Over the past few years, a series of global events have contributed to severe semiconductor supply chain disruptions, especially for leading-edge semiconductors. This has led to substantial government-led initiatives (e.g., the European Chips Act and U.S.’s CHIPS and Science Act) aiming to rebalance supply chains by increasing domestic semiconductor output. However, expanding domestic output in, for example, the Asia-Pacific, North America, or Europe faces substantial bottlenecks—and chief among these is the highly concentrated semiconductor manufacturing equipment market.
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Even with Government Support, Processor Supply Chain Rebalancing Will Face Considerable "Bottlenecks"
Currently, the semiconductor supply chain is highly globalized—Asia-Pacific (APAC) (especially South Korea and Taiwan) is dominating in foundry activities; the United States is focusing on designing chipsets (fabless); and Europe and the United States are producing Semiconductor Manufacturing Equipment (SME). However, in recent years, this international supply chain has struggled. The global pandemic, geopolitical strife, and now macroeconomic uncertainty have contributed to government-led initiatives aimed at onshoring semiconductor supply chains and expanding domestic production capacity to reduce risk in this vital market. These subsidy initiatives (e.g., the European Chips Act and U.S.’s CHIPS and Science Act) provide funding and legislative support to incentivize domestic investment in Research and Development (R&D), workforce development, and foundry capacity. But ABI Research believes that, even with this support, expanding regional semiconductor production capacity will face significant bottlenecks:
- A highly concentrated SME market, with ASML being one of the most dominant foundry equipment providers.
- Poor ecosystem readiness with a persistent talent gap. The majority of foundry operators are based in APAC, and attracting these key figures over remains challenging. Europe and the United States dominate chip design and SME expertise.
- Government bureaucracy and regulation impeding market efficiency. The U.S.’s CHIPS and Science Act was first outlined in 2019; however, it took over three years for the act to be passed into law while Europe’s political structure has increased stakeholder complexities.
- Long construction lead times for foundry infrastructure.
For ABI Research, the primary factor limiting global capacity growth will be the highly concentrated SME market as long supply cycles and government-enforced bans are hindering market efficiency. This market is dominated by Western suppliers. Most evidently, Dutch-based ASML, as the only manufacturer of Extreme Ultraviolet (EUV) lithography machines, has complete control over the production of leading-edge chipsets. U.S.- (e.g., Lam Research, KLA Corporation) and Japan-based (Tokyo Electron) SME competitors dominate the remainder of the SME market, making well over 60% of the sector’s revenue. China has some presence within the SME market with Shanghai Microelectronics Equipment Group and Advanced Micro-Fabrication Equipment Inc. China, but these players are far less advanced, with core competencies in etching and cleaning. Even beyond the immediate equipment suppliers, key players within this market supply chain are unable to keep up with the explosive demand. For example, ZEISS, who provides the lenses for ASML’s EUV machines, cannot meet ASML’s increasing output requirements.
The Western dominance of the SME market in conjunction with ongoing U.S.-China geopolitical competition has led the U.S. government to utilize its incumbency advantage to impede Chinese technological innovation. In 2020, the United States pressured the Dutch government to remove ASML’s EUV machine Chinese export license. This theoretically eliminated China’s ability to produce leading-edge chips. Since 2019, the U.S. government have also been imposing similar bans on SME exports from U.S.-based SME firms. Significantly, in 2022, the Biden administration introduced legislation banning the export of artificial intelligence/machine-learning graphics processing units to China. This included a ban on trailing edge SME, limiting China’s capacity to manufacture 14 nm chips.
Highly Concentrated SME Market Will Inhibit Global Processor Capacity Expansion
Clearly, the United States is utilizing their strong global influence and incumbency advantage to dampen China’s semiconductor and technology ambitions. But beyond this, the highly concentrated SME market will limit capacity growth in the United States and European Union.
- China: The principal SME barrier for China is the U.S.-led ASML ban on EUV machines. This embargo limits China’s leading-edge foundry capacity and will have substantial knock-on effects down the line. Although China claims to be able to circumvent this ban by manufacturing 7 nm chips utilizing Deep Ultraviolet (DUV) wavelength lithography machines, this process is time consuming and more expensive. In addition, SMIC (China’s largest foundry) and other Chinese foundry players are reliant on ASML for its supply of DUV-related equipment, with approximately 1,000 ASML-supplied pieces of manufacturing equipment. Given the current geopolitical challenges, it would not be unprecedented to see further embargos placed on long-tail SME. Overall, it seems that China’s semiconductor market is highly reliant on E.U.- and U.S.-based SME; due to rapidly deteriorating relations, this has led to a substantial bottleneck in China’s self-sufficiency ambitions.
- Europe and the United States: The highly concentrated SME market spells considerable challenges for western foundries, as well. The first and most pressing issue is the lead times for cutting-edge SME. Currently, SME supply cycles range from 2 to 5 years with long-run limitations on equipment productive capacity. For example, last year ASML only shipped 31 EUVL machines meaning that even if manufacturers wish to increase leading edge production the waitlist for appropriate equipment is very long. ABI Research recognizes that within the SME market, persistent excess demand exists, and this is only going to accelerate with the introduction of legislation aimed at ramping up output. Moreover, it is conceivable that—given ASML is based in Europe—the European Union could look to apply pressure and ensure that it prioritizes the local regional ecosystem. This would place additional strain on the U.S.’s expansion plans.
How Can Vendors and Policy Makers Reduce SME Market Friction?
China’s appetite for leading-edge chips will only grow. To remedy the pressing capacity constraint imposed by global SME embargos, the Chinese government has looked to provide subsidies to support R&D into EUV lithography technology. In 2019, the Chinese government replenished their National Integrated Circuits Industry Development Fund with more than US$35 billion while Huawei has joined this effort with investment in lithography R&D. But even with such sizable investments, there has not been many tangible advances, putting China in a fairly weak short-run position. Moving forward, China should focus on subsidizing R&D, investing in national knowledge pooling/transfer, attracting knowledgeable SME workers back to China, and driving collaboration between Chinese SME firms and foundry players, but even by employing these strategies, China’s limited SME knowledge store will limit progress.
From the E.U.’s and the U.S.’s perspective, solving the challenges of this highly concentrated market will be slightly more challenging, but easing bottlenecks will be essential to long-run capacity expansion. ABI Research recommends that manufacturers and government policy employ the following steps to loosen the SME market.
- Semiconductor manufacturers must anticipate equipment requirements for capacity expansion and negotiate deals ahead of schedule to ensure prompt delivery of required equipment.
- Semiconductor manufacturers should expand R&D/innovation partnership agreements between chip manufacturers and SME players to ensure a resilient supply relationship and support iterative innovation process.
- Government subsidies should target human capital development and investment in knowledge to sustain incumbency advantage.
- Government subsidies not only should look at building foundry infrastructure but also should support SME capacity growth to reflect its integral part within the wider semiconductor ecosystem.
- Government policy tools should be utilized to incentive private SME investment.
In the medium run, China is going to struggle to progress beyond legacy chip fabrication. Lacking access to EUV machines will hinder their ability to efficiently and effectively manufacture leading-edge chips. But this is not to say that the European Union or the United States, spurred by government subsidies, will suddenly dominate the supply chain. ABI Research expects that, even in the long run, companies like TSMC and Samsung will still dominate global manufacturing output. Why? Because increasing E.U./U.S. manufacturing capacity is reliant on increased availability of SME, but the human capital constraints within this market will be enormously challenging to overcome and will require sustained investment (which at present has not been committed) across the entire ecosystem. So even in the long run, ABI Research believes that, unless effective support is provided imminently to help alleviate SME market bottlenecks, the SME market will continue to constrain the effect of U.S./E.U. government subsidies on the semiconductor market.