Bloomberg: Chip shortage is a "chicken and egg" problem, the bottleneck is semiconductor equipment

A global shortage of semiconductor chips is hitting supply chains and shows no signs of easing.

Many automakers, from Ford to General Motors and Toyota, have cut production as a result. The U.S. Senate is urging the government to help auto production, and some Taiwanese companies have pledged to increase production.

Bloomberg columnist Anjani Trivedi wrote that the deeper meaning of this challenge is that it reflects the imbalance that has always existed in the semiconductor industry.

The multibillion-dollar industry’s miscalculation of demand is only one side of the shortage story. The other side is supply, and estimates for when the sudden chip shortage will recover range from the next few months to a year, depending on how long it takes to produce the chips needed by automakers and other consumer electronics companies.

Anjani Trivedi said the machines that make chips are the real bottleneck. It can take three months to make a chip, and chip manufacturing equipment takes even longer.

A handful of equipment makers, which account for 80% of the market, have effectively faced global supply shortages for much of the past 20 years. Demand is an indicator of semiconductor industry trends, rising and falling with the industry cycle.

But there’s another factor: deliveries. Between 2005 and 2017, the book-to-bill ratio for Japanese semiconductor equipment makers, or the value of orders for every $1 of product, averaged 1.04. That suggests orders were often piling up faster than they were being shipped. By 2015, the trend was accelerating.

Manufacturers around the world stopped disclosing order numbers in 2017 as orders continued to outpace sales, according to the North American industry association and other available data. That year, Applied Materials CEO Gary E. Dickerson noted on an earnings call that first-quarter orders exceeded all-time highs. At the time, CFO Robert J. Halliday said the company had an order-to-bill ratio of 1.6 or 1.7. By 2017, that number had dropped to 1.1, but Halliday said the company still had a large backlog.

However, in 2018, sales across the semiconductor equipment industry began to slow. End-user demand patterns changed: Chipmakers began to focus on AI, 5G, and IoT. Ordinary products like servers and PCs were being weakened. Equipment makers had not planned for this, but their customers adapted faster than expected.

As current Applied Materials CFO Daniel J. Durn said of the 2018 slowdown at the Barclays Global Technology and Telecommunications Conference in December 2020, "As we entered the downturn, we saw customers reduce capacity deployments," referring to chipmakers and saying it was the first time they had seen such "disciplined behavior."

Gauging demand has always been tricky for the more than $60 billion semiconductor production equipment industry. Rapid advances in chip design and technology, as well as consumer impulses, often make it hard for less nimble equipment makers to keep up in a volatile market. As technology evolves, machines for everything from etching to manufacturing silicon wafers can quickly become obsolete.

A big part of the challenge is managing production and inventory correctly. As a result, capital expenditures and R&D spending as a percentage of sales have been volatile. Return on invested capital increased from 19.5% in 2017 to 29% in 2018.

A look at what equipment makers are now expecting shows how big the shortfall is. Spending on semiconductor production equipment rose 17% in 2020 from the previous year, according to industry data from Sanford Bernstein analysts. Tokyo Electron, Japan's largest supplier and bellwether, raised its 2021 outlook. It now expects new equipment sales, based on orders received, to rise 23% from the previous year. Whether chipmakers can get their equipment in time is another question.

As a result, the industry will return to its original state - severely unbalanced.