The global semiconductor chip shortage continues to wreak havoc on supply chains and manufacturing operations across the globe, crippling production for some of the biggest brands and disrupting hundreds of industries.
The auto sector has been particularly hard hit, as automakers compete for microchip sourcing against big tech companies. As vehicles become more technologically advanced, automakers increasingly rely on microchips to produce their latest models. Modern cars can contain around 3,000 electronic chips that are used in various parts including digital displays, driver assistance systems, processors, brakes, power steering and many more.
Microchip manufacturing involves an elaborate process, taking around three to four months and requiring a bio-secure environment that can be disrupted by the slightest presence of contaminants, including human skin cells. The clean rooms in which the electronic chips are manufactured require air 10,000 times cleaner than the outside air. Microchips start their life as silicon which is stenciled into wafers using a complex process before being shipped to manufacturers for use in electronics around the world. Asia currently produces the majority of microchips in the world, with the United States holding a 12% market share. The US government recently pledged $ 50 billion to support microchip manufacturing and research in an effort to gain more market share.
What caused the shortage?
- When the pandemic struck, automakers halted production and stopped ordering microchips, reducing inventory levels. At the same time, the lockdown restrictions caused an increase in demand for consumer electronics, so tech makers started stockpiling chips.
- As restrictions began to lift, the auto industry began to recover much sooner than expected, causing a severe shortage of chips on their production lines and found fewer chips in the market due to adoption by consumers. technology manufacturers.
- A limited number of microchip suppliers in the world.
- Recent inclement weather and fires have disrupted major factories in the United States and Japan.
- Using just-in-time inventory systems designed to increase efficiency and reduce waste by receiving parts only when they are needed, reducing inventory costs. While this system can be effective in times of predictable supply, it is not robust in dealing with supply and demand shocks or economic downturns.
What are the short and medium term consequences?
- Soaring cost of electronic chips.
- Fewer cars manufactured and older technologies used in new vehicles.
- Inflated prices for used vehicles and longer waiting times for new models.
- Shortage of electronic consumer goods (game consoles, computers, televisions, smartphones, etc.) and increasing retail prices.
- Further plant closures and layoffs of personnel in industries awaiting more microchips.
- Slower development of new technologies such as 5G and the Internet of Things.
The effects of the shortage are expected to continue into 2022, with demand for new vehicles and technologies increasing as COVID-19 restrictions are lifted. Chipmakers are currently operating “super hot” production lines as they rush to meet increasing demand.
Contractual measures to mitigate disruption
Review your purchasing conditions to make sure:
- Longer term supply of electronic chips.
- The ordering procedures meet your operational requirements.
- Appropriate contractual remedies are available for supply disruptions / failures.
- Force majeure and material adverse change clauses do not compromise performance and respond appropriately to the persistent risks of COVID-19 and its variants. They should also indicate how termination rights, liability and payments are affected if such relief is claimed.
- The termination rights are constructed appropriately for both parties.
- The terms of the contract are in line with the latest legislation offering significant protection, for example the Insolvency and Corporate Governance Act 2020.
- The rights of the most advantaged customers are used to provide a buying advantage during short supply periods.
- The terms of delivery / performance have been properly drafted to ensure that deadlines are met, failures have legal consequences and all possible remedies are explored in the event of a breach.
Downstream supply agreements should have sufficient flexibility to relax commitments due to unforeseen events.
Operational measures to mitigate disruption
- Prioritize the use of chips in popular models.
- Try to bring forward the delivery of chips that have already been ordered.
- Engineering Solutions – consider using legacy technologies / workarounds. Some car manufacturers are replacing digital speedometers with analog versions. Consider removing features that customers rarely use.
- Consider updating inventory control systems and manufacturing resource planning programs for high risk parts. Such programs highlight problem areas by measuring lead times and cycle times throughout the production process.
- Evaluate the risk / reward of supporting a larger inventory of high risk parts such as microchips and plan for future shortages.
- Consider investing in the microchip industry and promoting sustainable supply chains. This will likely play a role in creating the most successful car manufacturers of the future. Some tech companies are ahead of this front, already manufacturing and selling semiconductors to third parties and using them in their manufacturing operations.
- Seek to improve relationships throughout the supply chain. Open and regular dialogue facilitates early warning and fosters collaboration.