By Tim O’Shannassy  and Chris Hope

Acknowledgement

Introduction

Taiwan Semiconductor Manufacturing Company Limited (TSM) operates in a difficult and uncertain business environment in the semiconductor industry, and is the world’s largest business in this fast growing sector (Forbes, 2023; TSM, 2021). As a consequence TSM’s strategy and success, or failure, is important to governments and corporations around the world. Semiconductors have major household, academic, industrial and military use.

There have been significant global political, and trade tensions between major economies since 2018, plus the Covid-19 pandemic (TSM, 2021). Covid-19 alone with its impact on health institution overload and lockdowns in particular legal jurisdictions (e.g., China) has led to global supply chain disruption – and this has impacted the semi-conductor industry.

The threat of war for Taiwan with China is real (Power-Riggs, 2023). Russia is at war with Ukraine. There continues to be the risk of the placement of tariff barriers, non-tariff barriers, and trade sanctions against particular countries, corporations and/or individuals. These types of trade barriers have the potential to have a strong impact on the semiconductor industry, adversely impacting TSM ability to produce product and/or provide services to customers (TSM, 2021).

TSM enjoyed another year of strong revenue and profit growth, but there remain a variety of challenges and uncertainties. What is their optimal strategy focus for the future?

Business Environment Challenges in the Semiconductor Industry

Currently, the political situation is very delicate for global business. China is pushing for the European Union (EU) and other regions to avoid official dealings with Taiwan, and the United States has made several plays to assist TSM, including partnering to develop a US$12 billion United States chip fabrication plant in the United States (Arizona) and banning technology access to Chinese companies (Power-Riggs, 2023). After the invasion of Ukraine by Russia, many United States and EU policy makers remain concerned about the reliance of the world on Taiwan and namely TSM to produce advanced chips (The Economist, 2023).

A recent study in the US State Department predicted that a blockade on Taiwan by China would have a significant adverse impact on access to semiconductors and world Gross Domestic Product (Power-Riggs, 2023). This has led to a complex political situation where TSM currently hold a great deal of industrial and political power for Taiwan, with the United States motivated to protect Taiwanese interests in relation to China because of this (Crawford, Dillard, Fouquet & Reynolds, 2021).

A semiconductor chip shortage has been caused in recent years by a series of global events which include raw material shortages, trade wars and the COVID-19 pandemic which led to a drop in demand. With difficult economic conditions including a rising cost of living across the globe and slower world economic growth (International Monetary Fund, 2023), companies are also now forced to balance the political element of their purchasing decisions and who to align with (China or the United States) (Power-Riggs, 2023). There is big money in the semiconductor industry, with the EU, United States and China throwing around billions of dollars to improve their position in the industry and avoid a reliance on TSM. Tokyo is attempting to lure TSM into Japan also for research and development (R & D) with US$1 billion plus the potential for further financial support for a manufacturing facility. China itself is also spending big, with US$1.4 trillion earmarked in 2025 alone for spending on chip development (Crawford et al., 2021). The US recently introduced the “Chips and Science Act” which as a result means more capability and R&D for US companies who are developing the microchips. This is expected to be worth several billion dollars to the industry in the US (Powers-Riggs, 2023).

Taiwan has begun to increase investment in its education sector, with a focus on recruiting students to the semiconductor industry and increasing the number of specialised schools that focus on the industry (Wu, 2022). A well educated workforce is important in the semiconductor industry. The complex geopolitical situation with China means that the Taiwanese population are directly affected by the economic and industry status of the semiconductor industry, and how the great power rivalry of the United States and China plays out (Power-Riggs, 2023). It is a delicate time.

Taiwan produces around two thirds of the world’s semiconductors (65%) and approximately 90% of the advanced chips. By comparison, China produces just over 5% while the US produces approximately 10% (Crawford et al., 2021).

Protecting intellectual property is crucial for success in this industry. In particular, it is important that industry players are prepared for any cybersecurity breaches or industrial espionage which could undermine the integrity of their intellectual property (Reuters, 2021). There is discussion among lawmakers in Taiwan to establish legislation to prevent China from poaching Taiwanese technology talent and offering them jobs in the Chinese semiconductor industry (Reuters, 2021).

Environmental considerations are very import in the semiconductor industry, and an important focus for governments and corporations; sustainability may affect future investment flows from governments, superannuation funds, or other corporate entities.

Samsung, Intel Inc., Micron and TSM are locked in battle for dominance of the chip industry, and this rivalry is only set to develop further as the political landscape is volatile and rapidly shifting, and technology in this sector advances (Investing.com, 2023; Ting-Fang & Li, 2022). For instance Huawei has made several recent investments to improve its chip capabilities to produce both chips at scale and to develop more advanced chips, after the United States moved to reduce their access to United States technology. In 2021, Huawei invested in just under half of domestic China chip technology companies which doubled their 2020 investment. Approximately 70% of these Huawei investments were in relation to semiconductor-related supply (Ting-Fang & Li, 2022).

There are high barriers to entry for the semiconductor industry due to the challenging technology required to make the chips (TSM, 2021). One such entry barrier is the large amount of investment required to be in the industry which creates a high financial hurdle for new players. Another hurdle is mastery of manufacturing capability at scale, something that the Chinese government and Chinese enterprise have not been able to achieve (Power-Riggs, 2023). Taiwan companies including TSM dominate the advanced chips industry now with more than 90% market share, and 60% market share in semiconductors (Power-Riggs, 2023). The political situation can dramatically shift this analysis (TSM, 2020).

There are no evident substitutes for semiconductors, but materials that could replace silicon include indium gallium and black phosphorus.

Should Europe or others rely on a large industry player like TSM given the geopolitical situation? How much advanced microchip making can Europe really do, or how much does it really need? These are some of the considerations to make when thinking about the threat of substitutes. Could quantum computing make an impact on the future of chipmaking? (Deloitte, 2023).

Volumes are falling in the semiconductor market with demand weakness evident. However, many semiconductor companies including Intel and TSM have long-term contracts with their suppliers and are unlikely to want to damage a relationship by breaking a commercial agreement (The Economist, 2023).

During the COVID-19 pandemic, the demand for cars dropped which meant car makers did not want to extend contracts with semiconductor companies. However, there was an increased demand in other sectors which resulted in a reallocation of semiconductor manufacturing capacity to these contracts. There is now a shortfall of semiconductors in the car industry due to these circumstances.

There is a focus on diversification in all parts of the semiconductor supply chain, with trends leaning to traditional supply chain strongholds in Asia shifting to North America and Europe (Power-Riggs, 2023). China will seek to influence this trend to its advantage in the short and medium term, however replicating Taiwan’s manufacturing capability will not be easy. When considering this and how it impacts suppliers to the industry, it is important to consider the impact of how partnerships and alignment with either the European Union, China or United States play a part (Deloitte, 2023).

Critical success factors required for survival in the semiconductor industry include manufacturing capacity, alliance partnerships, research and development, technology, design, intellectual property, patents, trademarks, product quality, service quality, political lobbying, distribution channels, employee training and development, employee mobility, and advertising.

Taiwan Semi-Conductors Strategy Situation

Taiwan Semi-Conductors Strategy and Governance

TSM’s mission is “to be the trusted technology and capacity provider of the global logic IC industry for years to come” delivering industry leading and advanced semiconductor products (TSM, 2021:2).

TSM’s stated vision “is to be the most advanced and largest technology and foundry services provider to fabless companies and IDMs, and in partnership with them, to forge a powerful competitive force in the semiconductor industry” (TSM, 2021: 2).

TSM core values include integrity, customer trust, commitment, and innovation (TSM, 2021).

In the previous financial year the key elements of the TSM differentiation strategy was:

• Improving quality and productivity from TSM fabrication facilities
• Generate greater wafer output from existing capacity
• Create greater production capacity, strengthening capital expenditure
• Improve customer service
• Improve research and development infrastructure (TSM, 2021).

TSM revenue is earned through customers using smartphones, internet of things (IoT), computing and digital consumer electronics (TSM, 2020).

TSM undertakes long-term demand forecasting for its operations and has determined the need to increase the capacity of its operations Taiwan, Nanjing in China, Arizona in the United States and Kumamoto in Japan (TSM, 2021).

During the Covid-19 pandemic TSM took strong measures to protect employees whilst ensuring the continuation of fabrication facilities to support customers. This action helped TSM to achieve a strong profit outcome (TSM, 2020).

TSM is committed to environment-social-governance (ESG) performance with green manufacturing, an inclusive work environment, supply chain responsibility and looking after the underprivileged priorities (TSM, 2021).

The TSM board comprises 10 directors including Taiwan’s Director, National Development Fund. The chairman is Mr Mark Liu. Mr C.C. Wie is Vice Chairman and Chief Executive Officer (CEO). Nine directors are male and there is one independent female director. Five directors are Taiwanese, four from the United States and one from the United Kingdom (TSM, 2021).

Taiwan Semi-Conductors Functional-Level Situation

The board and executive believe TSM is about to enter a period of high growth given the growth industry conditions with 5G, high performance computing and applications likely to push high demand for computing power (TSM, 2020). The TSM differentiation market strategy has been a clear winner for them (TSM, 2021).

The customer profile for TSM product and services is dynamic, so TSM need to be agile. A further risk management issue is the concentration of sales with the current largest customers currently at 71% of net revenue (2020 74%; 2019 71%) (TSM, 2020; TSM, 2021). In the current financial year the two largest customers of TSM account for 36% of net revenue. The nature of the electronics industry is that customer concentration is a characteristic, with only a small number of firms worldwide with capacity to produce mobile devices, applications and software with required capability at scale (TSM, 2021).

Net revenue by geographic segment is provided in Table 1 below and shows a clear reduction in sales in China over the three year period:

Semiconductor manufacturing operations at TSM are conducted across the globe, are a substantial investment, and are mainly a fixed cost asset once established (TSM, 2021). There are significant operations in Taiwan, Nanjing in China, Arizona in the United States and Kumamoto in Japan (Power-Riggs, 2023; TSM, 2021). When manufacturing output rises, and costs at the manufacturing operations is fixed, these costs are spread over higher output, and then profit margins increase. Applying the same principles when output declines, profit margins decline (TSM, 2021).

TSM maintains an ecosystem of employees, suppliers and semiconductor fabrication facilities in Taiwan that provides a flexible, efficient and effective resource that allows operational synergies (TSM, 2019; TSM, 2020).

TSM does extensive business in China, but is wary these “operations…may be delayed, interrupted, suspended or cancelled due to unforeseeable social and political factors” (TSM, 2021: 4).

TSM considers its human resources its most important business asset. The great majority of the TSM workforce of 65,152 (2020 56,831; 2019 51,297) is located in Taiwan, as is the majority of the top management team. The China business and operations has a head count of 4,131 and North America business and operations a head count of 2,188. Workers in small numbers are located in Europe (2021 54 employees; 2020 52; 2019 50), Japan (2021 152; 2020 78; 2019 32) and Korea two employees (TSM, 2021).

TSM maintain a workforce of engineers that is flexible in work location and can be moved temporarily from one manufacturing facility to another if required (TSM, 2021). This can assist working on a semiconductor design problem, or a manufacturing process issue in a timely way (TSM, 2021). This is easier to do between Taiwan, Japan and the United States, there remains risk on the ongoing ability of TSM to move human resources for this type of work in China who are not Chinese citizens (TSM, 2021).

In terms of education 4.1% of TSM employees have a PhD, 47.3% a Master’s degree, and 27.6% a university bachelor degree (TSM, 2021).

TSM are well aware of the risk of cyberattacks and have been proactive in establishing a comprehensive security network for internet access and computing. However despite these efforts TSM know they remain vulnerable to cyberattack on computing systems, and key corporate functions (e.g., accounting, manufacturing operations) (TSM, 2020).

ASML Holding N.V. makes the photolithography machines used to make computer chips. The major suppliers of wafers to TSM are GlobalWafers of Taiwan, Formosa SUMCO Technology Corporation of Taiwan, Shin-Etsu Handotai of Japan, SUMCO Corporation of Japan, and Siltronic AG of Germany (TSM, 2021).

Research and development (R & D) is an important requirement for success in the foundry segment and more broadly in the semiconductor industry (TSM, 2019). This is a fast moving industry environment with rapid technological change that can render recently introduced products and their associated technology obsolete (TSM, 2021). Sustained investment at scale is required to remain competitive, and TSM has established a large number of patents in the United States and other legal jurisdictions (TSM, 2020).

TSM spending on R & D in the past three years in New Taiwan dollars (NT), and United States dollars (USD), and as a percentage of total revenue is provided in Table 2 below:

R & D is currently focused on advanced process technologies including 5-, 7-, 10- and 16- nanometre technology to beat our rivals to the market. It is anticipated that process technologies will go to the 3- and 2- nanometre in future years requiring further R & D spend. R & D is also required on TSM mature technologies to service existing customers (TSM, 2021).

TSM currently do centralised R & D work, plus R & D located at each of their fabrication facilities. Centralised R & D is in a variety of areas: advancement of new logic (e.g., metal oxide semiconductor logic), system on a chip, system in package, derivative design approaches, and cost effective system integration solutions (e.g., chip on wafer substrate) (TSM2021; Sperling, 2012). The fabrication facilities R & D is focused on improvements in manufacturing process.

The majority of revenue is earned in Taiwan, though significant revenue is earned offshore (TSM, 2020). There is an historical trend of decline in average selling price for end use applications and the components such as semiconductors that go into these products (TSM, 2021).

In 2021 there has been a significant expansion in non-current liabilities, current assets and non-current assets. The 16% improvement in net profit after tax in 2021 compared to 2020 has assisted the improvement in net assets up 35% (TSM, 2021). Summary financial data is provided in Table 3 below. There has been a strong long run sales growth trend (TSM, 2021).

The Future for Taiwan Semiconductor Manufacturing Company Limited Strategy

The 2021 financial year has seen a strong increase in cash, total assets, net equity and earnings per share as the five key strategy elements were pursued:

• Improving quality and productivity from TSM fabrication facilities
• Generate greater wafer output from existing capacity
• Create greater production capacity, strengthening capital expenditure
• Improve customer service
• Improve research and development infrastructure (TSM, 2021).

But now, political tensions between Taiwan and China has been associated with a depressed TSM share price; these are matters of some social and political complexity which are difficult for the top management team and board to control (TSM, 2021). Great investors like Warren Buffet are significantly and quickly reducing their shareholdings (Forbes, 2023). Will the current strategy settings be enough?

What will be the best future for TSM? Is the corporate symbolism in the mission, vision and values correct? Is TSM doing enough on ESG? Should TSM diversify geographically its operations more? Or should TSM simply try to improve within its existing manufacturing footprint in existing countries? Should TSM diversify its key clients by total revenue more? What level of commitment is suitable for R & D? Is the structure of the board of directors optimal?

<tdstyle=”width: 20%; font-weight: bold;” colspan=”5″>Balance Sheet Highlights

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