No. 31: Plugging into the Right System, Automobile Semiconductor Power Balance, Beyond Meat podcast, Brian Eno
A common theme among some Amazon employees I spoke to was that the company could plug ordinary talent into the business and help them max out their potential. Why?
The data systems and access available to the average employee.
Systems and data availability can be a limitation in most large corporations, where they often get in the way of talented people, rather than helping them. In fact, at one friend's company, the "database" he was trying to access was a manually-updated spreadsheet held on his colleague's desktop – who would only email it if he asked nicely. This still happens at more than a few companies I have talked to over the years.
As a result, being part of a great system might yield better results than being talented alone. Great talent can be suppressed by bad systems. And conversely, average talent can be made to look better than it is with the help of great systems.
A useful analogy is the migration of brilliant tech talent from India to the US. Plug an Indian graduate into an Indian company and they will get an above-average result through sheer talent and ingenuity. However, they might have been blocked by systems, regulations, and frequent electricity cuts along the way.
Plug that same IIT graduate into an American tech company and they would be far more likely to achieve superstar results due to the infrastructure of the US - encompassing everything from uninterrupted power supply to clean air, which all together provide a great platform to build off. Of course, these are massive generalizations – but the point is probably clear.
Shifting of the Auto Semiconductor Power Balance
Semiconductors used for automobiles are typically older technologies. Up until recently they were commodity-like in nature, which in combination with the thug-like oligopoly negotiating power of the auto industry, meant pricing power of a typical automobile semiconductor company was limited. Auto OEMs overdosed on lean manufacturing ideology of just-in-time inventory, forcing semiconductor suppliers to bear costs of inventory management. And fair enough, auto manufacturing is a tough business. The OEM’s that stood a chance of winning were those who could aggressively shift capital requirements from themselves to customers and suppliers. In addition, auto customers used to negotiate contracts with semi suppliers which basically said, “Give me a discount plus a huge price reduction every year, or else we sign with your competitor who will gladly take our business”.
One by one, all these conditions have reversed polarity. In addition, COVID was a catalyst to make these industry changes happen much faster
Semiconductor fabrication plants (fabs) upgrade their existing capacity to build newer technologies every year (such as the latest iPhone or data center chips). Companies typically retain the old plants and run them as cash cows (since they've been fully depreciated), or divert their resources (fabs, machinery and people) to newer technologies to capture high-end customers. As a result, it makes very little sense for companies to build new lagging node capacity in today's dollars. The old plants have a much lower cost base and could price a new fab underwater before it recovers its investment. Therefore, there has been a secular reduction in old fab supply vs. demand.
COVID-induced lockdowns caused automobile sales to go virtually to zero for months. Automobile OEMs then cancelled all orders with semiconductor companies to preserve cash. However, instead of semiconductor companies mothballing capacity until auto customers returned, they simply moved production capacity to make more iPhones, laptops, and data center chips during the work-from-home boom. When auto demand returned later in the year, OEMs found that they were unable to secure capacity from the formerly compliant semi suppliers. A new normal had been created.
Here's an excerpt from ON Semiconductor's Q3 2021 Earnings Transcript:
(I) don't think the pricing benefit that we historically give our customers, the year-over-year is going to disappear, but definitely will be very muted for these new ramps given the capital intensity that is required to ramp those products and get them up. They are not going to be under your traditional, hey, every year give me x percent or else [Phonetic]? Those days are over for these strategic ones. So that's what gives me comfort in investing in the capex in order to increase that -- to match that demand.
There's the end part of that comment where the CEO refers to "strategic ones". What that refers to is high end products that are being developed for auto customers on demand - but that the OEM's must now pay up and shut up to give the auto semi players incentive to invest additional capex behind capacity for them.
Why is there such a semi boom for autos? Here's an excerpt from NXP Semiconductor's earnings transcript which illustrates this:
Now, with this currently dysfunctional supply chain as a backdrop, there are very clear and very positive trends that have simultaneously increased the demand for auto semiconductors industrywide as a consequence of content growth. We have seen multiple OEMs prioritize to production of premium vehicles, which require upwards of twice the semiconductor content from NXP and others. And another clear and emerging secular content driver for the auto semiconductor markets is the fast acceleration of full electric and hybrid electric vehicles, which combined have moved from 8% of global production in 2019 to about 20% of production in 2021. This is very impactful since the average semiconductor content in an xEV is about $900, which is roughly 2 times that of an equivalent ICE vehicle. These trends have resulted in industrywide content per vehicle increasing at 10% per year over the last three years. And on top of all of this, NXP is consistently gaining share in our focused growth areas and increasing content. These content gains includes 77 gigahertz radar safety systems, multiple electrification system opportunities beyond just battery management and new domain and zonal processing, as well as others
That's right - EV adoption is necessary for auto OEMs to meet emissions regulations. And those EV's have twice the semi content per vehicle compared to ICE vehicles.
The final piece of the industry dynamic shift is the burden of capital requirements. As I mentioned before, the semiconductor manufacturer previously had to bear the burden of inventory, cost reduction investments and capex as they were oversupplied relative to the demand of the auto industry. Now the auto industry has to put up capital to incentivise the semi industry to produce the value-added chips for them. Again from ON's transcript:
Now, what gives me the confidence in the ramps that we are signing up for with our customers is, when a customer co-invests with you in order to support the ramp, that's a pretty high confidence and high credibility of the ramp because everybody is easy to say they're going to be the kings of the world when it comes to EVs. But when a company says and puts money down on it as a co-investment in order to get their ramp and their supply assurance, that tells me that they're going to be winners in that market because they're putting their money where their mouth is. And we will be doing the same to our capex intensity that Thad talked about, we are increasing in order to support those ramps. So we get the long-term visibility. We get the sustainability of the revenue and the margin associated with it. We have confidence in investing our capex to expand for that capacity and the customers get the confidence that they're going to get it when they are ready for ramp and that the customer will ramp at on time when the time comes given the timeline of the LTSAs.
Overall, I don't know which part of the semiconductor value chain will benefit most from the shift in negotiation power of the industry, but it looks like OEMs must front up with cash, both in terms of capex and cost of inventory, if they are serious about getting supply. This seems to be secular, as the semiconductor content in cars increases faster than supply.
Beyond Meat Interview/Podcast
I really enjoyed this podcast with the founder of Beyond Meat. As we start to look at both the impact of climate change and zoonotic viruses, as well as the general resistance of people to change hardened protein consumption habits, technology seems to be the way forward.
Brian Eno Podcast
This podcast is from 4 years ago - but the content is brilliant - for those who are interested in the music industry. I’ve always loved Brian Eno’s soundscapes and music.