The Business Of

Semiconductors | TSMC | How Do They Make Money?

Morning All!

So yesterday, we started Part 2 of The Business Of Semiconductors. And our focus this week is on TSMC. As we now know, TSMC is a chip manufacturer. And before we get rolling, let’s have a look at who the other big chip manufacturers are globally. You may only recognise the 2 main players…

As we can see, TSMC has over 50% market share globally. Which translates into >$60bn in revenues. Nvidia had a comparatively measly $27 billion! But how does the Taiwanese company really make their $60 billion revenues? Well, let’s dive in and find out…!

Windshield Wipers Aren’t iPhones…

So, TSMC manufactures chips. And make lots of money doing so. But the first question to ask is… do they manufacture only one type of chip?

And the answer is no. TSMC manufactures both incredibly advanced chips that cater for 5nm and 7nm transistors. These chips power the latest phones and laptops. And they also manufacture much older chips (that were invented 15-20 years ago) that cater for 65nm and 90nm transistors. These chips are good enough to control mundane tasks like windshield wipers in cars!

Remember, the chips that cater for the 5nm transistors will be more advanced than those that cater for the 7nm transistors. This is because the 5nm transistors are smaller than the 7nm transistors. And so the chips catering for 5nm transistors, can pack more transistors on the chip. More transistors means more functions that a chip can perform for the phone, laptop, car, etc. it’s in!

The chart below shows us how TSMC’s revenue is split by the type of chips they make and sell. Just over 50% of revenues come from the most advanced chips (5nm and 7nm). And with the 3nm chips starting to be sold late last year, we can expect that they’ll take a good chunk of 2023 revenues.

Okay, so 5nm chips are more advanced than previous chips. And this article here gives you an indication of how much more advanced. But then surely TSMC will sell these chips to their customers at a higher price, right? And yes, that’s absolutely right! The table below gives us an idea of how prices set by chip manufacturers have moved up over time based on the chip type.

But let’s just dive into these prices for a moment. Because if we’re saying that the latest phones all use 5nm chips. How can that be if the silicon wafers cost $16,000?! My phone definitely doesn’t cost >$16,000! Well, the reason is because one wafer doesn’t equal one chip. In fact - depending on the chip size - one wafer can yield ~400-500 chips. Which means that the chip that goes into our iPhones actually costs Apple ~$40 ($16k / 400 chips) from TSMC.

The decision then for chip designers (like Nvidia) is the trade-off between quality and cost. They obviously want to have the highest quality chips in their GPUs. Which gives gamers the best graphics. But these more advanced chips (e.g. 5nm) come with a higher price tag. On the other hand, Nvidia could choose to go for the less advanced chips, (e.g. 28/10nm). And pay a lower price to TSMC.

Now, I don’t know about you. But I was pretty shocked by how much revenue TSMC make from the less advanced chips. I would’ve thought that as TSMC comes up with chips that cater for smaller and smaller transistors. Customers would all flock to the latest, most advanced chips. But that’s clearly not the case as ~25% of TSMC’s revenues come from chips that cater for >28nm transistors. Which were made ~10 years ago. I suppose windshield wipers don’t need the most sophisticated tech!

Okay, so we know which chips make TSMC their money. Now, let’s look at who TSMC’s main customers are. And I think customer number #1 will be pretty familiar to all of us…

The Apple Of Their Eye

So, a decade ago, in 2013, TSMC landed a big customer. And by big customer, I mean the biggest of them all.

After years of asking Samsung (the second biggest chip manufacturer in the world) to manufacture the chips for their phones. Apple decided to trial another supplier - TSMC. And Apple were so impressed with TSMC’s chips that in 2016, the US giant decided to make TSMC the sole supplier for their iPhones!

But hold your horses, because Apple didn’t just stop at iPhones! For years, Apple’s Macs used to be powered by Intel’s chips. Apple would let Intel design and manufacture the chips. However, in 2020, Apple decided to power Macs with their own chips. And they also ditched Intel as the manufacturer. And guess who they gave the manufacturing contract to…? TSMC!

These contract wins for TSMC have done wonders for their revenues. And the table below shows us just how important Apple is for TSMC as a customer. Making up a huge ~26% of the Taiwanese company’s revenues.

Now, why did Apple choose TSMC over Samsung and Intel? Well, there’s actually 2 different reasons. When it comes to the smartphone market, the two most popular brands globally have been Apple and Samsung. And so for Apple, it was always slightly uncomfortable that their biggest competitor was so involved in their chip manufacturing process. And the concerns about technological leaks led to TSMC being chosen.

So, whilst TSMC may have been the lucky beneficiary with the iPhone contract. In the case of Intel, there’s far less luck involved. In 2020, Apple’s M1 chip that was going to power their new Mac was using 5nm transistors. And Intel couldn’t make 5nm transistors! Their innovation had been too slow. To be fair, not many companies could. Only 2 - TSMC and Samsung - were able to create such advanced chips. And so given TSMC’s superiority, Apple decided to ditch Intel and go to Taiwan!

The importance of Apple to TSMC gives Apple some real advantages in tough times. We saw that during the chip shortages of 2021, TSMC moved a lot of their production to the smartphone market. In a bid to prioritise their biggest customer. Keeping Tim Cook, Apple’s CEO, pretty thrilled...

The final thing to note here is Nvidia. The chip designer only makes up 2.8% of TSMC’s revenues. And you may be wondering - why is it so low? After all, we said last week that Nvidia used TSMC a lot for their manufacturing.

Well, the reason for this low share is because of something we mentioned earlier. It’s because of the type of chips that Nvidia ask TSMC for. Apple ask TSMC for the most advanced chips - which also cost the most. But Nvidia’s chips that power graphics cards, actually only run on 12nm transistors. These chips cost far less than the most advanced 5nm/7nm chips. And so, whilst Nvidia may be a higher % of TSMC’s volumes, their revenue contribution is smaller than one might expect.

A Monopoly In Disguise?

So, we’ve been fortunate that 2 of the recent companies we’ve looked at have had the most remarkable revenue growth rates. Netflix has grown at 24% CAGR since 2014. And Nvidia 23%. Has TSMC grown even faster?

Well no, unfortunately not! But the chart below illustrates that whilst TSMC’s growth can’t quite match those 2. It’s still been a very impressive 14% CAGR since 2003… growing from $6bn in 2003 to $69bn in 2022!

And one of the main reasons why the company has been able to grow revenues in every year bar one (2009). Is because of the pricing power they gain from their almost monopoly-like position. TSMC is pretty much the sole manufacturer of cutting edge chips. So if a company like Apple or Amazon or Facebook or whoever wanted the most advanced chips. They would have to go to TSMC (and maybe Samsung too).

This almost monopoly-like position gives TSMC great bargaining power with customers. And allows the Taiwanese company to consistently raise chip prices. The chart below shows us that whilst Taiwan is the main manufacturing hub for older (10+ nm) chips. There’s a decent spread around the globe. However, with the latest chips (3nm, 5nm, 7nm) - Taiwan (and TSMC) dominate manufacturing!

9th May 2023

Nigel Jacob CFA