Demand weakens, but manufacturers are still expanding production: Is the semiconductor industry's boom coming to an end?

The semiconductor industry has been swinging between cycles of boom and bust for a long time, but now the industry has the potential to beat past patterns and make their boom last a little longer.

Semiconductor industry sales surged 26.2% to an all-time high of $555.9 billion in 2021 as the industry looks to invest record amounts of money in new manufacturing plants, also known as wafer fabs.

TSMC, the world's largest contract chipmaker, is preparing to spend another $44 billion this year to expand production capacity, while Intel is planning a multi-year expansion totaling $100 billion to build the industry's largest factory ever.

Such heavy investments in the past have led to overcapacity, and investment often occurs when demand is weak. But the situation is completely different now. Several analysts said that the obvious chip shortage has filled factories and pushed up chip prices. However, some analysts have warned that the supply of chips may be in excess as early as 2023.

“There’s a concern that there’s going to be overcapacity,” said Dylan Patel, a chip expert at research firm SemiAnalysis.

Some market segments have indeed shown signs of weakening demand over the past few months: Chromebook sales have fallen sharply after pandemic-induced demand for low-cost laptops for online school classes was met.

Demand for internet devices is also slowing as people working from home upgrade their WiFi devices. Likewise, sales growth for LCD TVs and online gaming devices is expected to taper as restrictions ease and consumers in Europe and the United States can go out again.

But many industry experts believe that this is just the beginning, not the end, of an extraordinary boom in the global semiconductor market.

“This chip cycle is not normal,” said Dan Nystedt, vice president of TriOrient, an Asia-based investment firm. He added that the disruption caused by U.S.-China trade tensions and the subsequent epidemic led many in the industry to misjudge demand and underinvest. “There is a larger trend happening that is likely to drive demand higher for a longer period of time,” he said.

The chip industry was driven by one or two key devices in the past, such as personal computers, and then smartphones. Now, the rise of artificial intelligence has enabled chips to be used in almost all devices, from cars to factories to home appliances. As a result, today's electronic devices need additional computing power to store and process the large amounts of data collected by smart devices and infrastructure.

As a result, the amount of chips used in each device has increased rapidly since then. Applied Materials, a US chip equipment manufacturer, predicts that by 2025, a smartphone will contain chips worth $275, compared with $100 in 2015. The chip content of each car in the future is expected to increase from $310 to $690, and the chip value of each data center server will increase from $1,620 to $5,600 during the same period.

In addition to this increase in demand for chips, there has also been a structural change in the end market. Nistedt said: "In the past 20 years, the main end users have been consumers. But now, the industry may return to a situation where enterprises and governments drive demand. While consumers want low-cost products, enterprises and governments pay more attention to quality, which may change the pricing structure."

As a result, chip executives believe that their investment efforts are insufficient under the new model compared with the industry's past model, which saw a cyclical decline every two to four years on average. In addition, chip companies have encountered another problem as the cost of building advanced wafer fabs has become increasingly high. Both TSMC and its competitors Samsung and Intel have realized that a significant increase in spending does not necessarily lead to a significant increase in production capacity.

“Most people will be surprised to find out in the next few years that these investments will translate into 10% to 15% annual capacity growth,” said Sebastian Hou, a partner at investment firm Neuberger Berman. “That’s probably just enough to meet the growth in demand.”

On top of that, global supply chains are also weakening as governments from the U.S. and Europe to Japan and China seek to build local capacity to hedge against competitors and disruptions like the pandemic. That means customers are likely to build larger inventories of chips to ensure they have enough to go around. “In a globalized supply chain, our efficiency will decline,” Huo said. “The chip industry will build more capacity.”