The Missing Piece In US Chip Policy

Only in chip manufacturing has our position slid. Outsourcing fabrication to foundries was an industry-wide decision. While a“fab” refers to any semiconductor manufacturing facility, a“foundry” specifically operates as a contract manufacturer available to all for chip production.

There are US fabs in the mix still, but we have primarily outsourced to foundries overseas like TSMC and UMC, both Taiwanese. Most of our foundries only produce chips for the company that owns them.

Fabrication capability is a critical part of having an independent semiconductor supply chain, which, especially with Taiwan's increasingly precarious position, we now desperately need.

For more on this, Chris Miller, in
“Chip Wars”, has written a detailed historical narrative about how American semiconductor companies moved from owning their own fabs to being fabless.

The primary reason for outsourcing chip fabrication is straightforward: it is immensely capital-intensive and often less profitable.

I've also mentioned node sizes several times. What does this term mean? Essentially, it means very little.“Node size” is primarily a marketing term. However, for our discussion, it refers to a generation of technology and a“process”-a combination of machinery, tooling, and techniques that collectively produce transistors with specific speeds and power consumption levels.

Smaller node sizes correspond to higher performance. The most modern GPUs and CPUs, which often feature in news stories, require quite small node sizes. That being said, the majority of the chips which allow for modern technologies are higher node sizes and less computationally intensive.

Let's break down some of the chips inside an advanced air-to-air missile and we can see why these higher node, less advanced chips are so fundamental.

• The radar system: These require communication equipment to receive targeting signals, also known as front-end components, which include multiple chips. While some of those chips within a single component might be extremely complex and high speed (including advanced materials, which are hard to fabricate), other simple chips like PLLs, which stabilize the signal, are fine to be at 65nm.

• Engine and propulsion systems: Again, here we might see two chips or a combined chip. Engines require continuous heat sensors and control systems to adjust the engine operation. One might include a heat sensor and microcontroller on the same chip, but quite often one separates them out. There is no reason why these need to be at a low node size and are often at 90nm to 180nm.

The most cutting-edge machinery is designed for the most cutting-edge, low node size, processes. Fabs always want to be ahead of the ball, so they devote resources to those cutting-edge processes, while machines for older processes depreciate in value.

TSMC is at such scale that they can keep depreciated equipment and facilities and continue using them, as they have some clever ways to squeeze cash out of these fully depreciated facilities.

However, for companies like Intel and GlobalFoundries, mature nodes generally do not fit into the margin structures. For the most part, American companies sell their old facilities and old equipment (sometimes to the Chinese).

One can see why. The economics of operating a modern fab are staggering. A reasonably sized fab might cost around US$5 billion in capital expenditures, which requires generating $50-$70 in revenue per second to achieve a 20% return at the outset.

Even after it depreciates, it still has to generate $30-$40. Producing a chip at 65nm might cost $5 per chip, necessitating the output of a large wafer every 30 to 60 seconds-a formidable challenge.

China's semiconductor strategy is driven by two main goals: the primary one being domestic self-sufficiency, viewing semiconductors as a critical national asset akin to strategic reserves of oil or food.

The secondary goal is to establish a strategic leverage point in the global supply chain through mastery of mature node chips, effectively creating a potential chokepoint that enhances their geopolitical leverage.

The Chinese simply do not face the same economic constraints that we do in achieving these goals:

R&D is done for them. They are buying mostly used or old equipment (from the West).

The ingredient that cannot be emphasized enough is the very deliberate Chinese economic strategy wherein strategic industries are catapulted forward with a blank check.

The graph below shows the capex-to-revenue ratio in the domestic semiconductor industry. The Chinese are going deep into the red on capex spend to push their chip industry forward.

Source: Claus Aasholm, SemiBizIntel, own research

SMIC has the goal of moving into more advanced nodes, but right now it's a struggle. SMIC is balancing between using the older Western equipment that they can still get access to and their own homegrown Chinese ecosystem, which is mostly just copied from the very same Western equipment.

And even if they did have access to the best Western equipment, they would not have the know-how to make it work for them.

Source: IC Insights (2022)

In the meantime, they are indeed swamping the mature node market. While the margins for individual mature node chips might be low, it sustains the business and it achieves the strategic goal of creating a chokepoint.

This deliberate“swamping”, and you can just read it in Xi's speech“Major Issues Concerning China's Strategies for Mid-to-Long-Term Economic and Social Development”, needs to be taken seriously.

CHIPS Act as response strategy

The CHIPS Act is essential in getting the US on the right path in terms of domestic chip production. We should not be totally dismissive of low node chips.

They are quite critical in light of the real risk of losing access to TSMC. However, the Act doesn't sufficiently address the balance needed in light of the aggressive Chinese strategy.

Coming back to the military supply chain, where an estimated 20-40% of chips used in our systems come from China. The sheer volume of components in military hardware makes it impractical to verify the origin of each chip, such as a generic microcontroller.

This is concerning, especially since some of these chips might originate from firms linked to the Chinese military, posing risks of side-channel and encryption attacks.

The CHIPS Act stimulates manufacturing through loans, grants, and subsidies for domestic and foreign companies to expand their fabrication capacity in the United States. The program seems to be working, despite initial skepticism that NIST or the Department of Congress could get anything done.

Source: Source: McKinsey, The CHIPS and Science Act: Here's what's in it, 2022

There is one thing missing: Mature nodes. Currently, only $2 billion has been given out in grants for mature nodes and somewhere between $8-$10 billion is earmarked for it eventually. Most of the money will go into leading-edge chips.

Not to be overly cynical, but the fact that Intel and GlobalFoundries definitely contributed to the contents of the bill should make it rather unsurprising that this was the outcome.

Source: Claus Aasholm

It's hard to make the economics of mature nodes work, in facilities that do not have incredible amounts of capacity/fully depreciated equipment and if it makes even less sense if the facility is new.

I'm all for public-private cooperation in designing economic policy and one might argue that friendshoring or pushing mature nodes when US capacity is already up and running might be a better strategy.

Those arguments would hold a lot more water if the Chinese were not acting so deliberately. We need to get more aggressive to respond effectively.

Offensive and defensive solutions

We can attack the problem defensively and offensively. I'd recommend doing both in conjunction. The first two are table stakes. I'd call them defensive actions.

We need to become far more aggressive about supply chain monitoring for military chips.

The second two are probably more painful. I'd call them offensive actions.

• We need to implement a more comprehensive tariff regime on Chinese chips of all node sizes.
• We have sanctioned equipment for leading-edge nodes, but we need to push this further, even into software tools like Cadence and Synopsys.

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