The world is in the grips of a global chip shortage because of demand for semiconductors surging far beyond capacity for supply. The shortage is crippling players in industries as diverse and far afield as automotives and smartphones—though carmakers have it the worst.

Apple, for example, has staggered the release of new iPhones to adjust for reduced supply. Ford, meanwhile, is predicting that the shortage of chips—used for onboard computers that control features like speedometers and antilock brake systems—will result in a $2.5 billion reduction in operating profit as the automaker mothballs factories. It expects production to fall by half in the second quarter.

Semiconductor manufacturers are already adding more capacity to meet future projections, and executives on the supply side of semiconductors have begun to speculate when the shortage, which emerged at the end of 2020, will ease.

There's consensus that supply will remain tight throughout 2021. Intel CEO Pat Gelsinger predicts the shortage will persist for a “couple of years.” German chipmaker Infineon likewise suspects supply to finally meet demand in 2023.

But the good news is that the shortage isn't the result of a genuine lack of resources, such as a dearth of the raw silicon that forms the wafer base for semiconductors; it’s just a disequilibrium between demand and supply. Rebalancing will require expanding capacity—and time.

Why is there a global chip shortage?

Demand for semiconductors experiences natural peaks and troughs since manufacturers tend to launch new deliverables, such as the latest smartphone model or the newest car marque, seasonally. But in 2020 a number of factors converged to create an unexpected peak.

In May last year, the Trump administration’s imposed sanctions against Huawei Technologies, which blocked the Chinese smartphone maker from purchasing semiconductors made with U.S. technology. The blockade, which gave suppliers 120 days to comply, prompted Huawei to increase orders and stockpile chips ahead of the ban.

“After the U.S. placed sanctions on Huawei, other Chinese smartphone makers started increasing semiconductor orders too because they wanted to take market share left by Huawei,” says Brady Wang, an analyst at Counterpoint Research. “That was one of the triggers for the shortage now.”

Next, the pandemic forced millions to shelter and work at home, increasing orders for personal electronics, which run on chips. China’s exports of laptop computers surged 9.8% in the first half of 2020, meeting the sudden demand for home offices. The pandemic also forced some chipmakers to temporarily shut down production lines, introducing a dip on the supply-side.

Perhaps more importantly, automakers expected the pandemic to reduce new car sales, and they cut production outlook and canceled their orders for semiconductors as a result. But the pandemic downturn was less pronounced than automakers expected, and consumer demand came roaring back as major economies rolled out vaccines.

Automakers that had canceled semiconductor purchases rushed to put in new orders but found themselves at the back of a line front-loaded with personal electronics makers. Daniel Nenni, founder of chip information forum SemiWiki, says, “Calling it a shortage is really not the case. It was just bad supply-chain management.”

Certainly not all automakers have been hit equally. Nissan chief operating officer Ashwani Gupta told Bloomberg that the chip shortage is something that every company “could have avoided” with better supply-chain management. Nissan, which has issued rolling stoppages on production lines because it can't source the chips it needs to complete orders, is among the companies that could have prepared better.

Meanwhile Toyota, which keeps a close eye on its supply chains, began stockpiling chips early and has coasted through the shortage.

Supply side

On a call with journalists on May 5, German chipmaker Infineon, which specializes in automotive chipsets, said automakers had learned their lesson from the chip shortage and that “this idea of ordering parts when you need them and canceling them then when you don’t will not return.”

But the semiconductor industry has other bottlenecks that are harder to resolve. Some 80% of the world’s chip supply—and, in fact, some 80% of Infineon's microcontroller supply—comes from Asia, where Taiwan’s TSMC dominates the market for contract chip manufacturing.

TSMC has invested $2.88 billion to expand capacity at a factory in China that produces automotive chips, in order to “ease the global chip supply challenge.” The company also has committed to spending $100 billion over the next three years to “address the structural increase in the long-term demand.”

The Taiwanese firm’s dominant position has made it something of a kingmaker amid the shortage. On May 5, U.S. Commerce Secretary Gina Raimondo said the commerce department was “working hard to see if we can get the Taiwanese and TSMC [to] prioritize the needs of [U.S.] auto companies.”

German ministers requested Taiwanese officials help get German automakers to the front of the queue as early as January. The Taiwanese side responded by requesting Germany help the island source COVID-19 vaccines, but the quid pro quo seemingly never materialized.

Both the U.S. and the EU have released plans to boost domestic semiconductor manufacturing capacity, limiting just slightly their reliance on Asia. The EU wants to double its chipmaking capacity by 2030, occupying 20% of the global market. Meanwhile U.S. President Joe Biden is pushing to secure $50 billion in government funding to revitalize the U.S.'s domestic industry. The extra capacity—some of which is being built by TSMC—won’t resolve the chip shortage soon but will help increase capacity in the long term.

“Across the industry, there will be a huge ramp-up of production by the end of 2021,” says Sanyam Chaurasia, an analyst at Canalys. Some chipmakers, he says, started increasing capacity even last year, but it takes roughly a year for new factories to come online.

“At the end of the day, supply will meet demand and there will be equilibrium,” says Chaurasia. “That's how business is run.”