Q&A: Chicago Fed Automotive Policy Advisor Talks Chip Crisis
Kristin Dziczek sees the higher number of chips per vehicle, reliance on mature technology, uncertainty regarding automakers’ long-term needs and the mismatch between product lifecycles as the main reasons for the ongoing automotive chip shortage.
The chip supply crisis started affecting the automotive industry in 2020. Automakers pared back on orders when most economies were on lockdown and new-vehicle sales were down, encouraging chip suppliers to reallocate capacity to meet soaring demand from consumer-electronics industries to compensate for the missing revenues.
Automotive demand bounced back earlier than expected when most lockdown restrictions were lifted in late 2020, while demand from consumer electronics remained high. Capacity was not immediately switched back to automotive-grade tech, and suppliers have struggled to fulfill automakers’ orders ever since.
The Federal Reserve Bank of Chicago, known as the Chicago Fed, has been monitoring the supply chain of automotive semiconductors. Wards Intelligence spoke with Kristin Dziczek, the bank’s automotive policy advisor, to understand why the shortage continues and whether it is close to an end.
Wards Intelligence: The automotive chip crisis started in 2020, and at that time, many said it would be solved by the end of that year. Why do we still have a crisis at the end of 2022?
Dziczek: The first consideration is, what does this industry make and sell? In the U.S., the luxury (vehicle) share (of the new-vehicle market) has increased by 50% from 12% to 18%. I saw one of the (car) companies’ chief economists say, “If you got one chip, are you going to put it in a pickup truck or a small car?” Having a limited number of parts meant (automakers) prioritized the highest trim levels and the most luxurious and profitable vehicles. They could make low-end dumb boxes, but that is not what is selling and is not profitable. The conundrum there is that those most-profitable vehicles require more chips because they have the (advanced driver-assistance system) and comfort features. That is one of the issues. Each car requires more chips, and if we had all the chip supply we had in 2019, we could not make the same number of vehicles that this industry made in 2019.
(Also), the (automotive) product lifecycle is not matched with the chip industry. Over the course of a vehicle run, the chip industry could give you better, faster and cheaper products. (However), the auto industry does not want to change all the time because the qualification process is long and costly, and you have to support those vehicles in the field and maintain and repair them for 10 years once they are out on the road. The chip industry wants to move fast and change, while the automotive industry wants to buy the same chip for 10 years.
(Ford CEO) Jim Farley has been talking about how heavily reliant we are on mature chip tech and capacity for most of the vehicle. It is difficult to make the (return on investment) for expanding mature chip capacity because it is still costly, especially considering that (capacity) could be built or allocated for higher-end, higher-margin chips. The (Creating Helpful Incentives to Produce Semiconductors) CHIPS Act set aside $2 billion to incentivize mature technology growth in the U.S., but it is not just the foundries that have to expand. It is all the different steps in making a chip that must expand at the same rate. And there could be bottlenecks down the road if the foundries have fatter margins than, say, the packaging and testing operations.
So, (chipmakers) are not going to (rush) until they know this demand is really there. And, as you know, with the move to software-defined vehicles, (automakers) will depend on this mature technology until they do not. It is like oil-refining capacity. Today, we are dependent on oil refining, but capacity is limited and nobody wants to expand it because we are trying to wean off oil, and it is uncertain for how long it will be profitable.
Will it make sense for chipmakers to put more money into mature technologies for automakers when the auto industry is so fickle? As soon as times got tough in 2020, they pulled back. The chip industry wants to see that there is a commitment to this for a long period of time before they put the investment into delivering what needs to be delivered. (Automakers face) really long lead times right now and requirements for long-term commitments.
Wards Intelligence: Chip suppliers say that automakers’ transparency about their sales forecast is important to manage the crisis in the short term. Are automakers being more transparent with their suppliers?
Dziczek: Well, that is what they have been aiming to do, but I heard that now that chip supply was more regularly delivered – meaning if you order X, you get X and not 0.8X – some automotive consumers were starting to trim back their orders, and some chipmakers seeing this order of X instead of X plus (are wondering), “Is demand starting to fall off, or is (the market) just normalizing (because automakers) are not in panic mode anymore?” A weakening demand signal could flow back to chipmakers pretty quickly, because they are nervous about automotive pulling back again.
Wards Intelligence: Automakers are investing in next-gen platforms powered by high-end chips, but vehicles will still rely on larger nodes for basic functions. How will automakers manage that?
Dziczek: Automakers are seeing mature technology as more of a strategic supply, meaning that there will be closer relationships with those suppliers, which may even include co-investment. Automakers need this tech, but they know the chip suppliers’ margins on mature technology are low, so they will provide financial help in building or maintaining capacity.
It is a big investment problem because the reason you can make money selling mature technology is that you sold (the chip) to people paying top dollar during the initial production run and now you are just amortizing down to using the equipment and running it out. But if you start running it out without having the first buyers pay off the equipment (in the case of expanding mature technology capacity), the cost will go up. That is why, for these mature technologies, we are also going to see higher costs.
Wards Intelligence: Will this strategic partnership strategy work in the short term?
Dziczek: It does not work right now. We are still in this valley of death.
Wards Intelligence: That said, will we continue to see vehicles being shipped with missing chips? If so, how will this affect customer satisfaction?
Dziczek: I live near the metro Detroit area. I drive the highways around Southeast Michigan, and so many vehicles are parked, waiting for chips all over the place. Right now, consumers wait six to nine months for an order, and when the vehicle comes, it does not have these one or two (features). But the demand for vehicles is so strong that people are willing to take it.
My car, which I ordered in January and got in September, came short of two chips. One was a Wi-Fi hotspot that I was not going to use and one was a convenience feature about how the liftgate operates. I did not care. I had someone tell me that their vehicle was delivered with just an on-and-off heat function and that the chip for different temperature settings would come later, and they could get it installed later.
Inventories are starting to tick back up again, and as the demand and the supply normalize a little, consumer satisfaction with vehicles missing features will drop. Automakers best organized and positioned to tackle this crisis will have a competitive edge.
Wards Intelligence: How will automakers perform the retrofit of these missing chips?
Dziczek: Automakers will not bring all vehicles back to the factory to retrofit chips, so the dealer involvement here will be big. The ability to have dealers put the retrofits in at a high quality will be a differentiator. The companies capable of working out the kinks in the retrofitting process and that have good relationships with their dealers and have good training are going to differentiate.
Wards Intelligence: What about the market dynamics for higher-end chips?
Dziczek: Automakers are not the majority buyers (of high-end chips), so the auto industry has less market power (than with mature chips). (Consequentially) the chip dollar value per vehicle is probably going to be similar, if not more expensive (than today), even if (automakers) are buying fewer chips because of the move toward more advanced chips.
(Automakers) will still have the production-run issue with advanced chips because their vehicle (platforms) run for seven to nine years unless they build in from the get-go that they are going to change as rapidly as the chip industry does. (Or) you could buy them all, the seven to nine years of the production run and the 10 years of support, maintenance and repair, (resulting in) enormous inventory and potential quality issues. I think there is still a product-cadence mismatch between chips and cars.
Wards Intelligence: What are policymakers doing to alleviate the chip supply problems?
Dziczek: Many countries are doing things like the (U.S.) CHIPS Act. I saw some news about Taiwan doing a big investment push, and they are critical in all of this. But the chip industry has had volatile swings of tightness and glut. It is hard to hit it right on, and it is hard to have demand and supply align perfectly. When there is tightness, there is lots of investment, and you have a gut period that might be good for chip consumers but not so good for investors and chipmakers. Then chipmakers and investors pull back, and you go through the cycle all over again.
Right now, we are in a period when the government wants to incentivize investment. But reports are showing that the chip industry is pulling back a bit and looking at their forward investments a little more carefully. They are trying to line up with where demand really will be because the scale of their investments is so much bigger than the automotive investment scale, so it is critical that they get it right, and that goes back to the transparency point.
Wards Intelligence: Are these actions enough?
Dziczek: (For years), we thought of chips only in the consumer realm, and that let these supply chains become so globalized. You cannot turn that off overnight and say all of this has to happen only in allied countries or in the U.S. because this is critical to our national security. But you cannot change it unless you invest in capacity building, R&D training, workforce issues and all the things in the CHIPS Act.
The Oct. 7 action from the Biden Administration to cut off access to advanced technology to China has really caused a huge movement not just of U.S. persons – there is also a bunch of people that had been working in China moving back to Taiwan, meaning China is getting a big brain drain going back to Taiwan. What will happen remains to be seen, but that was a breaking point in an increasingly global industry that is starting to pull back and regionalize.
Wards Intelligence: How are the macroeconomic and geopolitical events affecting the industry?
Dziczek: It is counterintuitive, but a complex supply chain has a better ability to adjust when things go wrong. They are more resilient because they have been de-risking, multi-sourcing and thinking about where things could go wrong on a regular basis to maintain production. I have always said that in the auto industry, things go wrong all the time, but they work around it. In 2011, Japanese suppliers got down into their supply chains and understood every place where everything was coming from, got better information and more transparency and were able to weather the next storm better. (Presently) chip buyers are trying to reduce to a smaller range of chips to make bigger buys and have more market power. They are (also) qualifying multiple plants instead of one source. Some things were on autopilot, as (Tier 1) suppliers would take care of the chip supply, so it is about learning more about where things are really coming from.