Adapting to a Quickly Evolving Global Semiconductor Industry

Plans by a growing number of international technology companies to begin designing their own semiconductor products – and by governments to develop domestic chipmaking capabilities – could bring some disruption to the market. Yet Taiwan’s ability to produce chips efficiently and at a relatively low cost should ensure its continued growth and success.

Taiwan’s production value of semiconductors is projected to have grown 25.9% in 2021 to a record NT$4.1 trillion (US$147 billion) as demand continues to surge amid a global chip shortage. Output is expected to continue to expand this year, driven by demand for specialized advanced chips.

In response to global headwinds, including the semiconductor shortage and supply chain delays, tech giants and governments are taking significant strategic and financial steps to bring vital parts of the chip supply chain in-house. The revolution taking place in the semiconductor industry could adversely impact chip designers and benefit advanced manufacturers, making Taiwan and its leading Taiwan Semiconductor Manufacturing Corp. (TSMC) the dominant beneficiaries. The trend has already been evident in profits, growth, and new partnerships and deals this year and next.

Apple, Tesla, and Oppo are just a few of the tech companies bringing some aspects of chip design in-house, while cloud giants like Google, Facebook, Amazon, and Microsoft have also been developing custom chips for their data centers. Beyond removing some of the uncertainty and instability of relying on third-party designers, these companies are also aiming to differentiate themselves from the competition through more specialized software and hardware.

The AI chips Google is developing for the Pixel phone will be optimized for the company’s AI model and will offer greater performance and efficiency than a standard chip. Google also plans to develop its own CPUs for its Chrome laptop and tablets by 2023. Apple announced in 2020 that it would replace Intel CPUs in Mac computers and laptops with its own designs.

Terry Tsao, president and chief marketing officer of SEMI Taiwan, says that for Facebook and Google’s data centers, designing their own chips enables them to equip the components with their unique AI and algorithms, optimizing them for the highest level of performance.

However, Tsao notes that the actual fabrication of these chips is still being outsourced to foundries like TSMC and Samsung. Big tech companies like Google and Facebook are first and foremost service companies – they want their designs to fit their needs, but would rather avoid the costs associated with building their own fabs. Establishing an advanced chip factory like those TSMC operates in Taiwan costs around US$10 billion and takes several years to reach full production.

The trend toward in-house designing will negatively affect fabless manufacturers like AMD, Nvidia, and Qualcomm as tech companies bring their designs directly to TSMC and Samsung, the only two companies in the world capable of manufacturing leading-edge chips at scale.

As a contract chipmaker, TSMC doesn’t design chips – it only manufactures according to other companies’ designs. In fact, TSMC is the largest firm of its kind, occupying a 50% share of the global foundry market. On top of that, the company is the dominant supplier of advanced chips made on the 10-nanometer process node and below, and it accounted for more than 54% of pure-play foundry revenue in 2020. The only other manufacturer capable of producing such advanced chips, Samsung, commanded a much smaller share of 17%.

TSMC is already benefiting from the increase in demand for specialized chips. Its revenue in the fourth quarter of last year jumped 21.7% year-on-year to a record high NT$438.19 billion (US$15.8 billion). The company reported in January that its annual sales revenue last year totaled NT$1.59 trillion (US$57.47 billion), an increase of 18.5% from 2020.

TSMC experienced record revenue growth in 2021, thanks to intense demand for products that rely on its advanced chip technology. Given its position as a pure-play foundry, it is unlikely to be impacted by the decision of many tech companies to bring chip design in-house.

Growth is not limited to TSMC, nor is it expected to slow down anytime soon. Taiwan’s semi-governmental Industrial Technology Research Institute (ITRI) last November projected that Taiwan’s semiconductor production value will reach NT$4.5 trillion (US$161.4 billion) in 2022 and NT$5 trillion in 2025.

ITRI forecasts that the global market for semiconductors will grow annually by 10.1% in 2022. TSMC plans to increase the price of its chips this year as it ramps up production in response to surging demand. The company announced last April that it would spend a record $100 billion over the next three years to increase production capacity.

State-led efforts

Governments around the world are also seeking to take greater control over their supply chains and move production closer to home. The U.S. government released a supply chain review report last year that warned of over-dependence in the American semiconductor industry on Asian production and called for enhanced domestic manufacturing capabilities. Last June, the Senate passed the U.S. Innovation and Competition Act, which includes US$52 billion in federal funds for domestic semiconductor research, design, and manufacturing. Congress is also considering the FABS Act, which would create a semiconductor investment tax credit.

Tsao of SEMI Taiwan says that the U.S. has observed the success of Asian countries like South Korea, China, and Taiwan at supporting their domestic semiconductor industries through government incentives such as R&D subsidies. It now wants to copy this model to address its historically low domestic manufacturing numbers. America’s largest chipmaker, Intel, is now leading the nation’s efforts to onshore semiconductor production and reduce reliance on overseas manufacturers. The company says it aims to develop the world’s most advanced semiconductors by 2024 and beat out TSMC and Samsung by 2025.

Yet Intel still lags far behind TSMC, even in the U.S. The Taiwanese foundry’s planned US$12 billion fab in Arizona is set to begin production in 2024 and according to unconfirmed media reports, it aims to build an additional five factories in the state over the next decade.

TSMC also recently landed a major deal with Apple to manufacture chips for the California-based tech giant. According to a report in Nikkei Asia last November, Apple plans to adopt TSMC’s 4-nanometer production technology to mass produce its own 5G modem chips by 2023.

The preference of U.S. companies for TSMC over domestic manufacturers like Intel is rooted in the interdependent relationship between the U.S. and Taiwan’s respective semiconductor industries and supply chains, says Tsao. The U.S. is TSMC’s biggest market, accounting for 70% of the company’s business. In return, TSMC is the top purchaser of semiconductor materials and equipment from the U.S. The result is that TSMC is one of the few foundries receiving U.S. subsidies to manufacture advanced chips on American soil.

Tsao says that the U.S. government sees Taiwan as a trustworthy and equal partner for strengthening and deepening collaboration in terms of R&D, business investment, and talent circulation. Over the past few years, greater levels of geopolitical cooperation between the U.S. and Taiwan have also been a driver for deeper collaboration in increasing semiconductor production capacity to address the recent global chip shortage and supply chain crisis. Cooperation between Taiwan and the U.S. on semiconductors may also advance talks on a potential U.S.-Taiwan bilateral trade agreement, Minister of Economic Affairs Wang Mei-hua said in October.

The U.S. is not the only country seeking to reduce reliance on the dominant Asian chip market. The EU hopes to nearly double its share of global semiconductor manufacturing capacity to 20% by 2030. EU leaders recently proposed the European Chips Act, aimed at supporting increased research, design, and testing capacity, as well as coordinating national investments with those of the broader union.

Taiwan also faces competition within Asia. In 2021, South Korea approved up to US$65 billion in support of its “K-Belt Semiconductor Strategy,” aimed at securing the country’s leading position in chips by 2030. The initiative involves federal R&D investments, relaxed regulations, tax breaks, and infrastructure investment. South Korean chipmaker Samsung plans to triple its foundry capacity by 2026 and will invest US$17 billion to build new chip-foundry production lines in Texas next year, its largest U.S. investment to date. In Japan, political leaders this year are setting out to revitalize the Japanese chipmaking sector and turn Japan into an Asian data-center hub, allocating about US$5.2 billion in its fiscal 2021 supplementary budget to support advanced semiconductor manufacturers.

Yet TSMC continues to have appeal for these countries in terms of collaboration and investment. The company recently established a new subsidiary in Japan to develop a US$7 billion fab in the country’s South, in coordination with Sony. TSMC Chairman Mark Liu has indicated that Germany is another potential location for expansion, as the chipmaker is a major supplier of semiconductors for Germany’s automotive industry. New Delhi is also reportedly in talks with Taipei for a US$7.5 billion deal to expand chip manufacturing to India. It is clear that even as foreign governments invest in their domestic chip industry, at least in the short term they will continue to look to global industry leader TSMC for collaboration.

The looming dragon

China is a net importer of semiconductors, bringing in US$350 billion worth of chips in 2020. However, the Chinese government has begun making extensive efforts to achieve technological independence in its semiconductor industry and reduce reliance on foreign chips, notably through its Made in China 2025 initiative. Beijing is working to develop chipmaking self-sufficiency and has invested billions of dollars in domestic semiconductor companies. The Chinese Communist Party’s 14th five-year economic plan for 2021-2025 is also aimed at strengthening China’s autonomy in semiconductor production and developing more core technology in-house.

Amid U.S.-China trade tensions and U.S. sanctions on Chinese tech giants like Huawei, many Chinese companies have turned away from the U.S. and toward the Taiwanese semiconductor industry to fulfill their demand for chips and collaboration. As a result, Taiwanese companies have experienced substantial revenue growth due to the increased orders from China. However, some Taiwanese chipmakers have also been negatively impacted by U.S. sanctions, as many of their major Chinese customers are included on the U.S. Entity List.

According to analyst Cheng Kai-an at the government-backed Market Intelligence & Consulting Institute (MIC), Taiwan’s semiconductor industry will be negatively affected by the continued U.S.-China decoupling if Taiwanese chipmakers continue to depend on the China market. Such dependency could prove negative for these companies’ long-term prospects, and they could face stiff competition from China as its domestic industries develop.

The Taiwan Semiconductor Industry Association reports that Chinese chip manufacturers received 100 times the amount of government funding received by companies in Taiwan over the past 20 years. This year Chinese Vice Premier Liu He was appointed by President Xi to spearhead the development of third-generation chip technology, with US$1 trillion in government funding allocated to investments in third-generation chip projects.

However, China’s plans do not pose a significant challenge to Taiwan in the short term. As MIC’s Cheng points out, China unveiled its targets in 2015 to achieve a 40% chip self-sufficiency rate by 2020 and 70% by 2025. However, at the end of 2020 that rate had reached only around 20%. Although China will continue to develop its domestic chip production capabilities, based on the speed with which it has expanded capacity thus far, it will likely fall short of its Made in China 2025 targets.

Cheng argues that in the short-term, the continued growth and success of Taiwan’s domestic industry and global dominance are secure. Although the U.S. and other countries are actively promoting development of their own semiconductor industries, these efforts will not be realized within at least the next two years because of their deep linkages to the dominant players in Asia. TSMC founder Morris Chang pointed out in October that other nations’ chip industries currently lack the comprehensive supply chain and comparatively lower production costs Taiwan can offer.

In the long term, though, Tsao of SEMI Taiwan warns of the danger associated with a more segmented global semiconductor chain. Not every region or country has the engineers, talent, or local manufacturing resources to satisfy the high demands of the semiconductor manufacturing industry. If governments continue to invest in domestic chip manufacturing and the global industry becomes ever more regionalized, the increased production costs will ultimately be shouldered by the customer.

Tsao emphasizes that the reason why Taiwan and TSMC dominate the global semiconductor industry is that they possess the technology, resources, and industry power to make production more cost-efficient than anywhere else. It isn’t a model that can be easily replicated by other countries or regions.