How Much Does Deglobalization Cost?
In TSMC's case, 4 to 5x!
When TSMC’s Arizona fab held its “tool-in” ceremony to much fanfare last December, its founder, Morris Chang, sagely framed the event as simply the “end of the beginning.”
This “end” not only marks the end of the beginning of TSMC’s $40 billion investment in Arizona, but also the “end” of the beginning of deglobalization. While the direction of deglobalization (or decoupling, or onshoring, or friendshoring, or whatever new cute term the zeitgeist comes up with) has been underway for a few years now, TSMC’s US investment is a major watershed moment of this irreversible trend. As Chang remarked during the “tool-in” ceremony:
“Globalization is almost dead. Free trade is almost dead. And a lot of people still wish they would come back, but I really don’t think they will be back for a while.”
Intuitively, we all know that when deglobalization unfolds, cost goes up. This extra cost is relatively easy to grapple with for consumer goods – t-shirts, socks, a pair of Nikes. It is much harder to wrap our heads around something as complex and quality-sensitive as manufacturing GPUs to compute your next silly question to ChatGPT.
Luckily, TSMC’s most recent Q4 2022 earnings call revealed some clues as to just how much more does its Arizona fabs cost, what is contributing to the higher cost, and who will bear that cost. I’ve pulled out the key passages from the call transcript in this tweet thread:
But they are worth a deeper dive.
How Much and From What?
When asked about the cost gap between its Arizona fabs and Taiwan fabs, here was what Wendell Huang, TSMC’s CFO, had to say:
“We're not able to share with you a specific cost gap number between Taiwan and U.S., but we can share with you that the major reason for the cost gap is the construction cost of building and facilities, which can be 4 to 5x greater for U.S. fab versus a fab in Taiwan.”
The “5x” approximation was repeated by Huang later in the Q&A of the earnings call, where he also mentioned this cost being lasting “a few years”, because it has to do mostly with constructing the facilities. And what is contributing to this rather astronomical cost increase?
Here is Wendell Huang again:
“The high cost of construction includes labor cost, cost of permits, cost of occupational safety and health regulations, inflationary costs in recent years and people and learning curve costs.”
There is a lot to unpack in this sentence. For anyone who has a baseline understanding of Federalism in the US (or has tried to build their own house at some point), you know all too well the myriad of state-level, city-level, county-level, or town-level permits and bureaucratic processes you must navigate when building something new. This “division of regulatory labor” can cause delays, red tape, and a ton of wasted time just bouncing around different levels of government offices, trying to figure out who to file the right paperwork with.
TSMC has acquired a huge swathe of land for its ambition in America. It will be building not just the fabs themselves to make chips, but other facilities for its supply ecosystem partners, new roads and transportation infrastructure, housing for expat employees from Taiwan, and many other structures that are new to Arizona. It is not hard to imagine the mind boggling number of permits to obtain, regulatory hurdles to jump through, and government officials from the State of Arizona, the City of Phoenix, the County of Maricopa (yes the same Maricopa County where Joe Arpaio made his name) to deal with. Navigating local bureaucracies is likely what Huang was alluding to in his answer – a hidden but massive cost that few people talk about.
The “people and learning curve costs” is another important dimension of the “5x” cost gap between Arizona and Taiwan. TSMC is running into difficulties hiring qualified people and finding new engineering graduates, so much so that it is hiring less qualified people and sending them to Taiwan for training that lasts as long as a-year-and-half, in order to bend the learning curve. This extra training cost is coupled with the already-higher labor cost in the US in terms of wages, benefits, and regulatory compliance (e.g. “occupational safety and health regulations” aka OSHA).
To be clear, there is nothing wrong with imposing higher costs for the employer to ensure safer and healthier working conditions for its employees. Nor is higher wage or more benefit unjustified, if the employees’ skills and the market’s demand for them warrant it. The sad, and more than a bit ironic, reality is that TSMC has to pay more money for less qualified workers and still can’t find enough of them in America.
TSMC’s Pricing Power
So who will bear this 5x additional cost? On this question, the earnings call also gave some clues. Here are a couple of noteworthy passages.
From Wendell Huang:
“We're not able to comment on pricing details, but our pricing is always strategic and consistent to reflect our value. Now value to our customers as C.C. said in his statement includes technology leadership, manufacturing efficiency and quality, cost, trust and recently also includes more geographic manufacturing flexibilities. Therefore, our overall pricing will remain strategic to reflect our value, which includes the value of geographic flexibilities.”
From C.C. Wei:
“In our view, the semiconductor becomes more essential and more pervasive in people's life. And the semiconductor industry value in the supply chain is increasing. And if we look at our customers' performance, they are rising structural gross margin over the past 5 to 6 years, it continued to improve. That reflects what I just said, the semiconductor value has been recognized and also very important in our daily life. And so we set up our pricing strategy to reflect all the values we share to customer and customer also earn their value from the end market.”
Basically, both C.C. Wei (the CEO) and Wendell Huang (the CFO) telegraphed TSMC’s plan to increase its price, due to its costly investments in the US (as well as in Japan to some extent), and skillfully framed it as an additional value-add called “geographic flexibilities.” And TSMC believes its big customers can bear this higher price because: 1. They demanded this “geographic flexibility” in their semiconductor supply chain, and 2. Heck, their gross margins aren’t so bad in the last 5 to 6 years either! And who are some of these big customers? Apple, Nvidia, and AMD, each of whom sent its CEO to speak at the “tool-in” ceremony.
Not only is a price increase certain, the magnitude of this price hike is planned to be big enough to maintain TSMC’s long-held gross margin target of 53% or more. TSMC reassured listeners on the earnings call that it can achieve this target, if only to quell shareholder concerns that its expensive undertaking in the US will eat away at its profitability.
And if TSMC can pull off this price hike and maintain its profitability, it will be one of the best technology companies with the highest pricing power in modern history. Berkshire Hathaway probably saw that potential, which is why it bought 60,060,880 shares of TSMC in Q3 of 2022.
Who Pays for the Cost of Deglobalization?
The most common, and kind of handwavy way, to answer this question is: it is always the everyday consumer! A more interesting, multi-dimensional way to think about this question is: is bearing this cost worth it?
While I don’t know exactly what I would get out of deglobalization, if anything, I don’t believe it is categorically all bad. There is more to deglobalization than just impact on an individual's pocketbook or a drag on mass consumerism. There is something to be said about whether it’s perhaps worth it to collectively pay for some supply chain redundancy or homegrown manufacturing capabilities, in order to reduce strategic vulnerabilities and mitigate future disasters that would cost even more. Less concrete than a more expensive XBox, but arguably more valuable.
As an everyday consumer and dutiful American taxpayer, I am already indirectly paying for TSMC’s US fabs via the CHIPS Act’s $39 billion manufacturing incentives. If we can build some decent training programs from the $13.2 billion allocated to workforce development, so TSMC does not have to send every new hire to be trained in Taiwan, I will be paying for that too. Meanwhile, my iPhone may also get a bit pricier. And I’m very ok with it all. In fact, I would have liked the entire CHIPS Act to be much bigger than what ended up getting passed by Congress. In my view, at least directionally, this is tax money well spent.
What I don’t like to pay for are the salaries of people in Congress, who took three years to pass something so mind-numbingly obvious as the CHIPS Act. If you happen to be paying Arizona state tax, you may not like paying for the local bureaucracies that are slowing TSMC’s construction down, causing the cost to “5x”! With Arizona ranking #34 (aka below average) in CNBC’s 2022 America’s Top States for Business Ranking, the state has some work to do to help make this once-in-a-generation TSMC investment a success.
When globalization was in its heyday, we all knew what we wanted out of it: cheaper and better quality stuff. Now that deglobalization is here to stay (and we are all paying for it in some way), we might as well think harder about what we want out of it too.