Semiconductors—the next frontier of geopolitics

More than 50 million cars are sold globally each year. Each car represents a dream becoming a reality for those buying them. Behind each purchase are countless visits to dealers, online research on cars, test drives, and years of saving. Imagine saving up to buy your dream car, narrowing the field to make your choice, and going to the showroom with payment in hand—only to be told that the wait time for the car is longer than a year. This was the global reality in 2021 as supply shortages resulted in the auto industry losing around $210 billion in revenues. The reason? A semiconductor chip supply shortage.

Semiconductors are everywhere, yet they remain unnoticed in the background as we make calls, brew coffee, and drive our cars. They are the driving force of the global economy and a key part of national communications, government, and defense sectors. Semiconductors form the bedrock of processing the data behind the surge in generative artificial intelligence (GenAI) models, the cloud, and our intelligent devices.

While we focus on the screen as the interface into our hyperconnected world and the ability to communicate, commerce, and collaborate with individuals, teams, and customers globally, the semiconductor is the invisible driving force behind our world. The average business leader largely ignored this little chip until their firm was impacted when supply became significantly constrained during COVID. And while COVID has retreated, rising geopolitical challenges threaten to upend this essential supply chain again as countries vie for control over critical technologies.

The semiconductor market is complex, diverse, and increasingly being customized into purpose-built offerings

The scale of use of semiconductors is massive, and multiple types of semiconductors are produced to process, compute, and store data, including these important types:

• Microprocessors: The brains of computers and digital devices, executing instructions and calculations
• Memory chips: Store data and program instructions, including RAM for temporary storage and ROM for permanent storage
• Graphics processing units (GPUs): Specialized chips for high-performance graphics rendering in gaming consoles and computers, also used in the development of GenAI LLMs (large language models)
• Application-specific integrated circuits (ASICs): Custom-designed chips optimized for specific tasks like cryptocurrency mining and networking
• Field-programmable gate arrays (FPGAs): Programmable chips offering flexibility for rapid development and specialized tasks
• Analog integrated circuits: Process continuous signals like audio and sensor data, used in amplifiers and power management
• Digital signal processors (DSPs): Efficiently process digital signals in multimedia and communication systems
• Sensor chips: Integrate sensors for measuring physical quantities and environmental conditions in various devices and systems
• System on a chip (SOCs): Integrated circuits integrating most or all components of multiple types of semiconductors like power management, connectivity, storage, or processing

The supply chain for each chip type is unique. Currently, the chips most in demand are GPUs. GPUs are at the heart of all computers; however, interest in them has grown as they are being used in the servers for LLMs powering artificial intelligence (AI) and data processing.

NVIDIA, which claims to design the most advanced AI chips, sold 2.5 million AI chips in 2023, and its market cap now exceeds $2 trillion. Google is spending up to $3 billion to build its AI chips, while Amazon is budgeting over $200 million for AI-centric chips. Others are going further: Apple, Meta, and Microsoft are embarking on efforts to design chips optimized for their environment and workloads.

The supply chain for semiconductors is global, complex, and fragile

The supply chain for semiconductors can be broadly divided into four broad categories:

• Design and development: Semiconductor companies, known as “fabless” companies, design chips but outsource fabrication. They collaborate internally or externally for chip creation.
• Fabrication: Specialized factories, referred to as foundries, manufacture semiconductor chips. They receive designs from fabless companies and use custom equipment to etch chips onto silicon wafers.
• Testing and assembly: After manufacturing, separate companies specialize in testing and assembly to ensure chip functionality. Once chips pass tests, they’re assembled into products for use in electronics.
• Distribution: Packaged chips are distributed to companies for sale to end users or incorporated into products either directly or through third parties.

Fabless companies are present globally, and the most prominent companies, such as NVIDIA, Broadcom, and AMD, are headquartered in the US. However, chip manufacturing is largely concentrated in Southeast Asia (SEA). SEA’s growth as a manufacturing hub occurred due to the cost-effectiveness of labor, government support and incentives, a skilled workforce, and the establishment of a manufacturing ecosystem.

However, this regionalization makes the semiconductor supply chain fragile. This location became important when high-tech device manufacturing moved to the region in the 90s. The increasing dependence on all types of semiconductors in public and private enterprises like automotive, industrial manufacturing, and medical technologies and interruptions in the semiconductor supply chain have a significant impact on customers and society. As nations seek to protect their data, information, and citizenry, they are increasingly concerned about an overdependence on the centralization of semiconductor fabrication in SEA.

TSMC: The behemoth at the center of chip manufacturing

In the global semiconductor supply chain, Taiwan stands at the epicenter of manufacturing. It is home to Taiwan Semiconductor Manufacturing Company Limited (TSMC), which manufactures some of the most advanced semiconductor chips in the world. TSMC has built its leadership position by providing the most advanced manufacturing facilities and leaving the design to its partners and clients.

Today, TSMC produces nearly 60% of all semiconductor chips used worldwide and manufactures 90% of the most advanced technology chips used in phones, industrial equipment, and military systems. TSMC is also the main manufacturer of NVIDIA’s most advanced manufacturing chips; thus, it has an invisible but highly relevant role in developing, adopting, and advancing GenAI solutions.

The semiconductor market is increasingly threatened by increasing geopolitical tensions—with all eyes on Taiwan

The past few years have seen numerous geopolitical conflicts increase from being a “risk” mentioned in the boilerplate legalese of company annual reports to upending supply chains. Disruptions from the US-China trade wars resulting in increasing usage of tariffs, the ban on Huawei from 5G rollouts, and two active wars—the Russia-Ukraine war and the Israel-Hamas conflict—are impacting supply chains.

Additionally, China views Taiwan as a breakaway province that it will eventually reincorporate under its domain. The Chinese government has often declared this “reunification” with Taiwan a goal. The United States has stated that it will defend Taiwan if the island is attacked, but the changing political climate in the West doesn’t mitigate all concerns.

A conflict in the region would place most of the world’s advanced semiconductor chip supply at risk, and it could disrupt the supply chain even worse than the pandemic did. The concentration of risk in Taiwan due to geopolitics and the increasing importance of semiconductors have seen governments globally trying to increase manufacturing in their respective countries.

India, the US, Saudi Arabia, and other countries are taking steps to diversify the chip manufacturing supply chain

The United States, India, Saudi Arabia, and a few other countries have been at the forefront of trying to set up more semiconductor manufacturing closer to home.

The US has seen its share of semiconductor manufacturing drop from nearly 40% of the global supply in 1990 to 12% today. The US government estimates the cost of constructing and operating a semiconductor fabrication facility is 25%-50% less expensive in other regions than in the US due to lower costs and government incentives. To offset this difference, the CHIPS Act provides $52.7 billion in federal subsidies to support chip manufacturing in the US. About $39 billion is earmarked for the construction of semiconductor fabrication plants; the remainder is meant to foster a domestic ecosystem for semiconductor production.

The US CHIPS Act has resulted in announcements for the opening of multiple new fabrication plants. However, concerns remain about the lack of skilled workforce, technologies, and access to additional federal and state subsidies. Investment examples include

• In February 2024, the US government awarded $1.5 billion in grants to chipmaker GlobalFoundries to upgrade and expand facilities in New York and Vermont, which make chips for automakers and the defense industry.
• In December 2022, TSMC announced plans to spend $40 billion to set up a hub for semiconductor production in Arizona. However, the start date for manufacturing chips has been pushed back from 2025 to 2027-28 due to uncertainty around equipment and local expertise.
• Samsung delayed its plans to start mass production at its $17 billion fabrication plant in Texas from 2024 to 2025 amid reports citing concerns over the government’s sluggishness in freeing up funds under the CHIPS Act.
• Intel has projects underway in Arizona, Ohio, New Mexico, and Oregon costing more than $43.5 billion; it has been awarded up to $8.5 billion in CHIPS Act funding as a subsidy and additional loans of $11 billion from the US government.

The US isn’t alone in trying to diversify the supply chain. In December 2021, the Indian government approved a $10 billion incentive program to promote semiconductor manufacturing. It is aggressively courting companies to invest in the country and is seeing developments in the building of semiconductor assembly and test facilities locally:

• The Tata Group is setting up two semiconductor manufacturing plants in the states of Assam and Gujarat, intending to start production by 2026. It is undertaking technology transfer with the help of Taiwan’s Powerchip Semiconductor Manufacturing Corporation (PSMC), the world’s seventh-largest pure-play foundry.
• CG Power and Industrial Solutions is setting up a joint venture with Japan’s Renesas Electronics and Thailand’s Stars Microelectronics to operate an outsourced semiconductor assembly and test facility.
• Foxconn has partnered with HCL Group for semiconductor assembly and testing as it aims to enter the chip-making space in India.

Other countries are looking to bring semiconductor manufacturing to their shores:

• In partnership with the Saudi Arabian government, Foxconn is investing $9 billion in establishing a foundry project in the city of Neom, which will act as a production hub for semiconductors and components for electric vehicles and other electronics.
• Saudi Arabia-backed Public Investment Fund (PIF) disclosed plans to invest in the semiconductor sector at the World Economic Forum 2024 in Davos.
• TSMC opened its first factory in Japan in February 2024 and has announced plans to invest in a second plant, which will begin operations by 2027, bringing its investment to more than $20 billion with the help of Japanese government subsidies.
• In June 2023, Intel announced plans to invest $33 billion, partially subsidized by the German government, to build two semiconductor facilities in Germany.
• In October 2023, PSMC and Japan’s SBI Holdings announced plans to set up a $5.3 billion chip manufacturing plant in Japan.

The Bottom Line: Geopolitical risks and the growing importance of semiconductors will drive a push toward greater supply diversification.

The importance of Taiwan, growing geopolitical tensions, and the importance of semiconductors make diversification of manufacturing facilities essential. Given the capital-intensive nature of the industry, government support will play a critical role in attracting investments.

This diversification is a boon for enterprises worldwide. Whether they are integrating semiconductors into their products or taking steps to design semiconductors that are fit for their purposes, greater certainty in the supply of these chips will boost the production and monetization of new solutions.

For firms looking to design semiconductors, HFS expects their technology services partners to play increasing roles in integrating chip design into technology and business strategies. As data, AI, storage, and processing become essential for the cloud, devices, and IoT, fit-for-purpose chip design will become a significant differentiator in products in specialized systems and everyday appliances.

HFS recommends that business leaders pay careful attention to the evolution of this market, the impact its global supply chain has on their businesses, and the initiatives of nation-states to protect, expand, and invest in the semiconductor market. Ignorance of this may lead to their undoing.