The Butterfly In The Chip Shortage
The global chip shortage has been rolling on for months now, with no end in sight. While a lot of it can, and has, been attributed to Covid disrupting global supply chains, there is more to it. Using the butterfly effect as a metaphor, Covid is merely the butterfly flapping its wings.
Of course, this makes the chip shortage the tornado, or at least, the most visible tornado right now. “Now”, because the chip shortage is brewing different kinds of trouble. Firstly, it has, and still is, causing massive production headaches in the auto sector. Carmakers simply have no visibility on how much they can produce, and when production can return to pre-shortage levels.
This in turn is leading to plant closures and layoffs, which is obviously bad news. The last thing any economy needs as the world tries to emerge from Covid’s economic shadow is even more layoffs.
There is also the spectre of higher inflation looming over the economy because of the chip shortage. This will happen when manufacturers who use these chips in their products get to the point where they can no longer tolerate the higher prices and start to pass it on to consumers. It would be yet another supply squeeze (oil, shipping, copper) jacking up prices for already beleaguered consumers.
But how did things cascade to such an extent?
Using the Iceberg model, we know that Covid is the event. It is after all the most visible cause of all of this, and hence our metaphorical butterfly. As for patterns of behavior in the system, the trend has been towards Just In Time (JIT) manufacturing for automakers (and lots of other industries).
As such, the system has restructured itself over the years to become as efficient as possible. In normal times, it can churn out new vehicles to meet demand with minimal waste, reducing the need for manufacturers to hold cars as inventory awaiting sale. Needless to say, this saves the automakers a lot of money, and the overall efficiency of it tells us what the system’s paradigm is – greater profitability.
Unfortunately, JIT comes at the cost of making the entire production process extremely fragile, as delays in any part of the process can lead to massive disruption. Our Covid butterfly illustrates this point perfectly.
As workers all over the world got locked down, chip makers suddenly found themselves having to meet a wave of demand for all the technological hardware that the new working from home reality required. This includes computers, laptops, monitors, TVs, etc, that consumers were buying in response to being stuck at home.
This in turn reduced the amount of chips that foundries could sell to automakers, creating our shortage. At this point, the entire system is destabilized and very susceptible to negative feedback loops. For instance, if consumer demand for autos holds up at current levels, or spikes even higher as more countries get closer to fully reopening, then automakers will have to order even more chips.
Foundries are obviously not in a position to meet this demand anytime soon, which creates the potential for a real spike in prices as everyone scrambles for chips. Inflation (not the good kind), will result, and as we are already observing, auto-worker layoffs.
As you can see, while Covid was the spark, it was lit in an environment completely unprepared for, and hence extremely vulnerable to the slightest disruption. Who knows how many more negative consequences will cascade from this, or even when this tornado of a global chip shortage will end?
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