How TSMC has mastered the geopolitics of chipmaking

How TSMC has mastered the geopolitics of chipmaking thumbnail

CHIPMAKERS’ CRAFT can seem magical. They use light to stamp complex patterns on a dinner-plate-sized disc of crystal silicon, forming arrays of electric circuits. Once cut out of the disc, each array is called a chip. The chip’s job is to shuttle electrons in a mathematical shimmer prescribed by computer code. They do the maths which runs the digital world, from Twitter and TikTok to electronics in tanks. Without them, whole industries cannot function properly, as carmakers forced to pause production because of microprocessor shortages are discovering.

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The most important firm in this critical business is Taiwan Semiconductor Manufacturing Company (TSMC). It controls 84% of the market for chips with the smallest, most efficient circuits on which the products and services of the world’s biggest technology brands, from Apple in America to Alibaba in China, rely. As demand for the most sophisticated chips surges thanks to the expansion of fast communication networks and cloud computing, TSMC is pouring vast additional sums of money into expanding its dominance of the cutting edge.

This has proved to be a successful business model. Last year TSMC made an operating profit of $20bn on revenues of $48bn. It is, in the words of Dan Hutcheson of VLSIresearch, a firm of analysts, “the Hope Diamond of the semiconductor industry”—and, with a resplendent market capitalisation of $560bn, the world’s 11th-most-valuable company. It is also an astute geopolitical actor, navigating the rising Sino-American tensions, including over the fate of its home country, which China claims as part of its territory and to which America offers military support. In 2020, 62% of TSMC’s revenue came from customers with headquarters in North America and 17% from those domiciled in China. It has managed the geopolitical divide by making itself indispensable to the technological ambitions of both superpowers.

TSMC was founded in 1987, and for the first quarter-century it made mostly unremarkable microprocessors. That began to change in 2012, with its first contract to make powerful chips for the iPhone. Apple wanted TSMC to push its manufacturing technology as far and as fast as it could, to gain an edge over rival gadget-makers. The notoriously secretive American firm liked the way Morris Chang, TSMC’s founder, made trade-secret protection one of his priorities; guests to TSMC premises would have their laptops’ USB ports sealed even if they only visited a conference room.

Two years later the Taiwanese firm’s chips were powering the iPhone 6, the best-selling smartphone of all time. Revenue from the 220m units sold kick-started TSMC’s ascent. Some of Apple’s competitors also used TSMC as a supplier, and wanted the same thing. All paid handsomely for the chipmaker’s efforts.

This windfall set TSMC steaming ahead. It overtook Intel, the American giant which once enjoyed a monopoly on the leading edge, then left it in the dust (see chart 1). Its remaining rival in top-flight chips, Samsung of South Korea, is barely able to keep up. Such is TSMC’s manufacturing prowess that Peter Hanbury of Bain, a consultancy, reckons it has given Moore’s Law, the industry’s prediction-cum-benchmark of doubling processing power every two years or so, at least another 8-10 years of life.

Its lead over rivals is growing. It is pouring cash into cutting-edge chip factories (known as fabs) at an unprecedented rate. In January it said it would raise its capital expenditure to $25bn-28bn in 2021, up from $17bn in 2020. In April TSMC raised the figure again, to $30bn; 80% will go on advanced technologies. It plans to spend $100bn over the next three years.

It has also stopped cutting prices—which in chipmaking, where processing power has only got cheaper, is tantamount to raising them. Its chief executive, C.C. Wei, has said it will skip a planned price cut in December 2021 and keep things that way for a year. IC Insights, a research firm, calculates that TSMC can charge between twice and three times as much per silicon wafer made using its most advanced processes, compared with what the next-most-advanced technology will fetch.

This creates a positive feedback loop. Developing the latest technology before anyone else allows TSMC to charge higher prices and earn more profit, which is ploughed back into the next generation of technology—and so on. The cycle is spinning ever faster. Four technological generations ago it took TSMC two years for those cutting-edge chips to make up 20% of revenues; the latest generation needed just six months to reach the same level (see chart 2). Operating income, which grew at an average rate of 8% year in the decade to 2012, has since risen by 15% on average. Combined with revenues that chip-designers make from semiconductors ultimately forged by TSMC, the company and its customers account for 39% of the global market for microprocessors, according to VLSIresearch, up from 9% in 2000 and a third more than once-dominant Intel.

This is an enviable position to be in. But it is not an unassailable one. The experience of Intel, which has fallen behind in the last two generations of chips because of technological missteps, shows that even the most masterful manufacturers can trip up. Chipmaking is also notoriously cyclical. Booms lead to overcapacity, and to busts. Demand may slacken as the rich world emerges from the pandemic, when purchases of gadgets that made it possible to work and relax at home were brought forward. That would hit TSMC’s bottom line and strain its balance-sheet. The company has $13bn of net cash, a modest rainy-day fund for a big tech firm. To help finance its most advanced fabs, it has issued $6.5bn-worth of bonds in the past six months.

The most serious danger to TSMC comes from the Sino-American ructions. The company’s position at the cutting edge offers a buffer against geopolitical turmoil. Chip-industry insiders say that the Taiwanese government encourages all its chipmakers, including TSMC, to keep their cutting-edge production on the island as a form of protection against foreign meddling. Taiwanese contract manufacturers account for two-thirds of global chip sales.

Reflecting this, 97% of TSMC’s $57bn-worth of long-term assets reside in Taiwan (see chart 3). That includes every one of its most advanced fabs. Some 90% of its 56,800 staff, of whom half have doctorates or masters degrees, are based in Taiwan.

The firm has made soothing noises to America and China, offering to invest more in production lines based in both countries. But it is hard not to see this as diplomatic theatre. Its Chinese factory in Nanjing, opened in 2018, produces chips that are two or three generations behind the cutting edge. By the time its first American fab, designed to be more advanced that the one in Nanjing, is up and running in 2024, TSMC will be churning out even fancier circuits at home. By our estimates, based on disclosed investment plans, the net value of TSMC’s fabs and associated equipment will roughly double by 2025, but 86% will still be in Taiwan.

In the past three years the American government has begun to disrupt the delicate balance. It has tightened export controls that prohibit any foreign company from using American tools to make chips for Huawei, a Chinese technology giant. That applies to TSMC, which in 2019 sold more chips to Huawei than to any other customer bar Apple. Most of these were destined for smartphones, and other Chinese handset-makers such as Oppo happily snapped up what Huawei (which on April 28th reported its second year-on-year decline in quarterly revenues in a row) could not.

Further American attempts to prevent TSMC from doing business with China could invite meddling by the regime in Beijing, which refuses to rule out taking back Taiwan by force. President Joe Biden’s administration has also announced a $50bn government plan to revive chipmaking at home: it is doubtful whether subsidies will restore Intel’s supremacy, but the initiative could involve putting more pressure on TSMC to put cutting-edge production in America, a strategic trap the firm has been keen to resist.

The rival powers have so far refrained from interfering with TSMC directly, perhaps concluding that this is the most reliable way of achieving their technological objectives. If the chipmaker’s importance keeps growing, one of them may decide that it is too valuable to be left alone.

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This article appeared in the Business section of the print edition under the headline “Living on the edge”

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