Global Microchip Shortage – Supporting the Automotive Sector
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By Adam Kelly, senior associate, DLA Piper
The global shortage of semiconductor chips continues to wreak havoc on supply chains and manufacturing operations around the world, bringing the production of some of the biggest brands to a standstill and disrupting hundreds of industries.
The automotive sector has been particularly hard hit as car manufacturers compete for microchip supplies against the big technology firms. As vehicles become more technologically advanced, car manufacturers are becoming increasingly reliant on microchips to produce their latest models. Modern cars can contain around 3,000 microchips used in various parts including digital displays, driver assistance systems, CPUs, brakes, power steering and many others.
The manufacture of microchips involves an elaborate process, taking around three to four months and requiring a bio-secure environment that can be disrupted by the smallest presence of contaminants, including human skin cells. The cleanrooms in which microchips are made require air that is 10,000 times cleaner than outside air. Microchips start life as silicon that is stencilled into wafers using a complex process before being shipped to manufacturers for use in electronic goods worldwide. Asia currently produces the majority of the world’s microchips, with the US having a 12% market share. The US government recently pledged $50 billion to support microchip manufacturing and research in an effort to claim more of the market.
What has caused the shortage?
- When the pandemic hit, car manufacturers halted production and stopped ordering microchips, reducing stock levels. At the same time, the lockdown restrictions caused a surge in demand for consumer electronics, so tech manufacturers began to stockpile chips.
- As restrictions started to lift, the automotive sector began to recover much sooner than expected, causing a severe shortage of chips on production lines and resulting in fewer chips on the market due to the uptake from tech manufacturers.
- A limited number of microchip suppliers around the world.
- Recent severe weather and fires disrupting to major plants in the US and Japan.
- The use of just-in-time inventory systems designed to increase efficiency and decrease waste by receiving parts only as they’re needed – reducing inventory costs. Whilst this may be an efficient system in times of predictable supply, it is not robust at dealing with supply and demand shocks or economic downturns.
What are the short to mid-term consequences?
- A surge in the cost of microchips.
- Fewer cars manufactured and older technologies used in new vehicles.
- Inflated prices for used vehicles and longer wait times for new models.
- Shortages of electronic consumer goods (games consoles, computers, TVs, smartphones etc) and increased retail prices.
- Further factory closures and staff redundancies in respect of those industries awaiting more microchips.
- Slower development of new technologies such as 5G and the internet of things.
It is anticipated that the effects of the shortage will continue into 2022 with demand for new vehicles and technologies increasing as Covid-19 restrictions are lifted. Microchip manufacturers are currently running ‘super-hot’ production lines as they race to meet the surge in demand.
Contractual measures to mitigate disruption
Review your purchasing terms to ensure:
- Longer-term supply of microchips.
- Ordering procedures meet your operational requirements.
- Suitable contractual remedies are available for breach/supply failures.
- Force majeure and material adverse change clauses don’t undermine performance and properly cater for the continuing risks of COVID-19 and variants. They should also address how termination rights, liability and payments are affected if such relief is invoked.
- Termination rights are suitably constructed for both parties.
- Contract terms comply with the latest legislation offering important protection e.g. the Corporate Insolvency and Governance Act 2020.
- Most favoured customer rights are used to provide a purchasing advantage during short supply periods.
- Delivery/performance terms have been properly drafted to ensure deadlines are met, failures have legal consequences and all possible remedies are explored in the event of a breach.
Downstream supply agreements should have sufficient flexibility to relax commitments due to unforeseen events.
Operational measures to mitigate disruption
- Prioritise chip usage in popular models.
- Try to pull forward delivery of chips that have already been ordered.
- Engineering solutions – consider using legacy technology/workarounds. Some vehicle manufacturers are substituting digital speedometers for analogue versions. Consider removing features that customers seldom use.
- Consider updating inventory control systems and manufacturing resource planning programs for high-risk parts. Such programs highlight problem areas by measuring lead and cycle times across the production process.