Supply Chain Security 

By: Dr. Michael Fritze, PIPS VP

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            The global CV-19 Pandemic has highlighted serious fragilities inherent in the US supply chain for critical items.   Medical supplies were impacted including PPE, drug components, testing and injection supplies etc. It became painfully clear that relying on uncertain overseas supplies of these critical materials was a major problem in times of crisis.   But the Pandemic impacted supply chains in many other important areas causing serious shortages in automobiles, building supplies, defense needs and a whole host of other industries.   The risks of relying on fragile supply chains were laid bare particularly the potential of getting cut off from critically needed supplied in times of crisis.   Supply chain security is inherently a global issue as the world has become so interconnected in recent decades.   The US needs strong Policy prescriptions to ensure our critically needed items have secure supply chains robust in times of crisis.

            We will use Microelectronics as a specific example of the supply chain issues that came up during the Pandemic, analyze their causes and propose some policy solutions to ensure more robustness going forward for this critical item. Microelectronics are a key part of both US economic strength as well as national security needs.   They are core to some of the most successful US companies and industries as well as forming critical parts of important defense systems. We simply cannot afford to get cut off from the supply of this critical technology in times of crisis.

            To understand the impact of the Pandemic on the Microelectronic supply chain, it is first important to understand key aspects of this industry and where the supply chain risks lie. Microelectronics was dominated by USG customers in its early development days ( ‘60s and ‘70s ).   Starting with the ‘80s, commercial applications started to become dominant ending up with a relatively tiny market share US Defense now has of around 1%.   So national security needs no longer drive the market and DOD needs to leverage & adapt commercial technology developments made for the consumer market.   Defense systems also have much longer time horizons that typical commercial applications leading to a challenging sustainment issue.    The key supply chain problem for US Defense is gaining guaranteed access to the wide variety of electronic chips it needs in a secure manner.  

The semiconductor industry is a highly globalized endeavor with key supply chain elements located around the world. (Fig. 1).   Note that the US is highly dependent on overseas suppliers for key SC elements including fabrication and packaging and test for example. (Fig. 2)   Chip fabrication is dominated by Asian companies including TSMC (in Taiwan) which holds a commanding 58% market share in the pure play foundry market. (Fig. 3) A major consolidation in SOTA fabrication capabilities has been occurring in Asia (TSMC, Samsung, etc). These Asian foundries are located in geopolitically risky areas presenting a high concentration of capability in very small geographic regions.  

China has also been making very large investments to develop their own domestic semiconductor capabilities [refs here] as they are currently highly dependent on imports in this key industry.   Large amounts of money are being spent on fabrication facilities as well as stimulation of domestic fabless design companies.   The Chinese have also convinced TSMC to build a modern Fab [ref] in Nanjing to help guarantee their access to advanced ME. These very large ME investments being made by China represent a major part of their global economic competition plan with the US.

Now that the industry basics have been covered, lets consider what impact the Pandemic had on semiconductor supply chains. When this crisis began, many industries hunkered down and cancelled their chip orders fearing a prolonged downturn.   This was particularly the case in the automotive sector.   At the same time chip demand for communications and computer technologies needed for home office use surged.   A perfect storm of supply shortage was thereby set up. Major economic impacts have been suffered by a number of key industries particularly the automotive sector. [ref] The chip shortage impact has been felt in many other industries as well. [ref]

The US is a capitalist economy strongly driven by market forces. These lead to a “just in time” supply chain strategy where companies are highly penalized for maintaining unsold inventories.   Unfortunately, this strategy fails badly in times of crisis like CV-19 where stockpiling would have been helpful. As a result, wide-spread chip shortages have resulted with major economic impacts.

How can we address the serious ME supply chain issues that the Pandemic has laid bare ?   There are no easy quick fixes here as fabrication capabilities take years and serious investment to develop.   It is also important to keep in mind that building extra Fab capacity for short term demand fluctuations will ultimately fail.   Prices will drop and these Fabs will not be economically viable in the long term.

So what can the US do to develop a more secure Microelectronics Supply Chain ? To start, we can recognize areas like fabrication and packaging/test in which our capabilities are limited and encourage more domestic efforts in these areas.   The pending “USICA” legislation in Congress aims to make significant investments ($52 B in the Senate Bill) in semiconductors aimed to encourage more domestic capabilities. We also need to work more closely with our allies with strong semiconductor capabilities ( ie Taiwan and S. Korea) to encourage them to set up shop in the US.

Finally, we need to discourage “just in time” supply chain behavior particularly in times of crisis for critical ME components.   One approach is a “take or pay” model in which such orders are guaranteed and free from last minute cancellation risks. In the semiconductor industry it is never wise to “lose one’s place in line” for critical parts as this could lead to long delays and shortages.   So it is important to first identify such critical parts and then develop policy to guarantee supply in times of crisis.