“API Geoeconomic Briefing” is a weekly analysis of significant geopolitical and geoeconomic developments that precede the post-pandemic world. The briefing is written by experts at Asia Pacific Initiative (API) and includes an assessment of burgeoning trends in international politics and economics and the possible impact on Japan’s national interests and strategic response. (Editor-in-chief: Dr. HOSOYA Yuichi, Research Director, API & Professor, Faculty of Law, Keio University)

This article was posted to the Japan Times on June 17, 2021:

https://www.japantimes.co.jp/opinion/2021/06/17/commentary/japan-commentary/taiwan-chip-dependence/

API Geoeconomic Briefing

June 17, 2021

Why the world depends on Taiwan and TSMC’s high-performance chips

KAWAKAMI Momoko,
Director-general, Area Studies Center,
Institute of Developing Economies (IDE-JETRO)

 

 

Taiwan Semiconductor Manufacturing Co. (TSMC) holds a strategically important position as a gatekeeper in the global supply chain for high-performance logic semiconductors, a key strategic component for technological innovations including 5G telecom networks, artificial intelligence, the Internet of Things and autonomous vehicles.

The company was founded in 1987 as the world’s first dedicated semiconductor foundry to manufacture chips designed by clients. It grew to occupy 54% share of the global foundry market in 2020.

The firm has also become the front-runner in leading-edge microfabrication technology, overtaking Intel Corp. TSMC is the only company in the world that can provide a stable supply of logic semiconductor chips mass-produced using 5-nanometer process technology.

As TSMC gains increasing superiority in the supply chain of cutting-edge logic semiconductors, top-tier high-tech companies around the world have relied heavily on its chips. Apple Inc.’s iPhone chips, Nvidia Corp.’s AI chips and semiconductors used in the U.S. military’s cutting-edge F-35 stealth fighter jets are now almost all made by Taiwan. This has led to global attention regarding the risks brought about by overdependence on the firm.

However, while many countries are similarly dependent on TSMC, the risks and the bargaining power against the firm differ according to each nation.

What kind of trump cards do the United States, China and Japan have in facing the rise of this gigantic foundry?

 

Supply chain risks

TSMC’s emergence as a strategic linchpin is nothing new. But in recent years the following situations have made more apparent the risks brought about by overdependence on TSMC.

First, amid intensifying confrontation between the U.S. and China and military tensions on the rise in the Taiwan Strait, people are increasingly concerned about the fact that TSMC’s factories are concentrated in Taiwan, located right next to China.

Second, while cutting-edge chip fabrication requires huge amounts of water and electricity, Taiwan is starting to run short of both. The island suffered from an unprecedented drought during the first half of 2021 and two massive power outages in May, casting a shadow on the global semiconductor supply chain.

Third, with its “being everyone’s foundry” strategy, TSMC expanded its business with Chinese companies including Huawei Technologies Co. This has led to new economic security concerns since 2018 as competition between the U.S. and China over high-tech hegemony escalated.

As Chinese high-tech firms started to fight for technological control backed by a gigantic domestic market and strong government support, TSMC provided a stepping stone for them to compete on an equal footing with American firms by closing the technological gap in chipmaking.

This is a geopolitical risk deriving from TSMC for the U.S., separate from the aforementioned risk of a break in the supply chain which can be brought about by overdependence on TSMC.

Why is the world’s logic semiconductor supply chain so dependent on TSMC? Why is the firm so competitive and unable to be substituted as a foundry?

TSMC has established an overwhelming position in the supply chain backed by a combination of strengths which the firm nurtured in its role as a dedicated foundry over nearly three decades. These include:

• Continuous massive investment.
• A long history of close collaboration with core equipment manufacturers.
• Technological superiority centered on cutting-edge processing technology and in other related areas including 3D packaging, which is becoming the focus of new technological competition.
• A strong support system to help customers design their chips, with its rich intellectual properties (IP) libraries.
• Information advantages and benefits from having a large number of diverse customers.

One of the key success factors of contract manufacturing business — including semiconductor foundries — is to make use of the flow of information acquired through repeatedly doing business with clients, strengthen customer support based on the information and attract more premium clients.

TSMC currently has some 500 clients, mainly U.S. companies, ranging from major firms, such as Apple, Qualcomm Inc., Advanced Micro Devices Inc. and Amazon.com Inc., to numerous startups.

TSMC is apparently gaining a competitive edge in terms of information gathering thanks to its large and diverse customer base.

Companies like Samsung Electronics Co. and Intel, which are trying to catch up with TSMC in the foundry business, excel in investment capabilities, close collaboration with equipment suppliers and technological strength, but are behind in terms of customer support and client base. Chinese foundries, meanwhile, lack strength in all of these areas.

Thus the firm’s predominance will not be challenged by its competitors for foreseeable period, meaning high dependence on TSMC is likely to remain for a long time.

 

Different risks, different cards

How does relying on TSMC affect the high-tech industries of different countries and lead to geopolitical risks?

Huawei’s case is a good example of making the most of opportunities provided by TSMC’s role as “everyone’s foundry” and then paying a big price after the risk of overdependence on the company became a reality.

Huawei has been outsourcing the production of most of the semiconductors used in its smartphones and base stations to TSMC through its design unit HiSilicon Technology Co.

To contain the geopolitical risk deriving from Huawei’s successful leverage of trading with TSMC and its rise as a global leader in 5G technology, the U.S. government strengthened export control measures in 2019 and 2020 to cut off deals between TSMC and HiSilicon, delivering a serious blow to Huawei’s global strategy.

The Huawei case made the world realize the huge risk of a break in the supply chain overly dependent on TSMC.

The U.S. industry is no exception in facing the supply chain risk associated with overdependence on TSMC, as it has led the trend of fragmentation in the logic semiconductor sector.

But at the same time, the U.S. has enormous influence on the firm.

High-tech industry in the United States has control over the most upstream part of the industry chain — such as core manufacturing equipment, electronic design automation (EDA) tools and IP — and the most downstream part, namely the market. TSMC is deeply incorporated into this camp.

Historically, TSMC’s technological strength was built up not only by the firm’s persistent efforts and massive investments but also through years of interacting with its American clients, including startups, digital platform firms and companies that outsource fabrication, as well as equipment suppliers and EDA tool vendors.

TSMC can be described as a company that was born and raised in the U.S.-centered global semiconductor technology ecosystem.

The firm, which had been reluctant to invest in the U.S. mainly because of costs, announced in May last year that it would build a 5-nm fabrication plant in Arizona in response to the U.S. government’s push, an apparent indication of the power of the U.S. government and the industry.

 

Turning weakness into strength?

Because of such a balance of power, if TSMC was asked to choose between the U.S. and China, it would likely choose the U.S.

Still, China’s potential as a market and a production base will continue to attract the firm.

TSMC set up a 16-nm fabrication plant in Nanjing, China, in 2018 and also started producing 12-nm chips there. It plans to make additional investment of $3 billion in the plant to establish a 28-nm chip production line to respond to the ongoing global chip shortage.

In view of the situation, there are so few cards that Japan has to play against the U.S. or China.

Japan’s strength in the semiconductor industry is equipment and materials, and it is good news that the country took advantage of this to succeed in attracting TSMC’s material research facility.

For TSMC, however, the Japanese market is rather marginal, occupying only 5% of the firm’s sales for 2019.

While the industry progressed toward fragmentation since the late 1990s, many of Japan’s chipmakers opted to adopt the fab-lite business model — outsourcing most of the production process but retaining a part of the manufacturing themselves — and did not choose to fully utilize TSMC.

No Japanese company has been globally successful enough as a manufacturer to become an important TSMC client.

Amid intensifying battle over the firm’s production capacity, Japan is at a disadvantage because of its low presence as a product outlet for the company.

But it is also possible that the Japanese semiconductor industry’s weakness in being late to adapt to the global trend of fragmentation might turn into a strength as the risk of supply chain break associated with overdependence on TSMC becomes more apparent.

For TSMC, the concentration of production facilities in Taiwan is increasingly becoming a potential risk rather than a source of efficiency. Japan may be able to make use of its semiconductor production plants and engineering talents — held by companies that took the gradual course of going fab-lite — as a factor to attract TSMC to deepen cooperation with the country.　The slow speed of Japanese companies’ reform is ironically reducing the risks they face.

Since the early 2000s, the semiconductor industry has been going after the economic benefits of fragmentation and has developed a high-level supply chain.

However, growing dependency on a gigantic Taiwanese foundry and the intensifying battle between the U.S. and China to gain high-tech hegemony appear to be leading to a turnaround in strengths and weaknesses of the semiconductor industry in different nations.

 

Disclaimer:
The views expressed in this API Geoeconomic Briefing do not necessarily reflect those of the API, the API Institute of Geoeconomic Studies or any other organizations to which the author belongs.