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Chip Shortage Exposes Supply Chain Vulnerability
February 2021
China’s car market staged a sparkling recovery in the second half of 2020, but this rebound set off a domino effect of chip shortages, panicking both suppliers and clients, and placing the supply chain, and its vulnerabilities, under a microscope.

The rebound has left companies including Germany's Volkswagen, US-based General Motors and Ford, and Japan's Toyota and Honda facing a shortage of chips as a lockdown-driven boom in games consoles, laptops and televisions sent demand for semiconductors soaring, overwhelming chipmakers. Sony blamed the chip shortage for why it's so hard to get a PlayStation 5 game console. Several carmakers have been forced to wind down plants this year as contract chipmakers in Taiwan and China were not able to keep up by the unexpected surge in orders.

The shortage could cut Ford's earnings this year by as much as US$2.5bn, according to CFO John Lawler. “The semiconductor situation is changing constantly, so it’s premature to try to size what availability will mean for our full-year performance,” he said. “Right now, estimates from suppliers could suggest losing 10% to 20% of our planned first-quarter production.” The semiconductor problems will place further pressure on Ford's earnings, with the Michigan-based carmaker reporting a US$2.8bn loss for the fourth quarter of 2020 on a 9% on-year slip in revenue to US$36bn.

The supply crisis is also putting the motor industry’s increasing reliance on chips and correspondingly, their tricky supply chains, under renewed focus. Given that just 10% of semiconductor fabrication plants are used for automotive parts, carmakers do not wield the same negotiating power as consumer electronics giants.

With no immediate fix available, the shortage is expected to last at least six months. The production of more than 280k vehicles has already been put on hold.

California-based Intel, which has decided on a new chief executive, is trying to reclaim its crown as the leader in advanced chipmaking from Taiwan’s TSMC. Meanwhile, TSMC, is dealing with an avalanche of new orders, following US sanctions against Chinese telecoms group Huawei and chip giant Semiconductor Manufacturing International Corp.

The sanctions are part of a broader fight between the US and China for technological superiority and has underscored the global dependence on the island democracy's semiconductor industry.  Tensions in the Taiwan Strait have been rising more broadly since last year since its president, Tsai Ing-wen, won re-election in January over an opponent who was friendlier to Beijing. In response, Chinese aircraft and warships have been keeping a closer watch on the island—which it claims as its own territory—with growing frequency, while the US has been lending increased support, such as via arm sales and warship patrols. Last year, the US Navy sailed through the narrow Taiwan Strait 13 times. In early February this year, the first such mission was undertaken under the new Biden administration. The Chinese military denounced the move as "deliberately creating tensions".  

Looking to chipmakers outside Taiwan, Netherlands-based chipmaker NXP and Japan’s Renesas Electronics said they were seeking to increase prices following the shortage and coupled with rising raw materials costs. Swiss rival STMicroelectronics is also considering a similar move, according to sources.

However, not every carmaker has been impacted in the same way. Following the Tohoku earthquake and tsunami in 2011, Toyota diversified its supply chain to hold more inventory. Meanwhile, Hyundai Motor, the world’s fifth-biggest carmaker, is not feeling the pinch of shortages given that it did not cancel any chip orders when the pandemic forced factories to temporarily close in early 2020.

Most carmakers keep limited inventory, instead relying on timely deliveries of components to preserve cash flow. The number of intermediaries in the supply chain also widely varies, with some waiting on their parts makers to secure chips, while others prefer to negotiate directly. Markus Duesmann, the head of VW’s Audi, said the company had relied on a “tier four” supplier for its semiconductors, and there was “a very long chain with different supply levels on the components that we are short”.

There are also calls in China for semiconductor companies to produce their chips domestically as the shortage threatens strong sales of electric vehicles.  China's sales of electric vehicles surged 281.4% to 158,000 in January from a year earlier, though they dropped 23.9% from December, according to the China Passenger Car Association. China is aiming to have new energy vehicles making up 25% of total new car sales by 2025, compared to less than 5% in 2020. “This episode of chip shortages has once again shown how urgent and necessary it is to have autonomous and controllable supply chains,” said Chen Shihua, a senior official at the China Association of Automobile Manufacturers.

Despite cracks appearing in the overall supply chain, in the short-term, carmakers seem to have few options left but to wait their turn. “Everybody is adjusting their productions but we will come out of it soon," said Ashwani Gupta, COO at Nissan, which has been forced to cut production of the Note, its new compact car, in Japan.

Carmakers are rushing to pivot towards electric vehicle production, with supportive government measures during the pandemic accelerating the shift towards fossil-fuel free cars. Global sales of electric vehicles increased by an estimated 39% in 2020 to 3.1m units, even though the total passenger car market recorded a 14% sales decline. Ford announced in early February that it would nearly double its investment in electric vehicles to US$22bn by 2025. The Detroit-based company will spend a further US$7bn on autonomous vehicles. The new spending target puts Ford ahead of General Motor's commitment to invest US$27bn in electric vehicles, but it has not matched GM's pledge to end production of internal combustion engine vehicles by 2035.  

Ford will cut production at two US plants for the week beginning Feb. 9, after ordering a one-month shutdown at one of its plants in Germany until Feb. 19. Meanwhile, GM will idle three factories in the US, Canada and Mexico until the middle of March as it awaits shipments of the chips, while its plant in South Korea will operate at half its usual production capacity. GM said it could miss its 2021 production targets as a result. Volkswagen said in December it will make 100k fewer cars this quarter as the chip shortages hit its plants in Europe, North America and China. Honda's plant in Britain shut for several days in January due to the shortage. Looking at suppliers, Bosch and Continental, two of the largest parts providers to the car industry, warned last month that they faced difficulties in obtaining enough chips for manufacturers.

The shortage, and the complexities of forecasting demand, raises issues for the car industry which will become increasingly dependent on chips as carmakers expand their electric vehicle offerings as the world moves to a lower carbon future. Carmakers uses semiconductors in everything from power steering and brake sensors to entertainment systems and parking cameras. The smarter cars get, the more chips they use. Although they only make up 3% of global car sales, the semiconductor content of electric vehicles is roughly three times more valuable than that of an internal combustion engine car. 

In an effort to avoid a repeat of the crisis, some carmakers and automotive chip specialists may decide to take more manufacturing in-house. Or carmakers may seek to forge closer relationships with chipmakers themselves.