Short Circuit: The Global Chip Shortage and the Bullwhip Effect

PS5 consoles have been hard to come by ever since they were first released. Likewise, securing the necessary parts for a PC rig has also been a difficult and frustrating experience for many builders. These circumstances are more than just marketing ploys to create more sales. It’s actually being caused by an alarming lack of chip supplies — not the snack kind.

The global semiconductor shortage became apparent towards the end of 2020, and it has persisted to this day. In fact, most experts are suggesting that this problem is only going from bad to worse. It doesn’t only affect gamers, this pressing issue also spans multiple sectors from household appliances to car manufacturers. Virtually anything that has electronics in it is in distress.

“What caused this global shortage to unfold?” you may ask. Well, it’s a classic case of an imbalance between supply and demand. This is best demonstrated through a phenomenon that economists call the “bullwhip effect”. The overarching principle behind this idea is fairly straightforward.

The bullwhip effect suggests that even the slightest shift in demand for a particular product can cause ripples. These ripples, fundamentally, will only grow bigger and bigger leading to more significant disruptions as it makes its way up the supply chain.

Case in point: Retailers will usually scale up their orders from suppliers to meet growing demands. In effect, wholesale suppliers will also adust their own orders from manufacturers. Manufacturers, then, will have to acquire more raw materials from their suppliers. And the list goes on. This is the same exact situation that happened to the semiconductor supply chain.

There was a massive boom in electronic sales as the world responded to the sudden outbreak of the global pandemic. At the onset, people bought PCs and other peripherals to adapt to the shift into remote working arrangements and distance learning.

As the pandemic dragged on, everyone soon demanded more gadgets from smart home technologies to gaming consoles to keep them entertained through constant implementations of lockdowns and stay-at-home orders.

Within the context of local electronics manufacturers, most firms have been maximizing their output production even in the face of factory shutdowns and other disruptions. This consequently leads them to take on higher costs of operations just to meet consumer demands. These additional costs will most likely be passed on to consumers somewhere down the line.

Pre-pandemic forecasts for the growth of the electronics industry were set at 5%. However, exports of electronic parts, which accounts for half of the country’s total exports, declined by approximately 8.8% to $39.67 billion in 2020 from $40.02 billion in 2019.

The Semiconductor and Electronics Industries in the Philippines, Inc. (SEIPI) has set industry growth projection at 7% for 2021.

Obviously, a drastic surge in demand should easily be addressed by increasing supply. In fact, big chipmakers have already announced that they’ve secured investments to build more foundries and factories to improve their chip production capacities.

Intel has expressed plans to spend $20 billion on two new manufacturing facilities in Arizona. Likewise, the Taiwan Semiconductor Manufacturing Co. (TSMC) is lined up to spend $28 billion on foundries as well. It’s important to note, however, that these projects will take time. The most optimistic timeline to completely finish building these facilities is at the end of 2022.

By then, the demand might fall immediately easing the current global shortage. “Just when the new factories come online, there’s all this excess supply and then prices collapse and no one wants to build another factory for a while,” said Willy Shih, a professor at Harvard Business School.

As chipmakers stall the creation of new factories, this will allow demand to amass gradually until it reaches up to the global supply. Ultimately, this can prompt another bullwhip effect plunging the semiconductor industry into a devastating cycle.

The primary goal for everybody along the supply chain is to carefully plan their expansion in light of the current crisis. Moreover, panicked firms have hoarded their chip supplies to help them weather the shortage and keep up with competitors. While it’s an understandable reaction, stockpiling only serves exacerbates the issue in reality.

To effectively address this shortage, a central arbiter is necessary to restore rationality throughout the supply chain. In this case, the responsibility falls upon the foundries. They have the power to properly ration their chips to each of their clients while working on solutions to boost supply.

The fact remains that the semiconductor shortage will only cause more economic damage — locally and globally — the longer it prevails.

Reference(s): Quartz, Forbes, CNBC, The Washington Post, Business World