The shortage of automotive microchips is a major factor in the surging valuation of auto dealerships since 2020. Due to the lack of these important components, automakers have cut 13.5 million vehicles out of their factory schedules since the start of 2020, including 3 million this year. Restricted new car availability has pushed up prices on current and pre-owned models and amplified service and repair revenues on consumers’ aging current vehicles. The elevated income and profit levels have increased the value of dealerships — just as an era of increased acquisitions and consolidation is hitting its stride. At the Dave Cantin Group, we feel it is imperative that current and prospective clients understand the contours of this issue in order to anticipate the effects on their business when normal vehicle production and availability resumes.
At the Dave Cantin Group, we feel it is imperative that current and prospective clients understand the contours of this issue in order to anticipate the effects on their business when normal vehicle production and availability resumes.
What are chips, exactly?
“Chips” refers to several various types of semiconductors, the two most common types of which used in road vehicles are “discretes,” which are single-function devices such as transistors that manage electrical current and other basic processes in complex devices, and “analogs,” which monitor and control comfort, convenience, entertainment, safety, and electromechanical features. Hundreds of billions of units of both types are used by the automobile industry annually, in addition to other, less prevalent types – such as microprocessors, microcontrollers, logic chips, and memory chips.
Microchips are classified by physical dimensions, node size (the width of their connection to the circuit board they are installed to) and wafer diameter (which determines how many functions can be impressed upon a chip). Automotive chips utilize mature “legacy” technology, based on >40 nanometer (nm) node size/<200 millimeter (mm) wafer size, which were introduced between the 1990s and 2011. That’s eons ago relative to the release of the latest 5nm node/300mm wafer spec used in PCs.
Smaller chips offer advantages in terms of power and portability when it comes to handheld or personal devices. By contrast, automobiles are among the physically largest chip-using product platforms, and it would be superfluous to use a smaller node size. Furthermore, automotive applications must meet the ISO 2626 “Road vehicles – Functional safety” standard — that is, the chips in question must legally be rugged enough to endure tens of thousands of miles of service in the jarring, exposed automotive environment and last through the PZEV 15-year/150,000-mile warranty mandate. Neither chipmakers nor automakers want to unnecessarily run up against that requirement.
While the 40-plus nm/200mm standard may be past its prime in other electronic use cases, it’s far from obsolete, and still accounts for 54% of installed microchip production capacity. So automakers are satisfied to continue relying on legacy-size chips – along with many other industries, such as defense, transportation, and energy. The global chip supply chain has usually worked well in everyone’s interest – but then came COVID-19.
Microchips in automobiles
In five decades, chips have gone from being nonexistent in automobiles to being a ubiquitous component. Practically every aspect of starting, running, and maneuvering a vehicle, not to mention managing the interior climate, entertainment, seat position, and other controls, is controlled and monitored by a web of microchips integrated invisibly throughout the vehicle. Microchips are the critical component in many, if not most, of a car’s functions.
The 1968 Volkswagen Type III Squareback equipped with Bosch Jetronic fuel injection was the first mass-market vehicle to successfully employ electronic computer control. (Others had not gone as far, or had made failed attempts: The 1957 Bendix Electrojection was withdrawn from the market after 35 production Chrysler vehicles rolled off the line and stalled; GM Rochester fuel injection was an entirely mechanical system.)
Bosch fuel injection was quickly adapted to other cars, and its principles were widely copied. Led by Chrysler’s Electronic Lean-Burn System (ELBS) in 1976, ignition systems were widely converted to digital control by the mid-1980s. These innovations were driven primarily by tightened emissions and fuel economy requirements, mandated by the EPA. The result was dramatically improved urban air quality, and more efficient, responsive, and reliable automobiles. Also, maintenance was simplified and tuning options were expanded. Electronic fuel and ignition revolutionized the industry and extended the internal combustion engine’s predominance by decades.
Chip industry and auto industry
Most current models incorporate at least 1,000 chips in their design. Several have as many as 3,000, and models in general utilize more microchips over time. Out of the 1 trillion microchips produced globally per year (the number was 946,312,000,000 in 2020), it shouldn’t be hard to scare up a few billion more for the automobile industry – after all, that represents a fraction of a percentage point of the global total. But that’s already proving harder than anyone expected, and automotive microchip applications are expected to double by the end of the decade. Will the necessary chips be available in the near and far future?
The auto industry’s relatively early adoption of digital controls contributed substantially to the growth and development of the global microprocessor industry, and consequently to the rapid growth in the use of personal computers and many other popular computerized devices. But as PCs gained popularity since the 1980, and especially since the advent of smartphones in the mid-2000s, microchip use and production has exploded worldwide. Even while the auto industry’s chip purchases grew year after year, the industry’s position as a leading chip user still faded. Today’s $39.5 billion per year in automotive chip sourcing reflects less than 9% of global chip sales. And while auto industry chip demand is projected to grow by 10% per year with no signs of slowing, its purchasing position will nevertheless probably further erode.
Before the pandemic, planners in both the auto and chip industries anticipated meeting current and future demand for automotive chips through the existing production infrastructure. Capital investment was oriented toward expanding production of more profitable, newer-design chips.
Complicated recovery
It’s unlikely that automakers can claw back all of the microchip production that has been redirected to other industries, so “legacy” chip production will need to be increased. Unfortunately, the tier is a low priority for global chip manufacturers. Global capital spending on new-gen (300mm) chip production was approximately $75 billion, versus less than $5 billion for 200mm production. Even the recently passed $52 billion CHIPS Act only devotes around $2 billion to expand domestic legacy chip production, with the federal government expected to lean its lending toward defense fulfillment.
The road back to adequate automotive chip supply is being led by the auto segment’s leaders, including Robert Bosch, Infineon, STMicroelectronics, and Renesas, who are investing in legacy production. But making up for billions of lost units of anything is a daunting task, and balancing adequate chip supply with automakers’ sales projections will probably take until mid-2024, with the gap progressively narrowing between until then.
What does the chip recovery mean for dealers?
Absent any other major shocks to the supply chain, dealers should be able to round-out their inventories through 2023, and resume normal operations in 2024. What does return to normalcy mean for dealership valuations?
Certainly a stable supply of vehicles will return dealership business to something like what it was before the pandemic. Yet, while the emergency may end, it has left a new paradigm in its wake. All of the pandemic-related factors in the economy, including the microchip shortage, have been driving the industry away from individual franchise ownership and toward corporate agglomeration. The shoe on the table is that there are still more than 10 million sales that didn’t get made over the last three years, which could cause a demand bubble for some time. Some knock-on effects from the 2020-24 chip crisis may include:
- Prices and incentives may fall back toward their pre-pandemic structure, but demand will remain strong.
- Demand may be strongest for the value model that took most of the production cuts during the chip shortage.
- Buyers may not be looking for the car they couldn’t buy in 2021, but rather a completely new type (for example, an EV).
- Service departments will have to effectively complete the assembly of millions of vehicles delivered without installed chips.
- Trade-in inventories will increase; CPO qualification will decrease due to higher-mileage trade-ins.
- The EV revolution will be further along, offering new models and ownership advantages, and reminding shoppers of recent gasoline price volatility.
- Cash-strapped factories may back off promotion of “direct-agency” dealership schemes.
- Online buying services (e.g., Carvana) will be buoyed by a surge of used inventory.
- A shortage of talent/staff will endure.
- Consolidation will continue.
DCG’s knowledge advantage
At DCG Acquisitions, our team has the wealth of experience in all aspects of automotive to help your business through challenging times. Our expert analysis is ready to power you through the current microchip situation and beyond whether you’re looking to expand or want to sell and secure your legacy.
Contact us to get in touch with our automotive M&A specialists and learn how we can help make your next transaction the best it can be.