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How the chip crisis is driving carmakers to rethink supply chain tactics
In this episode of the NextWave Global Trade podcast series, EY Global Automotive & Transportation Lead Analyst Anil Valsan discusses chipaggedon’s effects and how manufacturers are responding to it.
Chip shortage is rippling through sectors, delaying shipments of automobiles, gaming consoles and consumer electronics. According to estimates, about 3% of commercial vehicle production will likely be lost in North America and Europe due to the semiconductor shortage. Insufficient chips for everything from touchscreens to transmissions forced manufacturers to shut down for months and furloughed workers temporarily. It is not clear when this problem will be resolved. But the show must go on, and automakers are now looking for short- and long-term strategies to deal with the current imbalance in supply and demand.
Key takeaways:
The global automotive industry is projected to lose billions of dollars due to a shortage of semiconductor chips. The shortage has forced many automakers to halt production and temporarily lay off employees.
To be better prepared for disruption, manufacturers could have diversified supply chains, identified choke points, avoided overreliance on specific geographies and moved away from just-in-time sourcing strategies.
Automakers need to adopt more efficient strategies to secure their supply chains. Some of these strategies include shutting down production for short durations, purchasing directly from manufacturers and establishing trade agreements with governments to source chips securely.
For your convenience, full text transcript of this podcast is also available.
Justine Greene
Hello and welcome to the podcast series from EY Global Services. I'm Justine Greene and with global trade experiencing such uncertain times, we continue to look at how organizations can respond to survive and grow. Each episode will be joined by expert guests to share their opinion and insight on our theme. Our focus this time is on the shortage of microchips and the impact on the automotive industry.
Joining us from London is Anil Valsan, EY Global Automotive and Transportation Lead Analyst.
Greene
Hello, Anil.
Anil Valsan
Hello, Justine.
Greene
Let’s just start by explaining what microchips, also known as semiconductors, are and why are they so important?
Valsan
So, semiconductor chips essentially comprise of multiple electronic components that are packed on a silicon wafer. The semiconductor chips are grouped into four types, so one is what we call is memory chips. You have microprocessors; you've got commodity integrated circuits or standard chips. And the last one, which is a bit more complex, is called systems on a chip. Now, in a nutshell, these chips are present in almost every device that we use, from personal electronics to complex communication devices, health care systems, military systems, transportation, clean energy, just to name a few.
Greene
Now, cars are much more reliant on technology these days. How are chips used in the automotive industry, and more broadly, on other products?
Valsan
These chips actually control quite a significant number of functions within cars. You would often typically know them as electronic control units. They are a part of everything, from controlling, for example, the wipers and windows to the infotainment systems, to how the engines or even electric motors in the electric vehicles perform, to controlling the advanced driver assistance systems like collision avoidance or lane-keeping systems.
More broadly, as I mentioned earlier, these chips play a significant part in a lot of the electronic devices that we use every day – from the TV sets to your smart speakers and so on. So, as you can imagine, those consumer electronic devices are the biggest market for these chips.
Greene
Explain the chips journey from when it leaves the factory to how it ends up in, for example, a car’s engine management system.
Valsan
So once the semiconductors are manufactured, they actually get transported by air or land, depending on the origin and destination country. And, as a consequence, you can imagine, there are a significant number of international border clearances, customs clearances and so on. Now, most of the packaging happens around Asia. So, imagine Mainland China, Malaysia, the Philippines, Vietnam and other countries in the Pacific Rim. Once the packaging and testing itself is done, then these materials are consolidated in a different location before being transported to an automotive tier-1 or tier-2 supplier, who would take these chips and put them into modules or systems, which is then delivered to a manufacturer.
Greene
How big a consumer of microchips is the automotive industry?
Valsan
They are roughly about US$68 billion, and are expected to grow quite significantly by roughly about 7% between 2019 and 2026. Now, having said that, if you take all the sectors that consume semiconductor chips, the auto industry is actually a very small proportion of it. They make up only 10% of the semiconductor industry's revenues. The biggest sectors that consume semiconductor chips are the communication and computers sectors. They consume roughly about a third each of the semiconductor chips that are produced.
Greene
Across business in general, why is there a shortage of chips this year?
Valsan
A part of the reason is because of the pandemic. It forced manufacturers to shut down a lot of their plans, and as a consequence, a lot of the auto suppliers canceled their orders, including for chips. Now what they did not realize was that with these chips, there is a significant lead time from placement of the order to actual delivery. When the demand for vehicles actually started ramping up late last year, and the auto industry started ramping up production, the suppliers tried to place those orders again. But when they placed those orders, they found that the semiconductor industry could not service them because a lot of other sectors had continued to maintain some of their volumes and, you know, their consumption of chips. So, the auto industry almost went to the back of the queue. And, it's not just the auto industry that's facing this shortage. A lot of other consumer electronics sectors are, for example, the gaming console manufacturers are all complaining about chip shortage and expect it to have an impact on their ability to meet demand.
Greene
OK, well, let's look in more detail about the impact of what we call ‘chipageddon’ on the motor industry next. And, to what degree has the car industry’s quicker-than-anticipated bounce back contributed to the shortage of semiconductors?
Valsan
As demand picked up, the industry was trying to ramp production back up very quickly. They were expecting their supply chain also to start ramping up production quickly. But what they do not realize, and recognize, is the fact that the supply chain for the auto industry is typically very deep, meaning there are multiple tiers of suppliers that they are dependent on. Some of the suppliers in the lower tiers are not as well prepared to quickly ramp up their production. The manufacturers, because they did not have visibility into the supply chain, did not realize that bottleneck. Unfortunately, the foundries that they depend on for manufacturing these chips did not have the capacity to allocate to the auto industry the chips that the auto industry needed. Consequently, it caused a bottleneck and a shortage.
Greene
So what's been the impact of this shortage on the automotive sector?
Valsan
We've had a number of manufacturers, passenger vehicle manufacturers, commercial vehicle manufacturers shut down their factories for short intervals for long intervals as a direct consequence of the chip shortage. We’ve also seen the prices of semiconductors actually increase quite significantly. As you can imagine, when demand significantly exceeds supply, prices are bound to increase. In the case of semiconductors, for example, between November and December 2020, we had seen an increase of over 30%.
Greene
Can you estimate how many fewer vehicles are being produced and what the resulting knock-on effect on the workforce is?
Valsan
Sure. While it is hard to put an exact number, we will refer to some of the estimates put out by other research agencies in this case. So, for instance, LMC Automotive estimates roughly about 2.2 million vehicle production losses for the light vehicle industry. Similarly, for commercial vehicles, another agency estimates roughly about 3% of the commercial vehicle production to be lost between Europe and North America as a direct consequence of the semiconductor shortage.
Greene
Have some automotive manufacturers been hit harder by the shortage than others, or is it the same level of disruption for all?
Valsan
We have seen manufacturers in North America and Europe hit a bit harder. There have been some manufacturers who have been slightly better prepared because they had adopted a slightly different sourcing strategy when it came to semiconductor chips. One brand, in particular, what we found was they had stockpiled chips for about three to four months. As a consequence, they had some amount of inventory. Whereas the other manufacturers were using strategies like just-in-time, which meant their suppliers barely had any inventory, and therefore they were impacted a lot more.
Greene
And why does the automotive industry operate on a just-in-time model?
Valsan
What the industry found was - because there are such a significant number of components that go into a vehicle, financially, there is a huge amount of working capital that gets locked when the industry builds up inventory for various components along the manufacturing process. So, as manufacturers set up more efficient production lines, assembly lines, they created supplier parks, which could directly deliver assembled modules into the production lines. There was less of a need to maintain these inventories at the manufacturers themselves, and they could pass on that inventory management lowered down the supply chain. Obviously, you know what it meant is - it started freeing up some of their working capital itself. It had other benefits like the amount of storage that the warehousing and storage they required and so on. So, there was a whole host of benefits. But the consequence of it was the lack of visibility of their supply chain. It meant that if there was a breakdown in any of the lower tiers, it cascaded up the supply chain and had a huge impact on manufacturing.
Greene
So why didn't the car producers as a whole anticipate this problem arising?
Valsan
There are two primary reasons. One is the sourcing strategy that the industry was using, which is, you know, in many instances, there's a lot of just-in-time sourcing. The second one is a more fundamental issue in the industry, which is that the manufacturers don't actually have visibility into their supply chain. They know what is the level of inventory, the capability, the lead times, and so on required for the tier-1 suppliers, but they don't have visibility beyond those tier-1 and tier-2 suppliers. So, for instance, they wouldn't necessarily know who the next two or three tier suppliers are, and where those components are actually coming from different parts of the world. So, that lack of visibility is another significant reason for this shortage.
Greene
What’s the response from the chip suppliers unable to meet the demand?
Valsan
From a chip manufacturing perspective, the semiconductor chip manufacturers, they've slowly started dedicating some capacity, bringing some more capacity online to meet the growing demand. But the fundamental issue the chip industry has is that the technology that the auto industry uses is slightly outdated. Therefore, it is actually less profitable compared to some of the chips that are used in sectors like gaming or in some of the other consumer electronics sectors. So, therefore, you know, the chip industry struggles to prioritize the need of the auto industry. Nevertheless, they have started creating some manufacturing lines for meeting this demand. But it's not necessarily going to be sufficient or come online to meet the full demands of the auto industry.
Greene
All right, in our final part, we’ll talk about potential outcomes. Anil, would you think there's an overreliance on Asia for chip production? Do you think there needs to be more manufacturing alternatives?
Valsan
Absolutely. I think the overreliance almost came as an evolution of supply chains of the auto industry, and other sectors actually globalized. And what happened was in Asia there was obviously the cost of labor, the level of automation, it made sense to concentrate some of this manufacturing in that region. No doubt it's come back to bite a lot of the sectors. Now, what we are finding is a direct consequence of this chip shortage - various governments are recognizing the overreliance on these geographies. And, what we're finding is a number of governments around the world are planning significant investments to create their own local semiconductor supply chain. So, for instance, Europe is targeting roughly 20% share of advanced semiconductor manufacturing by 2030. The US government is allocating roughly 22 billion toward semiconductor R&D and manufacturing efforts, just to name a couple of them. We’ve heard of similar investments from governments like India, China, Japan, and so on. So, there is an initiative to make these semiconductor manufacturing more local. But, these capacities are not going to come online anytime soon. There is a significant lead time to set it up. Semiconductor manufacturing is capital intensive, so it will take some amount of time.
Greene
What are the automotive companies doing to respond to the current shortage?
Valsan
We see the automakers adopting a few different strategies in response to this crisis. One, we see manufacturers shutting down production plans for short durations regularly. And, of course, as a consequence, it has an impact on temporarily laying off staff and so forth. The other strategy we see manufacturers adopting is trying to purchase or directly connect with semiconductor chip manufacturers and trying to source directly from them, setting up contractual agreements with these semiconductor manufacturers. The third strategy we see these companies adopting is working through the governments and trying to establish channels, trying to establish specific trade agreements to secure sourcing of these chips.
Greene
Could the automotive manufacturers have done anything more to be better prepared and more resilient?
Valsan
Well, in hindsight, there are a few things they could have considered. So, one is, for example, reconfiguration. They could potentially have diversified their supply chain to identify and recognize some of these chokepoints. Their overreliance on specific sectors or companies, and specifically also recognizing the extent of the lead time required for some of these components. The other is from a resiliency perspective - moving away from generally adopting strategies like just-in-time to adopting an inventory strategy that would be more reflective of the sourcing complexity associated with specific components. They are anticipating and planning ways around different scenarios, identifying potential scenarios where some of these components could be chokepoints and identifying workarounds for such components. I’m not sure the industry had done some of that when it comes to the sourcing of semiconductors and chips.
Greene
Will these manufacturers be vulnerable to other supply chain shortages in the future that could delay the economic recovery?
Valsan
There is certainly a risk. We’ve seen in the past. From time to time, there have been instances where a tier-2 or tier-3 supplier has an incident. For example, it could have been a pigment manufacturer whose plant had a fire and resulted in a significant breakdown in the supply chain. We do expect similar issues to, unfortunately, continue until the industry gets greater visibility of its supply chain.
Greene
When do you think the chip supply will be properly restored?
Valsan
This crisis could, unfortunately, continue all the way into 2021. It may take either late 2021 or even early 2022 before the crisis itself is reasonably resolved and the industry is able to secure steady supply chains.
Greene
Finally, how much of a wake-up call is this been for the automotive sector and governments?
Valsan
It is a huge issue that they've recognized. We’ve also seen a lot of auto suppliers recognizing it as an opportunity that they can actually invest and meet an urgent need that the auto manufacturers have. When it comes to governments, what we recognize is the governments have put aside certain investment for chip research and manufacturing. And, as I mentioned, we see investments being announced in markets like India, for instance, that want to have their own independent semiconductor production facility. China aims to produce 70% of the chips that its industries need by 2025. You know, the Biden administration has made supply chain resiliency a top priority, and semiconductor chips are a part of that plan. It’s part of the incentive that it has announced for semiconductor manufacturing and research. The European Union has created an initiative called the Important Project for Common European Interests (IPCEI) to steer investment into the chip sector. They’ve also started making investments in specific semiconductor companies to help them stand up as independent manufacturers.
Greene
Anil, it's been great talking to you. Thanks very much for your insights on this hot topic.
Valsan
Thank you, Justine. It was wonderful speaking to you, too.
Greene
Do join us again next time when we will continue to discuss global trade with our expert guests. Also, you can subscribe to this series, so you won't miss an episode. From me, Justine Greene and Anil Valsan, thanks for listening, and goodbye.
