What is the semiconductor cycle? Why do chips swing from shortage to oversupply?

The "semiconductor cycle" in the news is chips swinging from shortage to oversupply and back, over and over: demand changes quickly, but chip supply takes years to catch up, and the gap in between makes the whole industry run short, then run over. It's also called the silicon cycle. "Chip shortage", "lead times are stretching", "inventory correction" and "order cuts" are all news from different points on the same loop.

Why does it swing between too few and too many?

Picture a shower in a hotel. The water is too cold, so you turn the tap toward hot. But the hot water takes a while to arrive; it still feels cold, so you turn it a bit more. When the hot water gets there it's suddenly too hot, you turn it back fast, overshoot, and now it's too cold.

You didn't do anything wrong. The water just arrived late. Chips are the same: how many chips people want can change overnight, but how many the factories can make takes years to change. That delay is what makes the industry swing from too little to too much.

How does one turn of the cycle go?

No two turns are the same length or height, but a common pattern goes like this:

Step 1: Demand rises

Lots of people buy more of some product at the same time, and the chips inside it are suddenly in demand. The fabs' tools were already nearly fully booked, so the extra orders have to wait in line. As a result, the lead time, the wait from ordering chips to receiving them, starts to stretch.

Step 2: Lead times stretch, and everyone orders more

The longer the wait, the more chip buyers worry about running out, so they order earlier and order more; in a shortage, supply is often shared out in proportion to orders, so some buyers inflate their numbers or order the same need from several places, which the news calls double ordering. Orders end up larger than what will really be used, and the factories read it as even bigger demand.

Step 3: New fabs and more tools

With orders overflowing, factories decide to expand their capacity, the number of chips they can make in a month. Adding tools to an existing fab means waiting for them to arrive, installing them and getting them stable, which often takes many months or more; a new fab (What is a fab?) takes years just from breaking ground to starting production. Even with the line ready, a wafer takes several weeks to a few months from wafer start to finish (How long does a wafer take to make?), and all this time the shortage goes on.

Step 4: New capacity arrives, and demand has already cooled

Most people who wanted a new product have already bought one, and the extra chips ordered earlier are still sitting in warehouses. Just then, several companies' new lines come online together. Suddenly there are a lot of chips.

Step 5: Too much inventory, falling prices, order cuts

Chip buyers find they hold too many chips, so they use up their stock first, order less, or even cancel orders they already placed. The factories' tools free up, and to keep them running, they often cut prices to win orders. Chip prices fall, and factories earn less.

Step 6: Less investment

Earning less, factories put off expansion and buy fewer tools. For now, supply looks about right, or even too much. But the capacity available a few years from now shrinks with it.

Step 7: Demand comes back, and there isn't enough

The stock in warehouses runs out, or a new product drives demand, and demand returns. The lines that weren't built in the lean years can't appear overnight. And it's back to step 1.

Nobody can say exactly when the next turn will come or how big it will be. You'll often hear that the cycle comes around "every few years", but each turn is a different length; it doesn't keep time like a clock.

Why are chips especially prone to this?

Plenty of industries swing between too few and too many, but chips swing harder, for a few reasons:

• Fabs are expensive and slow to build: a fab costs an enormous amount (Why are chips so expensive?), and it takes years from deciding to build one to running it full. That means guessing today what demand will be years from now, and a wrong guess is hard to fix quickly.
• The busier the tools, the better they pay: once a tool is bought, it loses value every day whether it's running or not, so a fab always wants to stay full (The news says "foundry"). In good times, everyone adds tools together; in bad times, stopping the tools saves little, so many fabs would rather cut prices and take orders to keep the tools running, and prices fall even faster.
• A wafer takes months: wafers started today become chips months later, and still need assembly and test after that. The other way round, wafers already started mostly keep coming out lot by lot, even after demand has weakened.
• A long chain, where every link keeps a little extra: on its way from the fab to you, a chip passes through several companies (What does each part of the semiconductor supply chain do?). Each link keeps a little more stock and orders a little more, and by the time it reaches the top of the chain, the swings are much bigger. This is called the bullwhip effect: a small flick of the wrist, a big crack at the tip.
• Memory prices swing more: memory chips follow fairly uniform specifications, and one maker's chips can often stand in for another's (How is memory different from a processor?), so buyers mostly compare prices. When there are too many, prices fall hard; when there are too few, they rise fast.

Is every chip short in a shortage?

Not necessarily. A shortage in the news is often a shortage of one kind or one generation of chip.

A production line makes certain generations and certain kinds of chips, and it can't switch at will: making a different chip means re-tuning and re-qualifying, and the buyer has to test it again too (The news says "automotive chips"). So sometimes the newest generation is fully booked while older ones have room; sometimes it's the other way round, and small chips made the older-generation way run short, so cars and appliances can't be finished (The news says "mature nodes").

It's also common for one kind of chip to be short while another is oversupplied at the same time. So when you see "chip shortage", a good first question is: which chips?

Next time you see it in the news

• "Inventory correction": chip buyers hold too many chips, so they use up their stock first and order less, or nothing, for a while. The number of chips actually being used may not drop; the orders drop first.
• "Lead times are stretching": the wait from ordering chips to receiving them is getting longer, often because the tools are fully booked. With long lead times, buyers order earlier and order more, so some of the orders may be stock bought ahead.
• "Running at full capacity": the tools are booked solid, and new orders have to wait in line. You usually see this in the shortage part of the loop.
• "Order cuts": buyers reduce or cancel orders they've already placed, usually when there's too much inventory. Once the tools free up, the next thing you often hear about is price cuts.

In fab24hr

The game covers a single day, so you won't see a cycle that takes years, and chips have no prices. What you do see is the smallest piece of it: a tool loses a little capacity, and the due dates move with it. Tap "Clock in", choose "A day in the fab", then on the "Your role today" card tap "Production fab" and swipe to Production control. On the morning shift, at the 09:00 production meeting, the etch tool ETCH-03 is down to one chamber with nine lots waiting behind it, and you decide which goes first; on the afternoon shift, a tool next door has a problem, a lot's ship date moves, and you re-plan this week's shipments and tell the sales rep. For how due dates are set, see "What does production control do in a chip fab, and how are due dates set?". Tap "Test-and-assembly house" on the card instead and swipe to the customer liaison, and on the afternoon shift, "The Missing Few", tomorrow's quantity is a few short of the order: you decide whether to ship what you have, short, and spell it out on the shipping order, or make it up from the next batch. The companies, people, tools and numbers in the game are fictional; what the semiconductor cycle is and why it happens come from public, general sources, and where sources disagree, such as how long one turn lasts, only the general picture is given. For other jargon, see Chip fab jargon in plain English.