Catastrophe Risks to the Supply Chain of Computer Chips
By: Joe Underwood, CPCU, ARM-E
Supply chain risk management has become more complex as computer chips have become ubiquitous components of an expanding array of everyday products from electronics to motor vehicles, appliances and LED lighting. As more types of manufacturers become essentially semiconductor businesses, they must rely on computer chip manufacturers whose own limited suppliers may be located in areas prone to natural disasters and other perils.
The integrated circuit (“IC”) industry manufactures the computer chips embedded in other products. The IC industry is capable of assembling, testing and packaging computer chips at a variety of locations. However, wafer fabrication is the basic building block underlying integrated circuit manufacturing. Wafer fabrication facilities (“fabs”) require substantial capital investment upwards of $1 billion. Many IC companies, therefore, remain entirely fabless. Other companies maintain one or more owned fabs, but those owned fabs might be incapable of handling all supply needs. Both situations are addressed by outsourcing wafer fabrication to a small number of fabs, many of whom are overseas. One company alone, Taiwan Semiconductor, accounts for over 50% of worldwide market share.
Consequently, risk managers at manufacturers that rely on computer chips should have a multi-tiered understanding of the entire supply chain from wafer fabrication through assembly and packaging to arrival for installation into their products to get the full picture of their supply chain risks.
Natural Catastrophe Perils
Asia, and specifically Taiwan, plays a dominant role in wafer fabrication for the IC industry. Companies that rely upon Taiwan manufacturing and other suppliers in Asia must carefully examine and manage exposure to several types of devastating natural catastrophes that are endemic to the region.
Typhoon:. There are more tropical and subtropical storms in the western Pacific than in the Atlantic Ocean and the typhoon season is longer than the Atlantic hurricane season. Taiwan Japan and China are vulnerable to annual typhoons. In addition to flooding and wind damage caused by typhoons, typhoons also cause landslides.
Earthquake: Taiwan and Japan are located on the Ring of Fire at the junction of two tectonic plates and are subject to frequent earthquakes.
Tsunami: As a result of their island locations in an area of frequent earthquakes, Taiwan and Japan are also subject to tsunamis. The southwest portion of Taiwan is at significant risk given its low elevation. The Indian Ocean Tsunami of 2004 resulting from an earthquake off the coast of Sumatra, Indonesia, is illustrative of the damage that tsunamis can cause. The tsunami affected 14 counties and killed over 200,000. Damage was estimated at over 10 billion.
Disruption from each of these natural perils can result from catastrophic damage to manufacturing facilities and inventory, shipping disruption caused by damage to roads and ports, and delays in getting factory workers back on the job due to how they may be personally affected by the event.
War: Chip makers rely on neon to operate specialized lasers in the manufacturing process. Half the world’s semiconductor grade neon comes from two companies in Ukraine who have ceased production because of the war there. Short-term, there are reserves stockpiled elsewhere in the world, especially in Taiwan, but longer term, chip production will be affected.
Fire: In 2021, there was a fire at the Renesas fab in Japan which disrupted chip production there for weeks. Two thirds of the plant’s production involved chips for the automotive industry, which was already suffering from supply shortages.
Power Outages: In 2021, Samsung had to shut down its Austin Texas fab production due to rolling power outages caused by stress on the electric grid from winter storms. Fabs are usually operational 24 hours a day, and restarting operations is complicated and time consuming. It took weeks before the Samsung fab was operational at pre shutdown levels.
In assessing computer chip supply chain disruption exposure, the first thing a risk manager or executive should seek to understand is where wafer manufacturing for the computer chips used in their products are located. Are there multiple locations in different regions? If so, is there enough capacity at other locations to replace lost production if a location is shut down?
The next thing to understand is what your contractual obligations to your customers are. Do contracts provide for liquidated damages in the event of failure to deliver? Are there force majeure provisions?
A final thing to assess is the competitive risk associated with loss of supply. If you lose supply and production capacity, but all of your competitors do as well, revenues might just be deferred rather than entirely lost. The financial loss may be absorbed by higher unit costs across the entire sector, provided your supply contracts with customers do not lock you in at set price levels.
Determine what your options are for alternate suppliers. It might be wise to pay a bit more for having multiple suppliers who rely on different fabs if the redundancy reduces your risk exposure. Obviously quality and reliability are important in sourcing decisions but relying on single-sourcing with the best provider can increase the risk of catastrophic losses.
The days of just-in-time production may be over, at least when it involves components containing computer chips. It is the point that Nicolas Taleb makes so poignantly with his analogy of the human body having two kidneys for good reason. Until there is a problem with one, the other just seems like dead weight. This same thought process applies to the amount of extra inventory to hold. Leanness creates operational efficiency but increases supply chain disruption exposure.
Flexibility in product design might also mitigate shortages if your product can be reengineered for substitute chips if your preferred chips are not available.
As computer chips become a critical component of a greater number and variety of products, risk managers must develop a more advanced understanding of their supplier’s suppliers in order to have a truly accurate picture of their companies’ risk exposures. Shortages of computer chips will be a major risk factor for the foreseeable future because consumers want more types of products that contain chips and the IC industry is constrained by supplies of wafers. Wafer production is in turn constrained by the exorbitant capital outlays and long lead times necessary to build new fabs.