Automakers’ challenges persist as chip shortage rages on

For the automotive and semiconductor industries, the past few years have been a journey of extremes. In both cases, the pandemic precipitated a devastating drop in demand. Then they both saw a big rebound as consumers sought to get back on the road and also increased the use of computers and other devices for remote work.

Now, again, the two sectors face a similar situation from different ends of the spectrum: dealing with the chronic shortage of chips.

McKinsey research has estimated that companies can expect a supply-chain disruption lasting a month or more every 3.7 years, on average. Options include dual-source manufacturing qualification with chipmakers; adjusting pricing levels with supply guarantees; and bundling volumes to achieve greater negotiation power.

Since the year 2000, the semiconductor industry has increased its production capacity by nearly 180 percent since; even so, capacity is nearly exhausted. Building new plants takes many years and many billions in investment.

The situation has not improved over the past year. Indeed, the war in Ukraine has made things worse. Ukraine accounts for 25 to 35 percent of purified Neon gas production, and Russia supplies 35 percent of palladium, an essential input.

To put it bluntly, the auto industry cannot expect supply to meet demand any time soon and atomakers need no reminding of this.

Chip shortages have forced more than a few to halt production, as Toyota recently announced. Others have cut back on options.

Overall, there were 1.7 million fewer vehicles built in 2021 than in 2019. A few carmakers were able to safeguard profits with manufacturing and sales strategies designed to optimise margins. But that raises problems, too, such as a shortage of lower-margin vehicles and more fluctuations in chip demand.

All semiconductor-enabled industries, such as consumer electronics and wireless technologies, face this problem. But the situation may be more acute for the auto industry.

Carmakers and suppliers typically follow a just-in-time manufacturing strategy. Since many players didn’t expect the chip shortage in 2020 and 2021, they had limited stock available, which disrupted the entire supply chain.

On the demand side, vehicles are complex and personalised products, making it more difficult to predict needs. Finally, the cars of the future will need more chips, and more sophisticated ones, as electrification, advanced driver assistance systems, and connected features become more popular.

In response to these pressures, some carmakers have started to order more chips than they need. Others are requesting “take or pay” contracts in which they can either accept a certain quantity of chips or pay a fee if they decline to do so; this arrangement helps companies match chip demand to manufacturing capacity.

But these actions fall short of being fixes. Building up inventory, for example, can work for a single company, but exacerbates the overall shortage.

 Changing suppliers is also unlikely to help much, because it can take six months to a year; chipmakers have to go through a complex qualification process, including meeting specific intellectual property requirements.

Finally, auto industry players may want to rethink the way they structure contracts for semiconductor-related sourcing. They could make up-front volume commitments more binding, guaranteeing demand for up to a year for technologies common to multiple chips.

They could also consider making selective investments in supply-chain resilience. Pandemic-related supply-chain shocks were dramatic, but cannot be considered unexpected.