A confluence of supply and demand factors has combined to create a shortage in semiconductors with far-reaching effects across end markets, and which could continue well into next year.
Focusing first on demand, following anemic industry growth from late 2018 through mid-2020, the semiconductor industry has experienced a resurgence in demand as global economies have reopened. Semiconductor revenue has grown 23% year-over-year through 1H21, while spending on PCs, phones and data centers has accelerated, reflecting increased work from home and digital transformation. In addition, demand for automobiles is on the rise, and vehicles today include more semiconductor content than ever before.
Semiconductor scarcity is being exacerbated by a host of supply issues. The pandemic caused factories to curtail production due to local lockdowns; weather events in Taiwan and Texas caused factories to reduce output; and a fire at an automotive semiconductor plant in Japan forced a temporarily cut in production. Finally, pre-pandemic trade conflicts led China-based tech companies to stockpile components ahead of potential sanctions. All of these factors have depleted inventories, resulting in shortages across the industry.
Even absent such transient factors, semiconductor supply would be structurally tight. The simple fix would be more capacity, but adding it comes with challenges. High-end manufacturing facilities, called fabs, can cost upwards of $10 billion and take years to complete. Equipment for fabs is also supply-constrained. Another solution is to move chips made using legacy semiconductor technologies to leading-edge technologies, but that process can take years and is not always practical.
How long will the shortages persist? The answer will likely vary based on end market. Mature semiconductor components used in autos, appliances, PCs and industrial equipment are most impacted. Industry experts expect leading-edge chips to normalize around 3Q22, while mature products could take until 2023, reflecting recent underinvestment.
Management teams believe supply issues will gradually improve, but have limited visibility on resolution. Companies with scale and superior leadership should outperform peers. Some outsourced semiconductor manufacturing companies are raising prices, which we generally expect to be passed onto customers, protecting margins. Dozens of fabs are currently under construction or will be in the next few years, adding some risk to the depth of the next down cycle. However, we remain constructive on longer-term growth drivers in the industry, and believe that demand growth will absorb incremental capacity, resulting in reduced cyclicality over time.