Semiconductor Industry: Question & Answer

Semiconductors have become crucial inputs in a wide array of technologies, from automobiles to mobile phones. The COVID-19 pandemic led to a dislocation of supply and demand which is expected to continue into the foreseeable future. The U.S., while a leading semiconductor designer, has lagged behind Asia in semiconductor manufacturing. This mismatch could potentially lead to the U.S. falling behind in the global tech innovation race, leading U.S. lawmakers to push for government support of this crucial industry. This blog is intended to answer frequently asked questions on semiconductors and more specifically, VanEck’s Semiconductor ETF (SMH).

Why SMH and Why Semiconductors?

Global semiconductor sales have been increasing since last June. China led regional sales in March, followed by Japan and the rest of AsiaPac, the U.S. and Europe.

Strong demand for electronic devices, in part because of widespread remote working and homebased learning, coupled with the push towards digitization, have helped the chip industry strongly hold its ground against the ramifications of the pandemic, although this has led to a chip crunch. Demand for microchips was on the rise even before the pandemic disrupted supply chains and altered consumer needs. For more information on SMH visit the product page here.

What is the general outlook for the semiconductor industry?

In our view, the outlook for the semiconductor industry remains healthy. As outlined in a piece we published earlier this year, semiconductors have become crucial components for many of the innovative technologies that are driving the global economy. Against this backdrop of tech innovation, semiconductor demand has remained very strong, and shows no signs of abating any time soon.

Why are issues taking place in the supply chain?

The supply chain disruption that the semiconductor industry experienced in 2020 was the result of rapidly-shifting market dynamic related to the COVID-19 pandemic. According to the Semiconductor Industry Association, “The events leading to the current auto chip shortage began during the second quarter of 2020, when automakers understandably reduced production and chip purchases as the virus spread across the globe. Chipmakers, meanwhile, saw surging demand for semiconductors used to enable remote healthcare, work-at-home, and virtual learning, which were needed during the pandemic.”

Because semiconductor production is a complex, detailed operation, massive shifts in semiconductor production cannot be stopped and started immediately. Decisions by auto-manufacturers to slow production, combined with increased demand in work-from-home sectors, led to a perfect storm of mismatched supply and demand, which has yet to fully restabilize.

Another key facet to understanding the semiconductor shortage is the fact that a significant overlap between industries that rely upon the same semiconductor technology, now exists. In other words, multiple separate, distinct industries use the same type of semiconductors, leading to exacerbated dislocations of supply and demand, against the backdrop of the COVID-19 outbreak.

A final point to note is that the automotive industry appears to be experiencing the effects of the semiconductor shortage most acutely. According to Barrons¹, this is due to a combination of factors, including increasing semiconductor usage in electric vehicles (EV), chip company reluctance to invest in older technology (i.e. cars), and continued growth in demand from the consumer services sector.

When is the supply chain expected to return to normal?

According to McKinsey, the global auto semiconductor shortage is not expected to resolve itself in the short term. “That is primarily because of the continued increases in volume and sophistication levels of the chips needed to power new technologies, such as advanced driver-assistance systems and autonomous driving.”²

Over the long term, semiconductor buyers will need to closely coordinate with chip makers to ensure more stability in the supply and demand relationship. The same McKinsey report suggests that purchase agreement commitments shift to more binding arrangements, which has not historically been the standard. Additionally, there is a general consensus that more allocation of resources needs to be made to the semiconductor infrastructure, in the form of fabrication facilities, which would boost the production capacity of the industry as a whole.

Is semiconductor manufacturing going to return to the United States?

The U.S. semiconductor industry accounts for 45-50% of global revenues, yet only accounts for 12% of the manufacturing. This mismatch has grown more pronounced since 1990, when the U.S. accounted for 37% of global semiconductor manufacturing.³

The semiconductor supply crisis has highlighted the risks associated with relying solely on offshore, non-U.S. semiconductor manufacturing. According to the SIA, with a continued reduced manufacturing footprint, the U.S. semiconductor industry runs the risk of lagging behind on the technological advances which will set the stage for future innovation. Essentially, the U.S. lagging could lead to more exponential lagging in the future.

Building semiconductor manufacturing operations is a huge capital investment, ranging between $10-$40 billion depending on the type of chip being produced. SIA estimates that the $20-$50 billion in federal grants would be needed over the next decade to reverse the loss of market share experienced in the last thirty years.

Will the U.S. bake semiconductor support into infrastructure deals help to bridge the gap?

Discussions around government support for the semiconductor industry are ongoing. From the Wall Street Journal:

Lawmakers in both the Senate and the House have introduced legislation to provide government help and incentives to increase domestic production of semiconductors. They propose doing so in a measure known, perhaps inevitably, as the CHIPS Act, or the Creating Helpful Incentives to Produce Semiconductors for America Act. It would, among other things, fund research into semiconductor design and production; create a pool of federal money to give manufacturers incentives to build semiconductor manufacturing facilities in the U.S.; and provide a tax credit to those who do so.

The Senate last month passed, on a bipartisan vote, legislation that would provide $52 billion to start funding such initiatives. But that legislation hasn’t yet been acted on in the House.