The chip shortage changed the economics of hardware
The chip shortage showed how inexpensive components could delay expensive products, lengthening delivery schedules and increasing the capital needed to fulfil orders.
On 8 June 2021, the White House released its first supply chain reviews under Executive Order 14017. The semiconductor assessment, led by the Department of Commerce, described an industry struggling to reconcile abrupt changes in demand with manufacturing processes that could take months. Automakers were among the most visible customers affected, but the report also identified consequences for industrial and communications products.
For a hardware startup, the problem was not confined to a higher component price. A missing chip could postpone assembly, customer acceptance and payment while engineering salaries and other commitments continued. Cash requirements and delivery risk therefore needed close examination alongside the merits of a company's technology.
Orders moved faster than factories could respond
The supply chain review traced the initial disruption to the pandemic. Auto parts suppliers cancelled chip orders as vehicle production paused and they anticipated weaker demand. At the same time, demand increased for computers, gaming devices and the infrastructure supporting activity from home. Semiconductor suppliers adjusted production and foundry orders to that changing mix.
Vehicle demand recovered faster than expected during the second half of 2020. By the time automotive customers returned, capacity had been committed elsewhere. The report explained that chip manufacturing could take up to 26 weeks, sometimes longer during constrained supply, and that changing a production line could take months. Its account also identified disruptions including the February 2021 Texas storms and the March fire at a Renesas plant in Japan.
There was no single market for an interchangeable chip
The report's demand breakdown helps explain the competing uses of production capacity. Automotive applications accounted for about 10% of worldwide semiconductor demand in 2019, compared with 26% for mobile phones and 24% for information and communications infrastructure. These shares describe the market before the pandemic and the different customer groups competing for capacity as demand shifted.
| Period or category | % |
|---|---|
| Mobile phones | |
| Information and communications infrastructure | |
| Computers | |
| Industrial | |
| Automotive | |
| Consumer electronics |
Worldwide semiconductor demand by end use, 2019. Figures reproduced from the June 2021 White House review, pages 24–25, citing SIA and BCG. Published rounded percentages total 101%.
Source1
Market size also says little about substitutability. Automotive components require qualification and testing appropriate to the vehicle application. A chip made on another process or offered in a different package may demand changes to circuit boards, firmware and validation. Buying access to nominal manufacturing capacity does not by itself produce an approved replacement part.
The bill of materials became a financing document
A useful cash plan starts with the parts required to ship a complete product. If one controller is unavailable, purchasing every other component can leave capital tied up in unfinished units. Conversely, securing a scarce part may require an earlier commitment before customer revenue arrives. Both choices affect how far a financing round can take the business.
The cash impact varies with purchase commitments and payment terms. Due diligence should examine supplier quotations and commitments, the conditions under which an order can be cancelled, and the point at which a customer pays. It should also ask what happens if a delivery moves beyond the current financing plan. A forecast built only around component unit costs misses much of that exposure.
Gaps in supply chain information
A subsequent Commerce request for information, published in the Federal Register on 24 September 2021, asked companies for lead times, inventories, order backlogs and bottlenecks. It sought information about demand signals and the stages at which work was performed internally or by suppliers. The notice requested company evidence rather than reporting inventory levels across the industry.
For customers, it asked about delayed production, purchase commitments and suppliers withdrawing expected deliveries. Those questions provide a practical way to review a young hardware business. A second source should be assessed against the actual product specification and available production allocation. A supplier list with several names may still depend on a common foundry, packaging provider or material further upstream.
Where a startup could improve the economics
The opportunity extended beyond fabricating more chips. Better component records, procurement coordination, testing equipment and production planning could help customers make decisions with less uncertainty. But the value of such products depended on access to reliable operational data and a route into established purchasing and engineering processes. A dashboard could display a shortage without giving its user an additional supply option.
The investment questions concern the decisions a product can improve. Does it help qualify an alternative, reduce time spent locating a compatible part, improve a production decision or make a commitment more dependable? Can the customer measure the improvement? The shortage demonstrated why technical differentiation, supply access and financing cannot be evaluated independently in a hardware business.
Investment implications
- A low cost component can determine the delivery date of a much more valuable system.
- An alternative supplier is useful only when the component and production process are qualified for the application.
- Purchase commitments, inventory and customer payment terms should be assessed together.
Sources
- Building Resilient Supply Chains: semiconductor manufacturing and advanced packaging review (opens in a new tab)
The White House and US Department of Commerce
- Announcement of the 100 day supply chain reviews and Supply Chain Disruptions Task Force (opens in a new tab)
The White House
- Risks in the Semiconductor Supply Chain: request for public comments (opens in a new tab)
US Department of Commerce, Federal Register
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