Demystifying the semiconductor industry
From making silicon wafers out of grains of sand to expanding the limits of artificial intelligence, understanding the complex industry that powers our digital world has never been more critical for investors.
Authors
Semiconductor shares have been driving stock markets in recent years, as a result of the huge demand for the computer chips that power artificial intelligence (AI). But the industry itself is a complex, interconnected web of companies spread across the globe. Understanding where different firms sit in the supply chain, how they interact, what goods and services they supply and why some are outperforming others can be challenging. Here, we aim to break it down and explain the semiconductor sector.
The brainpower behind technology
Imagine a city, with roads, buildings, and infrastructure crammed into a space smaller than your fingernail. That’s what a semiconductor chip looks like under a microscope. While its layout might resemble a city, its function is more like a brain, with billions of switches, called transistors, acting like neurons, transmitting electrical signals that power everything from smartphones to AI systems.
To grasp just how small these transistors are, consider this: the width of a human hair is about 180 micrometres, a red blood cell is 8 micrometres, and a modern transistor is just 0.008 micrometres, also called 8 nanometres, making it 1,000 times smaller than a red blood cell and nearing the width of a DNA helix. Using an alternative example, if a modern semiconductor chip were scaled up to the size of London, a single transistor would be just the size of a football.
One thing is certain: in the semiconductor industry, size matters. Smaller transistors allow for more computing power and higher efficiency, making them critical to innovation.
The global semiconductor supply chain
The semiconductor supply chain is highly specialised and spread across different regions:
Raw materials & equipment: Suppliers from Asia and Europe provide silicon wafers, copper wiring, and etching gases. Companies like ASML dominate the high-end equipment market but there are lots of other equipment manufacturers that are strong market leaders in their field, with some facing little competition given their experience.
Design: US firms like Nvidia, Broadcom, and Apple focus on chip design but outsource manufacturing. Firms like Intel and Texas Instruments design and build their own chips, a business model that is under threat from companies specialising on either design or manufacturing.
Manufacturing: Often called “foundries”, manufacturers use raw materials and equipment machines to physically assemble the chips. Taiwan’s TSMC and South Korea’s Samsung produce the vast majority of advanced chips, with TSMC holding a near-monopoly on the smallest, most advanced nodes.
An aerial photo shows a TSMC facility in China.
The takeaway? US companies design the most valuable chips, while Asian foundries manufacture them, using predominantly European and Japanese equipment. This highlights the interdependence of the industry but also makes it vulnerable to global risks.
Turning sand into intelligence: how chips are made
At their core, semiconductors are made from silicon, which is extracted from sand and purified into wafers. But the real magic happens in a process called photolithography, where complex patterns are printed and etched onto these wafers to form billions of transistors connected by copper wiring. To print these microscopic circuits, extreme ultraviolet (EUV) light is used, and producing it is a feat of engineering.
It starts with a tiny droplet of tin (just 36 millionths of a metre wide) which is superheated by one of the world’s most powerful lasers until it is 10 times hotter than the surface of the sun, at which point the tin turns into plasma and emits EUV light. This light is directed by a series of mirrors onto a silicon wafer. It is claimed by the manufacturers that these mirrors are the smoothest objects ever made by humankind – and that if they were scaled up to the size of Germany, their largest imperfection would be just one tenth of a millimetre.
Only one company in the world, ASML (based in the Netherlands), can produce these EUV machines, giving it a monopoly in this critical part of the supply chain and making it one of the most important companies to modern society.
Why more transistors equal more innovation
Transistors function as tiny switches that turn on or off. These "on" and "off" states represent the binary digits (1 or 0) that underpin all digital information and serve as the language of computers. No matter the type of digital information, whether text, audio or video, it will be stored as lines of 1’s and 0’s. The chip, acting as the brain, uses the transistors to generate lines of binary code that other components of the device can understand to perform a task. For example, when you unlock your phone, the chip will have to tell the screen pixels what colours to turn so you see your home screen. The more transistors a chip has, the more calculations it can perform, leading to more powerful technology such as breakthroughs in AI, self-driving cars, and quantum computing.
Over the last two decades, transistor density has exploded. In 2000, leading chips were built at 180 nanometres (which are found in simple household electronics today). By 2015, we reached 7 nanometres, used today to power modern laptops and smartphones. In 2025, the industry expects to break the 2-nanometre barrier, unlocking more powerful AI, advanced Augmented and Virtual Reality, and potentially quantum computing applications.
However, as chips become smaller and more complex, manufacturing and design costs skyrocket – a single 2-nanometre chip design could exceed $1 billion, making semiconductor investment decisions more crucial than ever.
The investment outlook
The semiconductor industry represents one of the most intricate, globally interconnected sectors that is driving innovation across various technologies, from AI to quantum computing. With major players in design, fabrication, and research located across the US, Asia, and Europe, these companies form a highly collaborative yet competitive market. While the industry faces significant risks, such as a potential slowdown in AI investments, trade tensions, and geopolitical challenges, there are vast opportunities for growth and profitability. As global demand for advanced chips continues to rise, understanding the underlying trends and potential risks is crucial for investors.
Where we see opportunities...
Semiconductor proliferation
More industries, from automotive to health care, are designing custom chips, increasing demand for custom design software and manufacturing capability.
Rising chip design costs
As chips become more complex, firms must invest in more sophisticated design automation tools and manufacturing equipment
Engineering productivity gap
By 2030, semiconductor companies expect a shortage of as many as one million engineers. The most likely solution? Automation software from companies like Cadence Design Systems, enabling fewer engineers to design more complex chips. Such companies may be somewhat more sheltered from the risks outlined below.
…and risks
AI investment slowdown
AI chip demand has fuelled semiconductor growth, especially for Nvidia and TSMC. However, some investors worry that companies like Microsoft, Amazon, and Meta might scale back spending if AI monetisation takes longer than expected. So far, though, AI investments are projected to rise in 2025, with over $300 billion earmarked by major tech firms.
US-China trade tensions & tariffs
Potential tariffs on Asian-manufactured chips could increase costs for US design firms, reducing margins. However, since US manufacturing capacity lags behind Asia’s, reshoring efforts are unlikely to fully replace TSMC and Samsung anytime soon.
Geopolitical risks in Taiwan
Taiwan’s role in semiconductor production is a significant geopolitical risk. If tensions with China escalate, disruptions to TSMC could have far-reaching consequences for the global economy. To mitigate this, TSMC is building new factories in Japan, Germany, and the US, but highend chip production is still centred in Taiwan.
Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell. This article may include forward-looking statements based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements.
Subscribe to our Insights
Subscribe to our newsletters to receive our latest news and insights
This article is issued by Schroder Wealth Management (US) Limited, a firm authorised and regulated by the Financial Conduct Authority and registered as an investment adviser with the US Securities and Exchange Commission. Registered office at 1 London Wall Place, London EC2Y 5AU. Registered number 10761882 England. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Schroder Wealth Management (US) Limited unless otherwise stated. For your security, communications may be recorded and monitored.
Authors
Topics