot for these components, providing an optimal balance between analog and power capabilities and the integration of some digital,” he said on a November earnings call. “A further shrinking will not happen anytime soon.”
He cited discrete power semiconductors like MOSFETs and IGBTs as another category where supply is still coming up short.
Despite being vital to the automotive and industrial sectors, companies have generally delayed investing in new production capacity because the chips—frequently priced at $1 or less—are much closer to obsolescence.
Even as inventories of electronics components loosen up, many engineers still have a cautious outlook on chip availability. “As engineers are trying to definitively pull out of the last several years of disruption, recovery will not be linear, and will instead be highly dependent on the industry one is designing for,” said Peggy Carrieres, VP of supplier development at Avnet, one of the U.S.’s largest electronic-component distributors.
Looking ahead, many engineers are preparing for continuously increasing prices (29%) and longer lead times (26%), according to a recent report from Avnet that polled more than 1,600 engineers from its global customer database.
Executives in some corners of the electronics industry, including the data-center sector, are crossing their fingers that fabs no longer racing to fill orders for the consumer market will shift to making more of what they need. But this transition will take time to play out, as anyone aware of the semiconductor industry’s inflexibility can attest.
But most sectors are likely out of luck in the short term. It can take months to shut down and reset production plants to fab the types of automotive- and industrial-grades chips that remain a challenge to buy in ample quantities.
Furthermore, it’s generally not viable to use chips designed for consumer devices in other markets that require more ruggedness—for instance, the ability to tolerate the harsh vibrations and high temperatures in cars.
Exit Velocity
As demand for consumer devices fades, secondary effects also could speed up the recovery, said Supplyframe’s Barnett. As the global economy recuperates from the pandemic, numerous electronics companies decided it was better to break from tradition and stockpile inventory in the event of further supply problems. As a result, many engaged in double-booking in an attempt to build “safety stocks” of components, said Barnett.
The lack of coordination between buyers and sellers blew demand out of proportion, prolonging the parts shortage. But this is now coming back to bite everyone as the supply chain suffers a so-called “bullwhip” effect. “With parts orders easing up, the level of previous excess booking has become apparent, leading to a rapid and dramatic shift in market condition in favor of buyers,” said Barnett.
He explained that 73% of the component types tracked by Supplyframe were rated as being in the red for lead times in the third quarter of 2022, meaning that the lead times were extended, or parts were on allocation.
In the fourth quarter, the percentage of components in the red category for lead times will be at 37%. Further improvements are on tap: less than 3% of parts will remain in the red by the third quarter of 2023.
“There’s been a dramatic shift in market conditions in just a matter of weeks,” said Barnett. The sudden shift also is helping tamp down prices for electronic components that have been artificially high due to supply-chain disruptions and a broader rise in inflation during the pandemic.
Nothing Comes Easy
While the end of the chip shortage seems to be in sight, it’s possible nothing works out the way we expect it to.
The electronics supply chain exists within a complicated and volatile environment, with the average chip traveling thousands of miles before landing in a customer’s hands. That puts the semiconductor industry at relatively high risk to disruptions due to climate change (prolonged droughts, severe storms, or floods) and other unforeseen events (earthquakes or fab fires), which could continue to create sporadic glitches in its ability to supply chips.
While industry analysts said the end of the chip shortage is finally in sight, geopolitical factors could throw a wrench into things. The U.S. recently imposed a new set of sanctions on China, seeking to cut off its access to the chip-design software and manufacturing tools that could be used to build high-end processors. Fears also are mounting that China could invade Taiwan and take control of its production facilities.
“Separate from the regular supply chain pressures, the whole U.S.-China conflict is a major issue for the electronics industry,” said ECIA’s Ford. “We’re going to start feeling the constraints more and more going forward.”