COMPUTER CHIPS, AND SHORT-TERM THINKING

December 17, 2021

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Over the last year, a shortage in computer chips has hobbled production of a wide variety of popular products like cars, phones, and gaming consoles. These chips have become a key input in our economy and few people appreciate what a huge disruption this is.

What is so remarkable about this situation is that it was totally predictable and yet so many companies completely failed to prepare for it.

Computer chips don’t grow on trees. They require multi-billion dollar factories that take years to build. These chips are typically low-cost components of much more expensive products and are basically a commodity, with razor thin margins and high volume.

Chip manufacturers have good reasons to not over-invest. Their business requires a lot of capital and long time horizons. Any amount of excess capacity that drives down chip prices is terrible for them. But capacity shortages only make them more profitable.

This supply-demand and competitive dynamic are well known to the big companies that depend on chips. Commercial buyers are very aware of how much capacity is out there and how much competition they face to purchase their key inputs.

This supply chain crisis was predicted by many analysts, perhaps as long as years ago. How is it that so many big companies failed to plan for this risk when the cost of shutting down production lines is so high?

My best guess is that, once again, this is a case of short-term thinking. Chip buyers had years to lock up production capacity with long term contracts, but that costs money and risks over-buying.

Before the shortage arrived, companies that contracted for a steady long-term supply would have added valuable stability and predictability to their business. Once the shortage arrived, they would be able to maintain production and benefit from both higher prices and higher volume.

Every company should have a clear understanding of their critical risks and opportunities and a plan to address the situation. This is a great example of how risk and opportunity are often the same thing. Companies that did not prepare are losing money. Those that planned ahead can now win big in a very tough environment.

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