The secrets of the big changes in the chip industry: the epidemic, the war, and this company

The supply chain crisis caused by the global epidemic has taken away the computer chips needed to produce many products. From PC, smartphone manufacturers to automakers, they are all struggling to find chips. However, in the three weeks from late May to June, everything suddenly changed, as high inflation, epidemic prevention and control measures and the war in Ukraine suppressed consumer spending, especially on PC and smartphone purchases.

Reversal of the situation

In some areas, chip shortages have turned into overcapacity, surprising Wall Street. By the end of June, memory chip company Micron Technology had said it would cut production. Micron's chief business officer, Sumit Sadana, admitted that the market reversal caught Micron off guard.

As U.S. chip company earnings season kicks off later this month, Dan Hutcheson, a chip economist at research firm TechInsights, warned that there would be more bad news following Micron's downbeat outlook.

Comparison of global chip sales growth and the Philadelphia Semiconductor Index

As a result, concerns about an industry downturn have hit chip stocks hard, with the Philadelphia Semiconductor Index down 35% so far in 2022, far outpacing the S&P 500's 19% drop.

The psychology of hoarding toilet paper

Stockpiling has made the situation worse. Just as nervous shoppers rushed to stockpile toilet paper in supermarket aisles before the coronavirus lockdown, manufacturers have stockpiled computer chips during the pandemic.

Prior to this, just-in-time (JIT) production was the norm for financially conservative companies, which would order parts as close to production time as possible to avoid excess inventory, reduce warehouse capacity and cut upfront expenses.

Just-in-time production is a production management methodology that originated from Toyota's production method. It improves the return on business investment by reducing inventory and related incidental costs in the production process. In the view of the just-in-time production system, inventory is a waste of resources and brings hidden costs, so efficient companies should not have inventory.

However, during the COVID-19 pandemic, that production regime shifted toward what some jokingly called a “just in case” practice of stockpiling chips.

“Stockpiling is a sign that they think chips are essential, until one day they say, ‘Why did I have so much inventory?’ ” said Hutchison, who has been forecasting chip supply and demand for more than 40 years. “It’s a bit like hoarding toilet paper.”

The chip industry also has the mentality of "hoarding toilet paper"

Jefferies analyst Mark Lipacis said in a July 1 report that while industry executives and analysts are unsure how many excess chips are sitting in warehouses around the world, first-quarter inventories at major foundries have hit record highs. The previous first-quarter inventory record was set more than 20 years ago, just before the dot-com bubble burst.

Lipacis warned that manufacturers might decide to use up the chips in their warehouses rather than buy new ones and cancel orders.

Smartphones are the first to be affected

Experts say the impact of the big shift in the chip industry will be uneven across sectors. Tristan Gerra, senior semiconductor analyst at Baird Capital, said large chip suppliers to makers of consumer electronics, especially low-end smartphones, will be hardest hit by the industry downturn.

Nvidia, whose graphics chips are used in video games and cryptocurrency mining, could see "another troubling outcome" as the recent cryptocurrency market crash exacerbates price declines, Guerra said.

Matt Bryson, an analyst at Wedbush Securities, pointed out that Apple's suppliers, such as TSMC, the world's largest chip manufacturer, are the least affected by the oversupply. Apple's devices are aimed at the high-end market, and demand remains strong.

Are automotive chips safe for now?

Guerra believes that automotive and data center chip suppliers will also thrive as demand remains unabated.

Another global chipmaker, an executive who declined to be named, said the company would have great success in power management chips, but for radio frequency chips used in smartphones, "we have seen a decline in demand due to the sluggish mobile phone industry."

According to him, the company's chip factories are "reequipping" production lines to produce more automotive power management chips and reduce RF chip production, which may ultimately help alleviate some automotive chip shortages.

However, some analysts believe that automotive chip suppliers are safe for now, but this may not last long.

Bernstein analyst Stacy Rasgon said in a research report released in September that automakers have ordered far more chips than they need, and this trend is still continuing. When automakers stop buying chips to deplete inventory, this will create a chip demand problem.