The global tech supply chain is about to be turned upside down. Tensions between the U.S. and China, heightened in a two-year-long trade war, were already instigating conversations regarding relocating and reconstructing the supply chain. Now that the coronavirus has further exposed the limited geographic diversity and concentration levels in the supply chain, it is less a question of whether a shakeup will occur, but rather when it will occur.
U.S. China Dispute and Tech Rivalry
When it comes to the technology sector, the U.S. and China have been at odds for years, and increasingly so during the Trump presidency. Reflecting the competition and opposing political viewpoints, Huawei, the Chinese-government-backed telecom supplier and phone manufacturer, is taking a beating. Despite its notoriety, the brand name is nowhere to be seen in the U.S., due to concerns that its equipment could be used to spy on behalf of the Chinese government. It was because of this fear that in 2012 the U.S. banned national companies from using Huawei networking equipment. Furthermore, in 2019, the Trump administration added it to the U.S. Department of Commerce’s Bureau of Industry and Security Entity List. Placement on this list requires American companies to obtain a specific license before they can sell to Huawei.
In recent weeks, the Trump administration went a step further, barring Huawei and its suppliers from using American technology and software. The new rule will impact Huawei and companies who previously sold to Huawei, such as Taiwan Semiconductor Manufacturing Company (TSMC), more than ever before. Given that all big chipmakers use some American equipment, the effect could be shattering. Potentially aware that they may not have the choice to continue to do business with both the U.S. and China, TSMC recently announced that it would build and operate another semiconductor manufacturing facility in Arizona. While about 20% of TSMC’s revenue in 2019 came from China, about 60% came from customers based in North America. This seems illustrative of the conundrum companies will be placed in as US and Chinese geopolitical tensions continue to rise, forced to choose one side at the potential cost of the other.
Coronavirus Pandemic Exposes Supply Chain Weaknesses Further
The coronavirus pandemic was an additional and timely catalyst waking national leaders to the urgent need to diversify the global tech supply chain. Many large U.S. tech companies revised their first quarter earnings projections, citing supply chain disruptions from COVID-19 as at least part of the cause. Apple, for example, revised its quarterly guidance due to expectations that iPhone supply would be constrained. Though manufacturing partner sites were outside of Hubei province where the virus broke out, the facilities were slower to ramp up after reopening than expected.
Research firm CreditSights also noted that chip vendors were forced to adjust their first quarter earnings down, due in part to the production/supply chain disruption. On the other hand, some chip manufacturers including Texas Instruments actually saw earnings surprise to the upside as customers stocked up on inventory ahead of anticipated disruptions. Bloomberg’s supply chain analysis tool reveals the cause for concern, as 26% of the company’s COGS is linked to just one company, TSMC. As we know, it is in manufacturing plants and facilities such as TSMC’s that the virus is most likely to spread, making it easy to understand why TI’s customers may have been concerned.
Due to the concentration of the major chip suppliers, restrictions on specific companies and/or regions have the potential to unleash ripple effects across the industry. Bloomberg’s supply chain analysis function shines a light on this, identifying both companies’ suppliers and customers. According to the tool, all of Apple’s top suppliers1, defined by the percentage of COGS paid to each supplier, are based in Taiwan. Together they account for more than half of Apple’s total supply chain spend, illustrating the risk to Apple should it lose access to that market.
Chip makers are even more susceptible to undiversified supply chains. Much of chip fabrication is outsourced to specialized manufacturers called semiconductor foundries, such as TSMC, who then provide chips to fabless manufacturing companies, such as Qualcomm, Broadcom, AMD, MediaTek and Nvidia. As a proportion of their own COGS paid to TSMC, the aforementioned companies spent 20.51%, 18.54%, 25.92%, 39.08%, and 28.65%, respectively.
Bloomberg provides a further indicator of the supply chain risk here, as well as an example of how this can translate to portfolio risk. On its own, SOXX, the semiconductor industry ETF, only has about 4% weight in TSMC. After bringing in the supply chain, however, we see that TSMC is actually the most influential company in the fund, as its customers have over 60% weight in the fund, and its suppliers have about 20% weight. All together, supply chain data estimates that 86% of SOXX’s weight is connected to TSMC, signifying the threat that the unwinding of global supply chains poses to the market.
Given such concerns of the same supply chain disruption coming to fruition in the case of another (inevitable) pandemic, companies are prioritizing the move to diversify their networks.
The Future of the Global Tech Supply Chain
All this said, the U.S. is now more focused than ever on restructuring the supply chain. The semiconductor industry has begun to lobby for U.S. chip manufacturing, asking for $37 billion in one proposal. The industry trade group’s proposal includes subsidies for construction of new chip factories, aid for states looking to attract semiconductor investment, and a general increase in research funding.
Consequences for the industry are inevitable, especially with China threatening retaliation. Such threats have included inhibiting the ability of companies doing business in China such as Apple, who attribute around 20% of annual sales to the country. As has been seen, companies and countries may be forced to decide whether to continue doing business with the U.S. or China, as it may be impossible to work with both. In addition to this, while the microchip is originally an American invention, the biggest semiconductor companies only earn about 27% of sales in America and have only 20% of physical plant located there. The chip industry is global and is bound to become less efficient as a result of these mandates. It has not yet been seen how vital U.S. chip making capabilities are to the industry, but will likely be decided as the tech war continues to play out.
1By % of COGS these are: Hon Hai (38.43%), Pegatron (16.60%), Quanta Computer Inc (11.24%), and TSMC (4.15%).