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The Silicon Cornerstone: Understanding the Business of TSMC

The Silicon Cornerstone: Understanding the Business of TSMC

David
April 23, 2025

The Silicon Cornerstone: Understanding the Business of TSMC

Welcome to this edition of our newsletter, where we delve into the fascinating world of technology and business. Today, we shine a spotlight on a company that operates largely behind the scenes yet powers the devices and innovations shaping our modern world: Taiwan Semiconductor Manufacturing Company (TSMC). Often unseen by the average consumer, TSMC has become the linchpin of the semiconductor industry, essentially the sole manufacturer of the leading-edge chips found in everything from your smartphone to advanced AI systems.

A Unique Beginning: The Genesis of a Manufacturing Powerhouse

The story of TSMC is intertwined with the remarkable journey of Dr. Morris Chang, a name many might not recognize, but whose impact on technology is profound. Born in China in 1931, Chang's early career involved stints at Sylvania's semiconductor division and a significant rise through the ranks at Texas Instruments (TI). At TI, Chang demonstrated his acumen by significantly improving chip yields for IBM's first transistor-based mainframe and later by pioneering learning curve pricing to drive market share in integrated circuits. This strategy helped TI become the biggest IC business in the world at the time.

Despite his success, Chang's career at TI eventually plateaued, leading him to General Instrument before a pivotal invitation in the mid-1980s. The Taiwanese government, recognizing its lack of strength in research, development, and circuit design, sought to elevate its technological standing. KT Lee, known as the father of Taiwan's economic miracle, recruited Chang to head the Industrial Technology Research Institute (ITRI), envisioning it as Taiwan's Bell Labs.

Then came the offer he "couldn't refuse". In 1987, with backing from the Taiwanese government and a crucial investment from Philips, Morris Chang founded TSMC with a revolutionary idea: a pure-play foundry. Unlike integrated device manufacturers (IDMs) like Intel and TI, who designed and manufactured their own chips, TSMC would focus solely on manufacturing chips designed by other companies. This concept was met with considerable skepticism initially, as the prevailing wisdom was that "real men have fabs".

The Rise of the Fabless Ecosystem

Chang's vision, however, was prescient. He recognized a growing number of talented IC designers who desired to start their own "fabulous" chip companies without the immense capital expenditure required to build and operate a fabrication plant (fab). TSMC became the enabler of this fabless revolution, offering a manufacturing platform for innovative companies like Nvidia, Qualcomm, AMD, and eventually Apple. Nvidia, for instance, started in 1993 and reportedly never built its own fab, relying heavily on TSMC. This fostered an incredible flywheel effect. As fabless companies innovated and grew, they drove demand for TSMC's manufacturing services, allowing TSMC to reinvest profits into more advanced technologies and expand capacity.

Manufacturing Mastery: The Unseen Art

TSMC's core strength lies in its unparalleled manufacturing prowess. Building cutting-edge semiconductors is an incredibly complex process involving breakthroughs in chemistry, physics, and mathematics. Today, manufacturing at the leading edge, such as the 5-nanometer process used in the primary chip inside every MacBook and iPhone, and the upcoming 3-nanometer process, involves incredibly sophisticated machinery, including the Extreme Ultraviolet Lithography (EUV) machines made by the Dutch company ASML. These machines, costing hundreds of millions of dollars and requiring multiple Boeing 747s to ship, use lasers to create plasma from molten tin 50,000 times per second with accuracy surpassing that of the Apollo missions. TSMC is ASML's largest customer, highlighting the deep integration between the two companies.

This level of manufacturing expertise is incredibly difficult to replicate. As one expert noted, even if another entity could acquire the same equipment, they "wouldn't know what to do with it". This "process power", a term from Hamilton Helmer's "Seven Powers" framework, represents a significant and enduring competitive advantage for TSMC. It has taken decades of continuous innovation and tens of billions of dollars in capital expenditure (capex) to reach this level.

Dominance in the Modern Era

TSMC's strategic focus and manufacturing excellence have led to its current dominant position. By the early 2020s, the number of companies at the leading edge of semiconductor manufacturing had dwindled from 22 in the early 2000s to just two: TSMC and Samsung. Even Intel, the historical giant of chip manufacturing, has faced challenges in keeping pace. Today, TSMC commands over 50% of the global foundry market share and an estimated 90% or more of the market for the most advanced chips.

Financially, TSMC has demonstrated remarkable growth. Since its IPO in Taiwan in 1994, it has achieved a compound annual revenue growth of 17.4% for 27 years. In recent years, its growth has even accelerated, with a 31% revenue increase from 2019 to 2020. This profitability allows TSMC to invest heavily in future capacity and technology, with plans to spend $100 billion in capex over the next three years. Notably, TSMC has recently begun to raise prices, signaling its significant pricing power in a market where demand for advanced chips continues to soar.

Reasons for TSMC's Competitive Moat and its Strengths:

Process Power: Unparalleled Manufacturing Expertise TSMC's core strength lies in its unparalleled manufacturing prowess. Building leading-edge semiconductors involves extremely complex processes and advanced science. The difficulty of replicating this expertise, even with access to the same equipment, creates a substantial barrier to entry. As one expert noted, others "wouldn't know what to do with it". This "process power," as described by Hamilton Helmer, is a significant and enduring competitive advantage. It has taken decades of continuous innovation and massive investment to achieve this level.
- The hosts note that TSMC has "essentially become the only manufacturer of the Leading Edge chips". This highlights their advanced capabilities that others struggle to replicate.
- They mention that by the "5 nanometer process," only TSMC and Samsung remain at the leading edge . This demonstrates the difficulty for other manufacturers to keep up with TSMC's advancements.
- The expectation is that TSMC will launch the 3-nanometer process next year, while Samsung has already slipped, suggesting TSMC's continued lead in process technology.
- The Bloomberg Odd Lots podcast cited mentions that even if China spends billions on building fabs (like SMIC), "they wouldn't know what to do with it" because the manufacturing process is so complex . This underscores the tacit knowledge and expertise that are hard to acquire.
- The discussion about ASML's EUV machines highlights the intricate and difficult nature of leading-edge manufacturing, involving highly specialized lasers and mirrors, requiring a crew of ASML employees to help run the equipment. This complexity contributes to TSMC's process power, built over decades
Scale Economies: Massive Capital Investment and Production The semiconductor manufacturing industry, especially at the leading edge, is incredibly capital intensive. TSMC's continuous and enormous capital expenditure (capex), recently announcing $100 billion over the next three years, creates significant scale economies. This level of investment is difficult for competitors to match and allows TSMC to stay ahead in technology and capacity. The cost of building fabrication plants (fabs) doubles approximately every four years, according to Rock's Law, further emphasizing the advantage of TSMC's established scale.
- Investment of investing $100 billion in capex over the next three years. demonstrates the enormous scale of their investment, a barrier few competitors can match.
- The hosts discuss "Mo's Second Law" or "Rock's Law," which states that the cost of a semiconductor chip fabrication plant doubles every four years. TSMC's continued investment at such a large scale reinforces their advantage.
- The fact that TSMC has over 50% of the market for foundries and 90+% of the profit showcases the scale of their operations and market dominance.
Technological Leadership: Staying at the Leading Edge TSMC has consistently pushed the boundaries of semiconductor manufacturing technology. The number of companies at the leading edge has drastically reduced over time, from 22 in the early 2000s to just TSMC and Samsung at the 5-nanometer process. TSMC is also expected to be the first to launch the 3-nanometer process. This technological lead enables its fabless customers to create increasingly powerful and efficient chips, reinforcing their reliance on TSMC.
- The reduction in the number of companies at the leading edge from 22 in the early 2000s to just TSMC and Samsung at 5 nanometers today. illustrates TSMC's success in maintaining and extending its technological lead.
- TSMC's expected launch of the 3-nanometer process ahead of competitors further exemplifies this leadership.
The Fabless Ecosystem Enabler: Counter Positioning TSMC's fundamental strength lies in its pure-play foundry model, focusing solely on manufacturing chips designed by other companies. This was a revolutionary idea that enabled the rise of the fabless semiconductor industry, where companies like Nvidia, Qualcomm, AMD, and Apple could innovate without the immense costs of building their own fabs. This model was a form of counter positioning as integrated device manufacturers (IDMs) like Intel were initially unwilling to adopt it because their profit center was the integration of design and manufacturing.
- Morris Chang's vision to create a pure-play foundry was a novel idea at a time when "real men have Fabs". This focus solely on manufacturing enabled the rise of fabless companies.
- The hosts point out that IDMs (Integrated Device Manufacturers) like Intel were initially unwilling to adopt the foundry model because their profit center was the integration of design and manufacturing. TSMC's dedicated focus on manufacturing was a key differentiator.
- The emergence and success of fabless companies like Nvidia, Qualcomm, AMD, and Apple, many of which started by working with TSMC, demonstrates how TSMC enabled this ecosystem.
Deep Integration and Switching Costs: Fabless companies deeply integrate their design processes with TSMC's manufacturing processes. This deep integration creates high switching costs for fabless companies. Moving to a different foundry would require significant time, effort, and cost due to the need to re-optimize designs for the new manufacturer's processes.
- The hosts mention that to move from TSMC to another foundry would take years because fabless companies are "so deeply integrated with the process". This deep integration creates significant stickiness.
- The EDA (Electronic Design Automation) companies and IP providers are "so deeply integrated with TSMC", making it harder for fabless companies to switch foundries without disrupting their design and development processes.
Ecosystem Collaboration: IP and EDA Partners TSMC fosters close relationships and deep engineering integration with Electronic Design Automation (EDA) companies like Synopsys and Cadence, as well as Intellectual Property (IP) providers like ARM. This collaborative ecosystem ensures that the tools and foundational IP are optimized for TSMC's manufacturing processes, further benefiting its customers and strengthening its position.
Strategic Relationship with ASML: TSMC is the largest customer of ASML, the Dutch company that is the sole manufacturer of Extreme Ultraviolet Lithography (EUV) machines, which are essential for producing the most advanced chips. This strong relationship provides TSMC with preferential access to cutting-edge manufacturing equipment, a critical advantage over competitors. The complexity and cost of these machines (costing hundreds of millions of dollars and requiring multiple Boeing 747s to ship) further highlight the barrier to entry.
- ASML, a Dutch company, is the sole manufacturer of the most advanced chip manufacturing machines in the world, and TSMC is their biggest customer.
- The fact that these EUV machines cost $200-300 million each and require four 747s to ship highlights the specialized and limited nature of this critical equipment, and TSMC's strong relationship ensures access.
- ASML's founding as a joint venture with Phillips , who also became an early investor in TSMC , hints at a long-standing strategic connection that benefits TSMC.
Learning Curve and Continuous Improvement: TSMC has accumulated decades of experience and learning in advanced semiconductor manufacturing. This deep institutional knowledge and continuous optimization of its processes lead to higher yields and lower costs, contributing to its competitive edge. Morris Chang's early implementation of learning curve pricing at Texas Instruments demonstrated the power of this concept.
- Morris Chang's early success at TI in increasing the yield of IBM's transistor line from 10% to 20% within four months demonstrates his understanding and application of the learning curve in semiconductor manufacturing.
- The continuous advancements in process technology by TSMC over decades reflect their ongoing learning and improvement.
Pricing Power: TSMC's dominant market position and technological lead have given it significant pricing power. Recently, TSMC has started to raise prices, a move unprecedented since its early days, indicating its confidence in its value proposition and the limited alternatives available to its customers.
- After years of following a learning curve pricing strategy of reducing prices, TSMC announced they would raise prices by 20%, a move unprecedented since its early days. This indicates their strong market position and limited alternatives for customers.

TSMC's competitive moat is built upon a foundation of unparalleled manufacturing expertise (process power), massive scale and continuous investment (scale economies), consistent technological leadership, a strategically enabling business model (counter positioning), deep customer integration (switching costs), strong ecosystem partnerships, a crucial relationship with its key equipment supplier (ASML), decades of accumulated knowledge (learning curve), and significant market influence (pricing power). These factors combine to create a formidable and difficult-to-challenge position in the global semiconductor industry.

Looking Ahead: Challenges and Opportunities

Despite its formidable position, TSMC faces certain challenges. The most prominent is geopolitical risk, with its primary manufacturing operations located in Taiwan, an island with a complex relationship with mainland China. This has led to increasing pressure for TSMC to diversify its geographical footprint, with plans underway to build a fab in Arizona. However, TSMC's chairman has noted that keeping the leading edge in Taiwan makes the most business sense due to the established ecosystem.

In conclusion, TSMC's journey from a government-backed initiative to a global technology powerhouse is a testament to strategic vision, relentless execution, and a groundbreaking business model. It has not only transformed the semiconductor industry by enabling the fabless revolution but has also become an indispensable cornerstone of the modern digital economy. Its dominance in leading-edge manufacturing, coupled with substantial reinvestment in future technologies, positions TSMC as a critical player for decades to come. Its story offers valuable lessons in focusing on core competencies, anticipating market shifts, and building deep, defensible competitive advantages in a rapidly evolving technological landscape.