Taiwan Tech’s Supply Chains Take a Hit

The novel coronavirus outbreak is set to do damage to Taiwan’s tech hardware exports, but the severity of the blow will depend on the length of the crisis.

Taiwan has undeniably reaped some benefits from the U.S.-China trade dispute as local manufacturers repatriate supply chains from across the Taiwan Strait. Exports to the U.S. have surged. The economy grew 3.34% in the fourth quarter of 2019, according to a preliminary government forecast.

The novel coronavirus outbreak will further test Taiwan’s resilience as well as highlight risks of dependence on China. As of the beginning of March, the virus – which originated in the Hubei provincial capital of Wuhan – has sickened more than 92,700 and caused 3,158 deaths, mostly in China. In February, it began to spread rapidly to other countries such as Korea, Italy, Japan, and Iran.

China (including Hong Kong) accounts for 40% of Taiwan’s exports. Taiwan’s top contract electronics manufacturers have long been entrenched in China, serving customers like tech giant Apple, which sees China as an ideal production base and vital consumer market. Taiwanese firms also sell components to Chinese smartphone giants Huawei, Xiaomi, and Oppo.

Chinese factories were at a standstill for most of February as Beijing sought to prevent the highly contagious COVID-19 from spreading. “Taiwanese companies are closely in line with the Chinese government’s control policy when deciding whether to resume business operations or not,” says Pan Chien-kuang, a senior industry analyst at the semi-governmental Market Intelligence & Consulting Institute (MIC). At present, “before fully resuming factory operations, they only allow certain key personnel to resume work,” he notes.

Since Taiwanese manufacturers source parts from China for products that are exported globally, a shortage of those components could foment knock-on effects that ripple throughout the supply chain. “It’s not just parts and products that will be disrupted: Revenue of Taiwan’s affected manufacturers will also feel the effects,” Iris Pang, a Greater China economist at ING Bank, said in a February research note.

“We don’t know when mainland China’s factories will resume work at normal capacity, but it is unlikely to be in the first quarter,” she added.

If the coronavirus outbreak lasts three months or more, mounting disruptions to China-dependent electronics supply chains will occur, says Stephen Su, vice president and general director of the Science and Technology International Center at the Hsinchu-based Industrial Technology Research Institute (ITRI). The most impacted products would include network communication equipment, mobile phones, tablets, and computers.

In a February research note, Fitch Ratings said that electronics vendors’ limited inventory has increased global supply chains’ vulnerability to external shocks. That holds especially true for the semiconductor industry, which “traditionally relies on thin inventory buffers,” the ratings agency observed.

Semiconductors form the bedrock of Taiwan’s tech hardware sector. The Hsinchu-based Taiwan Semiconductor Manufacturing Co. (TSMC) is the world’s largest contract chipmaker. Taiwan was the world’s largest semiconductor equipment market last year, ahead of China.

Taipei-based Digitimes Research estimates that the combined revenues of Taiwan’s top three foundries – TSMC, United Microelectronics (UMC), and Vanguard International Semiconductor (VIS), will fall 1.2% in the first quarter compared to the October-December period.

In late January, Apple said the coronavirus outbreak wouldn’t affect its iPhone production schedule. Since then, the contagion has spread to every continent but Antarctica. To reduce the chances of transmission, the U.S. and many other countries have recommended against traveling to China and have banned or imposed restrictions on Chinese visitors.

Taiwan’s Hon Hai Precision Manufacturing Co. – widely known as Foxconn – is the world’s largest contract electronics maker and the primary iPhone assembler. In line with Beijing’s directives, it postponed reopening major iPhone plants in Shenzhen and Zhengzhou after the lunar New Year holiday. While production at the Zhengzhou plant restarted in a limited capacity on February 21, Chinese media outlet Caixin reports that the Henan provincial government has allowed only employees from within the province to return to work. Those returning from heavily affected parts of China are still subject to a 14-day quarantine, while those from less impacted areas can return to work after obtaining a certificate of good health.

 Given these constraints, Apple reportedly will not ramp up production before the summer. Normally, the company decides assembly details with its key suppliers early in the year, analysts say.

While integrated circuits and camera modules for the iPhone are produced by factories within Taiwan, the vast majority of components for the devices are made in China, and capacity utilization of factories there is expected to remain low, MIC’s Pan says. As a result, “not only will shipments of older iPhones be in trouble, but the rollout of new iPhones in the first quarter of 2020 will also be affected.”

If the virus is brought under control relatively soon, companies in the smartphone supply chain could try making up for lost time in the second half of the year. That would hold especially true for the Chinese smartphone brands that are key customers of Taiwanese manufacturers.

If the outbreak is resolved by May, “then Chinese brands are expected to make a major push in both production and sales” in the third and fourth quarters, says Boyce Fan, an analyst at the Taipei-based market intelligence firm TrendForce.

Fan says that it’s worth keeping an eye on China’s 5G rollout and whether Beijing will use it to stimulate domestic demand after the COVID-19 outbreak has been contained. “The Chinese government may very well use its policies to accelerate 5G infrastructure build-out and 5G smartphone sales,” he says.

Diversifying production

The COVID-19 outbreak has laid bare the risk of overdependence on China, both as a manufacturing hub and a customer. To be sure, the U.S.-China trade dispute had already highlighted the problem, prompting many Taiwanese hardware makers to begin shifting production from China to Southeast Asia or Taiwan.

But the impact of the coronavirus cuts deeper, undermining the world’s trust in China. By most accounts, local officials in Wuhan ignored signs of a potential epidemic when there was still a chance to contain it. Beijing later took draconian measures to contain the contagion’s spread, notably the lockdown of Hubei Province. Still, it came too late to stop the coronavirus. Throughout the outbreak, China’s lack of transparency has hindered an effective global response.

“The impact of the coronavirus is a huge learning opportunity for the supply chain,” says Rupert Hammond-Chambers, managing director of BowerGroupAsia, a Washington, D.C.-based consultancy. “All production emanating out of China is vulnerable to disruption and we should be looking at the length of the crisis and how deep the disruption was.”

For now, many multinationals are focused on resuming production in China. In the months ahead, though, some will accelerate plans to diversify their supply chains.

According to the Chinese-language DigiTimes, the coronavirus outbreak has prompted Apple to look for ways to do just that. “Apple intends to gradually increase the proportion of production in Taiwan while still trying to maintain its cooperation with suppliers on the other side of the Strait,” DigiTimes said in a February report.

For their part, Taiwanese manufacturers are trying to move some of their production capacity to Southeast Asia – mainly Vietnam and Indonesia – to mitigate the impact of the virus on their business.

Another possibility is developing regional supply chains. That strategy would involve making products for specific markets close to the customers in those markets. For instance, products made in China would be for Chinese customers, not for export to the U.S. and Europe. China’s rising labor costs and the impact of tariffs have already prompted multinationals to explore this business model, and TrendForce’s Fan predicts that it will likely expand in the next few years.

A good example of how this approach is catching on is the Chinese tech company Huawei, which has spent over US$10 billion in procurement from Taiwanese suppliers since 2018, according to MIC. Taiwanese firms can produce much of what Huawei needs in China, with the exception of the most advanced components, like certain semiconductors that are made nearby in Taiwan.

“The deployment of 5G creates an immense opportunity, and being part of Huawei’s supply chain during its current phase of ‘de-Americanization’ offers a positive growth outlook for the Taiwanese tech sector,” wrote Mathieu Duchatel, director of the Asia program at the Paris-based Institut Montaigne think tank, in an October commentary.

In the longer term, ongoing trade tensions between the U.S. and China will weigh heavily on the many Taiwanese tech firms doing business with both countries.

“While [Taiwanese companies] remain inadequately plugged in to the policy debates impacting their businesses, they are making significant moves to address their overexposure, primarily re-shoring investment back to Taiwan,” says Hammond-Chambers. “This is the smartest and safest choice given the fluid nature of American trade policy.”

At the same time, Beijing’s appetite for economic reform will also impact Taiwanese manufacturers. Under Chinese leader Xi Jinping, China has doubled down on state capitalism, with Xi calling for self-sufficiency in semiconductor manufacturing. That is much easier said than done. Yet China seems more interested in extracting advanced technology and know-how from foreign companies than establishing long-term partnerships with them.

“While the size of China’s economy represents growth opportunity for many Taiwanese manufacturers, if fair competition and regulatory transparency cannot be improved over time, there will be more exodus out of China, particularly with the U.S. keeping up the trade and technology pressure,” says ITRI’s Su.