The complex sequence of inputs, outputs, and processes involved in producing the components powering virtually all modern electronic equipment is exposed to many risks that industry experts say must be addressed quickly.

U.S. Secretary of Commerce Gina Raimondo recently stated in an interview with CNBC: “If you allow yourself to think about a scenario where the United States no longer had access to the chips currently being made in Taiwan, it’s a scary scenario.” She then added: “It’s a deep and immediate recession. It’s an inability to protect ourselves by making military equipment.”

According to an April 2021 report by the Boston Consulting Group (BCG) and the Semiconductor Industry Association (SIA), “semiconductors are the world’s fourth-most-traded product after only crude oil, refined oil, and cars.” The importance of the semiconductor supply chain can’t be understated, as chips feature in almost all modern technology, including medical devices and telecommunications equipment, and underpin much of the infrastructure that keeps society functioning. 

Governments are thus now widely discussing supply chain resilience – the assurance that supplies will not be disrupted by either natural disasters or man-made obstructions. The U.S., Japan, India, and several EU governments have all recently met with delegations of Taiwanese companies that are integral to the semiconductor supply chain to encourage them to establish operations in their respective countries.

Realizing the economic and national security risks and alarmed by the war in Ukraine, the ongoing auto chip shortages, and the growth of the Chinese semiconductor industry, the U.S. government has been taking the lead in trying to secure supply chains both domestically and in friendly countries. Both the newly launched U.S.-Taiwan Initiative on 21st-Century Trade and the Indo-Pacific Economic Framework for Prosperity (IPEF) heavily emphasize supply chains in their agendas.

Even more explicitly, the U.S. is working to establish a “Chip 4” alliance with Taiwan, Japan, and South Korea as a bulwark against China, though currently South Korea seems hesitant. Working with the Netherlands, this grouping successfully lobbied Dutch lawmakers to limit ASML Holding NV from selling China its most advanced extreme ultraviolet (EUV) lithography machines used to etch chips. ASML is the equipment’s sole supplier.

Hoping to further cut China out of the supply chain, the U.S. is now trying to expand that ban to cover deep ultraviolet (DUV) lithography systems that are used to make less advanced chips and are supplied by ASML and Japanese firms Nikon and Canon. On the domestic front, the Biden administration is seeking passage by Congress of the CHIPS for America Act, which “establishes investments and incentives to support U.S. semiconductor manufacturing, research and development, and supply chain security” and authorizes US$52 billion in funding to qualified manufacturers. That legislation cleared the Senate in late July under the name CHIPS-plus (or the Chips and Science Act) and is expected to be signed by Biden into law this month.

The challenges to securing the supply chain are enormous as it has one of the most complex production processes of any industry. Describing the scale of this enterprise, BCG and SIA in their report note: “There are more than 30 types of semiconductor product categories, each optimized for a particular function in an electronic subsystem. Fabrication then typically requires as many as 300 different inputs, including raw wafers, commodity chemicals, specialty chemicals, and bulk gases. These inputs are processed by more than 50 classes of highly engineered precision equipment.”

The supply chain is also widely distributed. To illustrate the journey a chip makes from end to end, a 2020 report by the Global Semiconductor Alliance and Accenture provides an example of a 25,000-mile trek. It starts with raw silicon being shipped from Michigan – and chemicals from Texas – to Taiwan for fabrication into wafers. From Taiwan, those wafers travel on to Malaysia for testing and assembly, and from there to Munich, Germany, for module assembly. Once completed, the chip goes to China for original equipment manufacturing (OEM) assembly and then, for the purpose of this example, embarks on a final trip to the customer in California.

“The need for deep technical know-how and scale has resulted in a highly specialized global supply chain, in which regions perform different roles according to their comparative advantages,” BCG and SIA explain in their report. They add that the high level of interdependence of the different countries involved in the supply chain means that they can rely on free trade to transport different equipment and functions around the world to optimize production. The alternative of independent, “self-sufficient” local supply chains, the report notes, would result in a 35-65% overall rise in chip prices and “ultimately higher costs of electronic devices for end users.”

The report also notes that more than 50 points exist across the supply chain in which one region dominates more than 65% of the global market share, “although the level of risk associated with each of these varies.” It further highlights the Indo-Pacific region’s centrality in the supply chain and underscores why countries like the U.S. are so concerned with bringing more of its functions back onto their shores. The report notes that around three-quarters of manufacturing capacity and a significant portion of key materials suppliers are located in East Asia (defined as Taiwan, Japan, and South Korea, but excluding China), “a region significantly exposed to high seismic activity and geopolitical tensions.”

In addition, the report finds that the world’s most advanced semiconductors are produced in Taiwan, which accounts for around 92% of manufacturing capacity, and South Korea, which makes up the other 8%. Both constitute “single points of failure that could be disrupted by natural disasters, infrastructure shutdowns, or international conflicts, and may cause severe interruptions in the supply of chips.”

Meanwhile, the U.S. continues to dominate electronic design automation and core IP (74%) as well as logic (67%), according to the report. In the category of “discrete, analog, and other (including sensors and optoelectronics),” the U.S. maintains a small edge at 37%, followed by East Asia at 33%. In terms of memory, East Asia dominates at 70%, followed by the U.S. at 29%. On the manufacturing side, the U.S. still leads in equipment at 41%, followed by East Asia at 36%. East Asia led in the remaining three categories – materials (57%), wafer fabrication (56%), and assembly, packing and testing (43%), though in the latter category China held a 38% share.

Complicating matters is the sheer volume of inputs along the supply chain. Brian Sung, country manager of Cadence Taiwan, a leading electronic design automation and intelligent systems design provider, notes that while IC design companies have relatively fewer inputs, systems companies like Wistron or Foxconn must maintain inventories of tens of thousands of components.

At every stage, from the initial design to delivering the chip to a manufacturer to installing the final product, risks and choke points exist in the supply chain. Some recent high-profile disruptions have included shipping and transportation logjams caused by labor shortages, the pandemic, and China placing large portions of major port city Shanghai under lockdown.

Other issues include the increased U.S.-China competition that has grown out of the trade dispute begun during the Trump administration, as well as the war in Ukraine.  For example, 80% or more of the rare gases krypton and xenon used in the chip industry are purchased from Ukraine and China. Ukraine sourced many of those rare gases from Russia, which is also a major source of chlorofluorocarbons and helium.

Poor planning, which famously gave rise to the recent auto chip crisis, is another issue facing the semiconductor industry. “At the beginning of the pandemic, the car industry had low visibility about how many cars would be sold,” says Terry Tsao, global chief marketing officer at SEMI and president of SEMI Taiwan. The miscalculation led car companies to drop chip orders. “They didn’t understand semiconductor industry production,” he explains. “They didn’t understand that once you drop the production [for one industry], it will be replaced by another industry. It took a much longer time to get [production for auto manufacturers] back to normal.”

Cadence’s Sung also points out that the just-in-time, zero-inventory strategy traditionally used by car companies will need to be replaced with something more sustainable. He notes that electronics companies and Tesla usually have 3-6 months worth of inventory on hand, which provided them with a buffer during the chip shortage.

Additional concerns

While the consensus is that the chip shortage and shipping problems will ease in the second half of this year, the entire semiconductor supply chain is riddled with vulnerabilities that are less well known and that could cause problems at any point. Some examples, highlighted in April 6 comments provided by SEMI to the U.S. Commerce Department regarding semiconductor supply chain risks, include a lack of qualified machinists needed to produce materials and components such as quartzware and sputtering targets. The comments also cited low margins that lead to a lack of expansion of production of high-purity wet chemicals and a tight market for mature-node, 200-millimeter production tools.

Furthermore, due to hoarding, many types of valves, containers, and components needed for storing and delivering gases and materials now have wait times of up to 40 weeks. Forest fires can even contaminate clean rooms. On a geopolitical level, China controls about 80% of the mining production of tungsten, with 95% of supply controlled by one Chinese company, while 45-50% of global palladium supply comes from Russia. The list goes on.

Government regulations such as environmental controls on chemicals can cause slowdowns in elements of the chain. In Taiwan, one issue is that while other key countries such as the U.S., Japan, and China have adopted an R&D exemption for manufacturers to import chemicals in smaller volumes, Taiwan’s regulations require a registration process that takes three to four months on average to complete. If a first trial run goes badly, the company may need to re-do the entire registration process.

Another Taiwan government policy with the potential to disrupt supply chains is redundant taxation on transactions involving drop shipping, an approach adopted by many companies in the semiconductor industry to reduce costs and lead times. In AmCham’s 2022 Taiwan White Paper, the organization’s Tax Committee notes that “if a foreign company ships products from a contract manufacturer in Taiwan directly to its foreign customers, the transaction is deemed a Taiwan sale and subject to local income tax, even if the sale is actually completed overseas while the goods are in Taiwan.”

This approach, the committee says, differs from those of other jurisdictions in the supply chain, could raise concerns of double taxation on drop-shipped goods, and has changed the logistics decisions of foreign companies operating in Taiwan. Furthermore, it “not only greatly reduces logistics efficiency and unnecessarily increases transportation costs and the carbon footprint, but also exacerbates the chip shortage problem faced by customers and the industry.”

In Taiwan, there is also considerable anxiety regarding the most basic of inputs – electricity and water – says John Lee, managing director of Merck Group Taiwan. “The consistency and quality of the supply of power and water will be very crucial to overall industry development,” he says, given that the industry requires vast quantities of both, and demand is rising faster than the government anticipated. Last year’s drought was a wake-up call for the industry, as were the multiple rolling blackouts that have occurred since last May, as well as record-breaking electricity usage that is straining the state-owned Taiwan Power Co.’s reserve capacity. Delays in building a liquefied natural gas terminal and in expanding offshore wind capacity, combined with the government’s plans to end the use of nuclear power by 2025 and to shutter some coal units at the Taichung Power Plant, suggest that supply will be tight for the foreseeable future.

Another basic input is talent; the industry is in dire need of qualified people who can perform semiconductor research and development and design – not just on the chips themselves but also in the processes used along the supply chain. Those interviewed for this article all cited talent acquisition as a major challenge.

In May, the Taiwan Semiconductor Manufacturing Co. (TSMC) announced plans to hire more than 8,000 personnel, while in June U.S.-based memory chipmaker Micron, already Taiwan’s largest foreign employer with around 10,000 employees, announced plans to add a further 2,000 to its ranks. And it’s not just the foundries that are hiring, but many companies along the supply chain. ASE Technology, the world’s largest IC packaging and testing services provider, last September announced plans to hire over 2,000 staff for its Kaohsiung production base.

Merck, which plays an essential role in the semiconductor supply chain and participates in all seven critical front- and back-end unit operations – patterning, deposition, planarization, etching, cleaning, doping, and packaging – in December announced a NT$17 billion (US$568 million) expansion plan that includes adding 400 new staff. The demand for talent across the entire industry – which generated NT$4 trillion in output value last year in Taiwan – is enormous.

The government is aware of the industry’s talent needs and has set up four dedicated colleges in partnership with industry heavyweights at local universities around Taiwan. Such a measure, while helpful, will likely not be enough, as Taiwan’s declining birthrate is expected to cause a sharp drop in university enrollments in the coming years. As the White Paper points out, more qualified foreigners will need to be brought in to fill the gap. Given that the shortage of skilled and qualified professionals extends globally, targeting students from abroad to train locally in Taiwan will also need to be a priority.