Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: the chip shortage has raised the stakes for Taiwan, U.S. GDP soars, and Verizon throws in the towel on digital media. To sign up for the Capital Note, follow this link. The Semiconductor Shortage Could Save Taiwan Founded in 1987 by Chinese native Morris Chang, Taiwan Semiconductor Manufacturing Company (TSMC) was the first “pure play” foundry, a manufacturer of integrated circuits designed by other companies. Previously, chip designers manufactured their products in house, but the founding of TSMC reshaped the semiconductor industry, splitting the market between “fabless” design firms without in-house manufacturing capabilities, pure-play foundries that only manufacture, and integrated-device manufacturers that do both. Three decades later, TSMC is far and away the world’s dominant producer of semiconductors. Now, in the midst of a global chip shortage, TSMC is arguably the world’s most important company. Late last year, automakers began warning that insufficient chip supply was constraining car production. The shortage soon hit producers of everything from industrial machinery to mobile phones. Yesterday, the severity of the shortage was put on stark display when Apple, which accounts for one-fifth of TSMC’s revenue, told investors that sales of Macs and iPads would fall by some $3 billion because of supply constraints. If the world’s most valuable smartphone company can’t get its orders filled, no one will come out unscathed. Wait times for semiconductor orders, typically between four and eight weeks, have stretched as long as 52 weeks, and neither CEOs nor policy-makers can address the constraints through brute force, because new production sites take years to come online. Intel recently announced plans to build two new fabs in Arizona, but those won’t be operational until 2024. And the $50 billion allocated to semiconductor manufacturing in Biden’s infrastructure bill is unlikely to move the needle, considering that the U.S. has only 10 percent market share in chip production. While the supply shortage will eventually subside, and — if past semiconductor cycles are any indication — likely lead to a supply glut, the episode highlights the strategic importance of chip-manufacturing capabilities. TSMC and Samsung alone control close to 75 percent of the foundry market, providing inputs for a wide range of products both high and low tech. That means a large chunk of the global economy depends on just two suppliers that are not easily replaceable. Businesses may want to diversify suppliers, but the amount of knowledge and capital necessary to compete with the dominant chipmakers is staggering. The Chinese government has poured hundreds of billions into its domestic foundries to little avail, and integrated-device manufacturers in the U.S. have seen their market share steadily erode over the past three decades. Meanwhile, Beijing and Washington have sparred over the fate of Taiwan, which China claims as its territory. Over the past year, Beijing has been flexing its muscle in the Taiwan Strait, and reportedly began circling warplanes around the island in January, just days after Biden’s inauguration. The Trump administration deepened ties with the island, but the U.S. still maintains a policy of “strategic ambiguity” toward the island, offering support but stopping short of recognizing its independence outright. If American alliances in the Middle East tell us anything, it’s that Washington will go to great lengths to protect overseas economic assets. While the fight over Taiwan has largely been an ideological one, the chip shortage has added a new dimension. Should Beijing attempt an invasion, it could tip the scales toward U.S. intervention. Around the Web U.S. GDP grows 6.4 percent in the first quarter US economic growth received a boost in the first three months of 2021 from massive fiscal stimulus that fuelled consumer spending, as well as looser lockdown restrictions, bringing output close to pre-pandemic levels. Gross domestic product advanced 6.4 per cent on an annualised basis in the first quarter, the commerce department said on Thursday. That topped economists’ expectations for 6.1 per cent growth, according to a Refinitiv survey, and marked the quickest first-quarter growth since 1984. The chip shortage is worsening In a dizzying 12-hour stretch, Honda Motor Co. said it will halt production at three plants in Japan; BMW AG cut shifts at factories in Germany and England; and Ford Motor Co. reduced its full-year earnings forecast due to the scarcity of chips it sees extending into next year. Caterpillar Inc. later flagged it may be unable to meet demand for machinery used by the construction and mining industries. Now, the very companies that benefited from surging demand for phones, laptops and electronics during the pandemic that caused the chip shortage, are feeling the pinch. After a blockbuster second quarter, Apple Chief Financial Officer Luca Maestri warned supply constraints are crimping sales of iPads and Macs, two products that performed especially well during lockdowns. Maestri said this will knock $3 billion to $4 billion off revenue during the fiscal third quarter. After big-ticket acquisitions of Yahoo! and AOL, Verizon throws in the towel on digital media Verizon Communications Inc. is exploring a sale of assets including Yahoo and AOL, as the telecommunications giant looks to exit an expensive and unsuccessful bet on digital media. The sales process, which includes private-equity firm Apollo Global Management Inc., could lead to a deal worth $4 billion to $5 billion, according to people familiar with the matter — assuming there is one. Other details couldn’t be learned. Verizon splashed out billions of dollars assembling a portfolio of once-dominant websites, including AOL in 2015, and Yahoo in 2017, paying more than $9 billion in total to acquire the pair. Random Walk The Financial Times ran a good overview of TSMC last month, explaining how it has combined scale and process knowledge to build a massive competitive moat: [TSMC] is getting more dominant with every new process technology node: while it only accounts for 40 to 65 per cent of revenues in the 28-65nm category, the nodes used for producing most car chips, it has almost 90 per cent of the market of the most advanced nodes currently in production. “Yes, the industry is incredibly dependent on TSMC, especially as you get to the bleeding edge, and it is quite risky,” says Peter Hanbury, a partner at Bain & Company in San Francisco. “Twenty years ago there were 20 foundries, and now the most cutting-edge stuff is sitting on a single campus in Taiwan.” Since every new node of process technology requires more challenging development and bigger investment in new production capacity, other chipmakers have over the years started focusing on design and left production to dedicated foundries such as TSMC. The steeper the cost became for new fabrication units the more other chipmakers started to outsource, and the more TSMC’s competitors in the pure-play foundry market dropped out of the race. One solution would be to diversify the supply chain by distributing TSMC fabs globally. That was the rationale for the Trump administration’s successful push to open TSMC factories in Arizona, but it’s not a perfect solution: According to analysts, one key reason the company is so efficient and profitable is its concentration of manufacturing in Taiwan. “TSMC’s major sites in Taiwan are sufficiently close enough that TSMC can flexibly mobilise our engineers to support each other when necessary,” says TSMC spokeswoman Nina Kao. A person close to the company estimates that production costs in the US are 8 to 10 per cent higher than in Taiwan. TSMC is therefore not ready to disperse its manufacturing operations across the globe. “In the US, we committed to building a fab after the authorities made clear that they would subsidise the cost gap. In Japan, our investment is focused on an area of technology that is key to our future,” says a senior TSMC executive. “But in Europe, the case is not that strong, and [the Europeans] really should figure out what exactly it is they want, and whether they can maybe achieve it with their own chipmakers.” — D.T. To sign up for the Capital Note, follow this link.