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How Samsung fell behind TSMC in the race for cutting-edge chips

Trailing in technology risks hurting company's smartphone business

Vice Chairman Lee Jae-yong made a quick trip to ASML in the Netherlands to secure much needed advanced chipmaking gear.

SEOUL -- Samsung Electronics Vice Chairman Lee Jae-yong flew to the Netherlands in fall 2020 despite the COVID-19 pandemic, seeking crucial semiconductor production equipment supplied exclusively by Dutch manufacturer ASML.

This equipment is indispensable for the South Korean company's cutting-edge products. ASML says it has shipped about 100 units worldwide -- but more than 70% have gone to Samsung rival Taiwan Semiconductor Manufacturing Co.

The trip by Lee, Samsung's de facto leader, signals the sense of crisis for the company, which has lost ground to TSMC in advanced semiconductors. Samsung is struggling in the mass production of advanced products such as the central processing unit -- which serves as the brain of smartphones -- and losing market share in contract manufacturing. Inferiority in cutting-edge products could weaken the competitiveness of other core items such as semiconductor memory and smartphones.

"Our competitiveness in advanced processes is comparable. We have secured large customers and are closing the gap," Kim Kinam, Samsung Electronics vice chairman and head of its semiconductor division, said when asked about the technology gap with TSMC at a shareholders meeting in March.

But on April 29, Samsung reported that operating profit at its semiconductor division dropped 16% on the year to 3.37 trillion won ($3.03 billion) for the January-March quarter, despite sales rising 8% to 19.01 trillion won. This marked the first profit drop in a year.

Brokerages blame the drop primarily on Samsung's non-memory business, which handles contract production of CPUs and communications chips. A plant in Texas has been shut down since mid-February due to a power outage caused by a cold snap. Normal operations are expected to resume during the April-June quarter, but prolonged difficulties could lead to defections from Qualcomm and other customers.

Samsung also has struggled to debut state-of-the-art production at home in South Korea. Several suppliers say the company was delayed in boosting the yield on the most advanced chips, with 5-nanometer circuitry. It trailed TSMC by several months in the launch of 5 nm mass production, and the technology gap has been widening ever since.

The thinner the semiconductor circuit width, the higher the processing performance and the lower the power consumption. This also aids in miniaturization of electronic devices.

A "buying frenzy" in semiconductor manufacturing equipment seems to have caused the delay. Equipment for advanced technology called extreme ultraviolet (EUV) lithography prompted Lee's emergency visit to the Netherlands. Though Samsung is increasing the number of units it purchases, the company has failed to grab as much production technology as TSMC, which secured equipment before anyone else.

The scale of investment required by the contract manufacturing business also likely will impact Samsung. In April, TSMC revealed plans to allocate $100 billion to capital spending over the next three years to 2023 as a response to the semiconductor shortage.

Samsung plans to invest around $40 billion in 2021, but the majority will be in dynamic random access memory and other memory chips, and the scale of investment is inferior to that of TSMC, which specializes in contract manufacturing.

TSMC is accelerating its dominance, amassing a 56% share of contract manufacturing in the first three months of 2021, up 2 percentage points from the same period last year, according to Taiwan-based research firm TrendForce. The share is up 8 points from two years ago, while second-place Samsung has lost 1 point of market share over the same period.

Major U.S. customers such as Apple and Advanced Micro Devices outsource almost all of their orders to TSMC, and the hurdle to gaining that scale is high.

Mounting tensions between the U.S. and China also play a role. Taiwan and the U.S. are united against Beijing, while South Korea comparatively maintains two-way diplomacy that risks isolating South Korean companies from semiconductor supply chains.

Samsung's declining competitiveness in advanced semiconductors may spread beyond the company's chip business. Though non-memory semiconductors manufactured on a contract basis account for only 7% of total semiconductor sales, the performance of Samsung's own smartphones depend on the company's CPUs and image sensors. Apple, a competitor in smartphones, outsources all of its CPU production to TSMC, and the technology gap with TSMC could develop into a gap with Apple in smartphone performance.

Smartphones and memory chips account for a combined 60% of Samsung's total sales. If Samsung falls behind in the technology race for advanced semiconductors, which has generated a virtuous cycle for its mainstay business, it could lead to a decline in the profitability of Samsung as a whole.

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