The microchip shortage is fading, but the changes it wrought remain

For the past three years, the global microchip shortage has wreaked havoc on the auto supply chain, forcing automakers to cut millions of vehicles out of production plans and sending new-vehicle inventories and supplier profit margins plummeting.

Now, as the industry enters a fourth year since the start of the COVID-19 pandemic and its ripple effects on the supply chain, the chip shortage is fading into the background. Instead of shutting down supply chains, it's become a mild nuisance at worst for many companies. And new-vehicle inventories have recovered.

But the chip shortage has scarred the auto industry, forcing companies to reimagine their procedures and causing some automakers to prioritize production of higher-margin vehicles over entry-level models. The issue prompted the Biden administration and many manufacturers to push to shore up both supply chains and chip production to alleviate risks.

"Companies have completely had to rethink their relationship with the supply chain," said Phil Amsrud, associate director of automotive semiconductor research at S&P Global Mobility.

It was a hard lesson learned for the industry.

According to U.S.-based AutoForecast Solutions, 10.56 million vehicles were removed from automaker production schedules in 2021, along with 4.39 million cuts in 2022. The firm expected about 2.47 million vehicles to have been axed from factory schedules worldwide in 2023, though most of those cuts occurred in the first half of the year.

When the semiconductor shortage began in late 2020 and early 2021, the auto industry found itself caught off guard. Microchip suppliers, struggling to keep up with a swift uptick in demand following spring 2020 manufacturing shutdowns amid COVID restrictions, were forced to prioritize where to allocate their production.

To the auto sector's dismay, consumer electronics and other industries took top priority. Tech giants making smartphones, computers, televisions and video game systems proved more willing (and better able) to shell out big money to maintain their chip access, and the semiconductors they called for were generally newer designs. Auto companies, with their slim margins and reliance on more mature semiconductor technology, suddenly found themselves playing second fiddle — an unfamiliar role for the industry.

"The first thing that stands out, looking back at the semiconductor shortage, is the arrogance of the industry," said Sam Fiorani, vice-president of global vehicle forecasting at AutoForecast Solutions. "The automotive industry for a century has seen itself as very important, but also very important to its own suppliers. Automakers are not used to playing second fiddle to anyone when it comes to getting their parts.

"Perhaps the most significant item that they share with other industries are semiconductors, and they've realized that they are not the most important customer when it comes to chips."

New-vehicle inventories plummeted in the U.S. and Canada largely due to the lack of chips, along with other supply chain woes in the wake of COVID-19. In the U.S., inventory fell to a low point of less than 1 million vehicles across the industry in spring 2021. A recovery began in the summer of 2022 as supply chain snags were sorted out, rising to about 2.5 million vehicles in November, according to an estimate by Cox Automotive.

Similar estimates were not available for Canada.

Low vehicle inventory levels put a cap on the industry's new-vehicle sales even as consumer demand remained high. Reduced new-vehicle production, paired with volatile assembly line schedules, sent supplier profits plummeting and left many parts makers, especially smaller ones, in a precarious financial state.

But for automakers and dealers, lower inventory wasn't necessarily a bad thing. Automakers prioritized production of high-margin vehicles such as pickups and crossovers. Low supply and high demand meant dealers had to put fewer incentives on vehicles to get customers to buy from them.

Despite all the headaches of the chip shortage, the past few years have been some of the most profitable that automakers and dealers have seen. Hoping to maintain high profits moving forward, automakers continue to prioritize higher-end models over entry-level vehicles, Fiorani said.

"Now automakers are realizing that selling $40,000-$60,000 vehicles doesn't have to be offset by selling $20,000 vehicles as well," he said. "Profits are stronger because of it, and assembly lines seem to be humming along fairly well. The only issue is that entry-level customers are relegated to the used-car market."

That could provide an opening for new entrants into the North American market to establish a foothold, Fiorani said. He said the situation is analogous to when quality slipped at American manufacturers in the 1960s and 1970s, opening the door for Japanese automaker sales growth in the U.S. and Canada, or when import prices spiked in the 1980s and 1990s, leading to Hyundai and Kia gaining market share.

"In all likelihood, it's going to be a Chinese company," Fiorani said. "Because of tariffs, that will require them producing outside of China, but that's right around the corner. There are already Chinese manufacturers looking to produce in South Korea, in other southeast Asian countries and, more importantly to this market, they could easily open up a plant in Mexico."

Geopolitical tension between the U.S. and China was a big motivator for the Biden administration to pursue the passage of the CHIPS and Science Act in 2022, a bipartisan bill that provided $52 billion (all figures in USD) in subsidies for U.S. semiconductor research, design and production. That includes $2 billion for legacy chips used by the auto industry, as well as a 25-per-cent tax credit for investments in semiconductor manufacturing through 2026.

The law is intended to help make the U.S. more competitive with Asian countries such as Taiwan, China and South Korea that dominate the global market for semiconductors.

The act came as companies made enormous investments in new U.S. semiconductor capacity.

Taiwan Semiconductor Manufacturing Co. is investing $12 billion on a chip manufacturing site in Arizona that's slated to open in 2024. U.S. chip giants Intel and South Korea's SK Group are also among those that have pledged to invest billions of dollars in new facilities and research domestically.

Meanwhile, Robert Bosch, the world's largest parts supplier, said in April that it acquired chipmaker TSI Semiconductors in Roseville, Calif., with plans to spend $1.5 billion to upgrade the facility to make it a hub for silicon carbide chip production by 2026. Bosch is still seeking federal funding for the project, but plans to move ahead with upgrades, said Paul Thomas, president of Bosch Mobility Americas.

"We haven't changed our timelines for introduction," Thomas said. "Everything is still underway to modernize the facility in certain areas to get a good start in silicon carbide by 2026, though we won't be in full production by then, of course. It's an industrial ramp-up plan that makes sense. It has enough reward and risk that we're comfortable with it."

Demand for silicon carbide chips such as those Bosch will make in California is expected to rise across the industry as automakers roll out new EV models. Silicon carbide chips offer new advantages over typical silicon chips when used in EV inverters, enabling faster charging and extending range.

That has sent suppliers scrambling to secure silicon carbide supply for the future. It was the motivation behind Vitesco Technologies' $1 billion silicon carbide microchip deal with Japanese microchip maker Rohm Co. in June.

"As we look at securing a sufficient supply of chips and industrializing all this at once, it means we need great technical partnerships," said Vitesco North America CEO Sandy Stojkovski.

According to forecasts, demand for the new chips will rise, even as automakers scale back some of their vehicle electrification plans in anticipation of lower-than-expected consumer demand, Thomas said.

"There are still opportunities to make the existing hybrid and electric vehicles more efficient," he said.

In the wake of the yearslong chip shortage, securing supplies has become a major priority for manufacturers, a reality that would have been hard to imagine before the shortage, when chips were viewed as commodity purchases.

"They've gotten much closer to suppliers that they used to view as a commodity," said Dan Hearsch, managing director at AlixPartners. "It went from the purchasing people barely thinking about them to the chairman of the company calling [semiconductor companies] just to have a better relationship and understand what's going on."