An Interview with Dan Kim and Hassan Khan About CHIPS – Stratechery by Ben Thompson

Good morning,

This week’s Stratechery Interview is with Dan Kim and Hassan Khan. The CHIPS and Science Act was passed in 2022 to encourage the manufacturing of semiconductor chips in the U.S.; it included $39 billion in subsidies for chip manufacturing on U.S. soil, $13 billion for semiconductor research and workforce training, and a 25% investment tax credit for semiconductor manufacturing equipment. Kim and Khan helped distribute that money.

Kim was the Chief Economist of the CHIPS Program Office. Prior to that he was Chief Economist for SK Hynix, the South Korean memory maker, the Director of Economic Strategy for Qualcomm, and the Senior International Economist for the U.S. International Trade Commission. Khan was the Director of Economic Security and Strategic Planning for CHIPS; prior to that he was an executive fellow at Carnegie Mellon, focused on Semiconductors and Supply Chains, and an Operations Program Manager at Apple. Both Kim and Khan have left their positions with the CHIPS program, and do not speak for the U.S. government.

In this fascinating and highly educational interview we discuss the CHIPS program and the role Kim and Khan played in figuring out where to spend this $52 billion. We cover their overall goals, and why they extended beyond capacity; the question of subsidizing supply versus coercing demand; the overall role of government in a free market; and how they thought about the leading edge versus the trailing edge. All of these have been topics at one time or another on Stratechery, and I’m honored they chose me as the venue to explain what they learned to the world, and why they are optimistic that the CHIPS program can provide a template for U.S. industrial policy moving forward.

As a reminder, all Stratechery content, including interviews, is available as a podcast; click the link at the top of this email to add Stratechery to your podcast player.

On to the Interview:

An Interview with Dan Kim and Hassan Khan About CHIPS

This interview is lightly edited for clarity.

Background

Dan Kim and Hassan Khan, welcome to Stratechery.

Hassan Khan: Ben, it’s great to be here.

Dan Kim: Great to be here.

So this is a very timely interview in some respects. There was news today about the Trump administration banning the sale of Nvidia H20 chips to China. I know that you two weren’t working on chip controls, but you were certainly in the chip space, on the other side of the question, how do we make chips in the United States?

Before we get into details though, I’d like to just learn more about each of you individually. What’s your background? Where did you get started with technology or chips generally, how did you come to join the Biden administration? Dan, why don’t you go first?

DK: Sure, yeah, happy to. I actually covered semiconductors for the United States government at a place called the International Trade Commission. It’s a unique place. It’s an independent agency in which every sector of the economy is specifically covered by a special analyst or an economist. And so when I first joined, they asked me if I would cover semiconductors or the smartphone market, with a warning that there was nothing interesting happening in semiconductors and related to international trade, or international competitiveness.

(laughing) When was this?

DK: This is 2015.

Okay. Oh, wow, that’s pretty late.

DK: So not that long ago if you think about it, right. And I said, “Well, look, I was born in South Korea, I know semiconductors are very important to the economy and to the technology itself”, surprising that nothing is happening trade-wise, because they said, “Well, look, we had the information trade agreements, tariffs are essentially zeroed out, US is dominating in this space, nothing to see here. So if you’re going to cover semiconductors, you should probably find something else to do as well that will keep you occupied” — and just a couple of months after that, everything blew up. So that was during the Obama administration and they wanted to do a study right away about China’s efforts to dominate the industry and catch up and dominate the industry.

And does this refer to the Made in China 2025 report?

DK: That’s right. And if you recall around the same time around there, there was an acquisition effort for Micron at the time, if you recall that, so this is way back. And so we were actually quite ready to go in Congress and the Office of the President asked me lots of questions about the industry and how the market works, and then we were ready to go with them.

What was your experience with the industry before you joined the ITC?

DK: Actually, I had no exposure to the industry before that, other than the fact that my first job out of grad school was covering trade in South Korea. I worked at a place called the Korea International Trade Association, which represents every company that is wanting to do international trade for South Korea, and the current acting president of South Korea, Han Duck-soo, who was the former Prime Minister, he was Prime Minister twice actually, he had led the charge in creating the Korea-US Trade Agreement, and then he was in charge. He became the CEO and chairman of the Trade Association for all Korean companies and he recruited me out of my PhD. I was studying in England at the time, I had just finished up my PhD and postdoc at Cambridge, and he asked me to join him and be his economist in DC.

To your point, South Korea was very attuned to the importance of semiconductors, obviously.

DK: Oh, no doubt. It was decades in the making, and a lot of efforts, and actually a lot of what South Korea did has been a bit misunderstood, and if you would ask my former CEO — I also used to work at SK Hynix, I’m jumping around a little bit here, as their chief economist — and I would ask their CEO very bluntly, I said, “What does the government do that is the most important for South Korean companies in the semiconductor space?”, and no hesitations, “That we invest in the workforce, workforce is the most important thing, and without the workforce, nothing else matters”, and so I learned a lot there.

Is the one sentence summary, government invests in the workforce, unlocks these large companies, and then I think the thumbnail version of South Korea’s rise to dominance is really investing from downturns driving the Japanese out of the memory market and that’s sort of been the foundation. Is that a good synopsis of how they got to where they are?

DK: The way that I think it made sense to me is there are a couple things. One is on the workforce aspect of it, if you wanted to study electrical engineering or material sciences that were relevant to semiconductors as a PhD student or a Master’s student, there was a lot of availability of dollars for you to get into that and then you could get into the companies thereafter.

The other, of course, is yeah, they went into the memory sector first and they were part of this consolidation trend at the time, and so it really was, “How do you innovate and achieve scale and not die along the way?”. I think there was a couple of interventions by the government in terms of guaranteeing loans and things like that, but by and large, it was just scratch-and-claw to survive, and I think if you have ever lived in Asia, if you’ve ever lived in Korea, scratching-and-clawing to survive, it’s actually not a bad way to describe their economic efforts for the past 50 years or so. So I think it sort of played right in their wheel house to be in the memory space.

I was fortunate enough also to be part of the SK Hynix organization as their first chief economist, their CEO recruited me to come do that after working at Qualcomm, and to see all of that play out, it was during the pandemic, and I remember just sitting in their massive cafeteria, everything protected in a sense so that people could show up during COVID and they took such pride in being able to have production without any interruption during COVID at the time. The CEO’s office was not too far away from the cafeteria, and he would go and eat with the staff and it was just in the trenches all the time and that was really impressive to see.

Was there a striking contrast for you to go from Qualcomm, an IP organization, large margins, to SK Hynix, basically you have to get to scale and you have to control yields and you have to keep your — manufacturing, it’s a tipping point, you’re either making a lot of money or you’re going out of business.

DK: That’s right.

Was that really jarring, that contrast?

DK: Absolutely. And by the way, in the memory business, you could have scale and still lose money depending on when you’re in the cycle.

Right. You have no control on pricing.

DK: I remember every year, we would get this note that said, “Hey, we’re actually entering into a down cycle, so we’re going to cut your budget”, and then the year after that we would say, “Actually, we’re entering into an up cycle, but we anticipate a down cycle after that, we’re going to cut your budget again”, it was so disciplined.

What I really appreciated about Qualcomm, it was my first job actually into the American private sector after working at the International Trade Commission for many years, is they really took innovation so seriously, and if you wanted to be entrepreneurial about anything as an economist, as an engineer, about anything, you would have the license to do it, but you would be accountable for it and you could take credit for it. That was just built into the culture of Qualcomm. I really, really enjoyed it, and so you had the freedom to roam around and you had the freedom to get to know other teams and collaborate together and everything else.

The margins were great, but they were also at the time when I was there, heading straight into the US-China relations becoming much deteriorated, and on two aspects they needed to sell their — they were just getting into the 5G era and they needed to sell their chip sets into the Chinese handset market because that was half the market. So to have restrictions put on them, any potential restrictions put on them was a huge existential threat to their business. So how do you approach that as a company was a really interesting question, and at the same time, they were doing legal battles, IP battles with Apple at the FTC and others. So they were fighting just Goliaths when it comes to their customers and competitors, and then here comes the US-China relationship. So for them to do everything and innovate at the same time I thought was really impressive.

There is something that did occur to me when you were talking about SK Hynix, which is there’s that famous Andy Grove quote, “Only the paranoid survive”. And Andy Grove, his most famous decision was getting Intel out of memory, and I do sort of wonder, you could argue one of the biggest mistakes Intel made over the last whatever number of years, if you could sort of bring it down to one sentence, it’s they stopped being sufficiently paranoid to a certain extent, and I wonder if there’s a bit where being paranoid is intrinsic to memory in particular for the point that you mentioned, because you don’t have control of the market and that to your point, credit to Qualcomm, but you still do have margin to play with. It’s maybe hard to be paranoid when you have margin.

DK: Oh yeah, for sure, and I think part of Clayton Christensen’s theory is that if you listen too much to your best customers, it’ll be your downfall because you’ll miss the disruption on the lower end, and companies like Qualcomm, where they really did catch the wave of mobile and they caught it at the right time, they invented so much of 3G, 4G and 5G, and billions of handsets being produced and they’re getting a piece of that was an amazing business model.

But I think one thing that I really appreciated about how both Steve Mollenkopf and Cristiano Amon when they were CEOs, and Cristiano being CEO at the time, was they were always cognizant of the fact that they couldn’t always be fully reliant, completely reliant on the handset market that they needed to diversify. The nature of the 5G technology itself was that it wasn’t just for handsets, it was for everything, the low latency and everything else, but the market has its own timing. Not everyone’s going to adapt that technology in the timing and the way that you want it and so how do you pursue that with patience when the market is going to catch up or not? And then of course, how do you foresee something like an AI revolution coming in that space? They did make a really good smart acquisition in NUVIA, and getting into the data center space. So I think there were efforts there, there was a lot of luck and patience and perseverance required in these things, so I learned a lot from there.

And then the CEO of SK Hynix, when he called me, he had a very simple proposition, he said, “Look, we don’t see us being fully prepared for the US-China competition as a memory company, we are trying to survive. Every year, we try to survive. We’re doing well, but we try to survive. How do we make sense of this? How do we strategize our geographical presence as well as our competition in a way that can withstand the bifurcating of the two largest markets that we serve? China’s 45%. US is 45%. Everybody else is 10%. What do we do? And by the way, we have fabs in China that we need to get equipment into. How do we get that in there? Is there anything we can do?” So he had lots of thoughts and I said, “Well, I think you need to take a step back and do some restrategizing about how you’re going to function as a company”, and so that’s the premise in which I went over there.

So I was doing that for a couple of years, and then [Commerce] Secretary [Gina] Raimondo, when CHIPS Act was passed, asked for me to join the government at the time, from the ground up to really strategize what CHIPS should be in terms of what the accomplishments should be. We were given this, not a blank check, but a huge amount of freedom to do with $52 billion in terms of R&D and manufacturing incentives. So she came in and said, “We need someone with industry experience, but someone who has also been in the government who understands how this all works”, and so that’s the context in which I joined CHIPS, and then I immediately asked Hassan to come join me because I knew him from reputation and other references.

That’s a good segue, we’ll let Hassan hype himself up. Hassan, tell me your background and where you were at previously and how you ended up — leaving aside, we’ll pretend that Dan doesn’t exist — in the government.

HK: Right out of college, I worked at a solar firm called Twin Creeks Technologies founded by a bunch of semiconductor guys, and that was the first time that I saw the US-China conflict head-to-head, because we were the same vintage of solar firms as Solyndra, although we didn’t get DOE LPO [Department of Energy Loan Programs Office] money, and we all lost when the Chinese drove down the price of polysilicon to I think like a 1/10 of what it was at its peak, and our business model stopped making sense.

So I went to grad school, I was at Carnegie Mellon. It’s funny to hear Dan talk about how in 2015, no one was worried about it — in 2017, I was writing my dissertation on the end of Moore’s Law, what are successor silicon CMOS going to look like? People basically asked me, “Who cares if computers get faster?”, and so this comes back to this point of urgency you guys were talking about. I think there just was absolutely not any urgency around these questions of strategic competition and semiconductors.

I finished my PhD, I ended up at McKinsey working with semiconductor clients and electronic manufacturing clients, actually doing a lot of reshoring and looking at their manufacturing spend, and then I spent a few years at Apple.

What was the motivation then? If no one was worried about this, what was the motivation at that point to do any sort of reshoring?

HK: The customers that I did have were actually kind of navigating the way supply chains were being dominated by handset makers. So they were losing some of their access to contract manufacturers because they’re being outbid by the Googles, Facebooks and Apples of the world. The East Asian contract manufacturing supply chain was just being fully reoriented to smartphone competition, so if you weren’t in that sector, you were like, “I got to figure out a new manufacturing strategy”, and I also worked with some semiconductor fabs that were basically going through and reanalyzing all of their manufacturing spend to try and maintain, I think probably because of price pressures. It was not necessarily framed as the Chinese are coming at that point, but there was a general understanding that price competition was getting more severe, and so they needed to really scrub through their entire procurement spend.

I ended up spending two years at Apple and through the pandemic actually on nightly calls with suppliers to keep our builds running in Vietnam. A lot of calls with semiconductor firms being like, “I need a thousand chips to do this build, can you get me a thousand chips? You don’t need to fulfill the whole order even”, and I actually had a family member who was on the NEC and she was working on supply chain things. That’s kind of how I got looped into a broader question of, “Who are people who are aware of the space and might want to work for the government?”, and then Dan gave me a call.

One more question before we get into the specifics of the CHIPS Act and what you guys were actually working on. You are approached by the government through whatever channel might’ve made sense. What was your expectations versus what you were promised versus what it was actually like doing this job? Was there a big disconnect between the three?

DK: Well, I think Hassan should go first on this one.

HK: Okay, yeah. So people would ask me, “What is it like working for the government?”, and I would always respond, “Well, I worked for the CHIPS Program Office and I’ve recognized from day one that we were not a typical government agency”. Some of that was codified in statute, we had special hiring authority, some of the people in the CHIPS Program Office could get paid beyond that, because they recognized we needed to bring in special talent, and I think that permeated through the way we operated, which you said, “Hey, we have a very particular mission that matters to the government, it matters to the future of this country”, and I think you saw that permeate through the entire experience.

There are so many parts about working in government that are deeply frustrating and I’m going to say the first one that I don’t even remotely hesitate to name is the laptop they give you. It sucks so much, and Dan heard me complain about it. So there’s a laptop, you’re certainly taking a pay cut, and then you’ve got to wear suits all the time, I really hated that part too. But working at CHIPS, I think to a person, everyone was so mission-oriented that we were flying around the way any top consulting, any top tech firm says “You’re sending emails 11 PM on weekends”, and I think that was what defined the program for us. Yeah, your laptop sucks. You don’t get paid as much. You’ve got to wear business casual or business and it sucks, but every one of your coworkers really gives a damn about making sure this works.

How about you, Dan? You had some government experience before, so did you kind of know what you were signing up for?

DK: To some degree, but it was a completely different experience. I think if anyone thinks of what CHIPS was like as a 9-to-5 job with phones turned off during the weekend, that’s the mistake.

I talked to you on Zoom. I don’t know, time’s a flat circle, I can’t remember when it was, and you looked pretty haggard. I can attest that the visual appearance validated the fact that you were working very hard.

DK: (laughing) Yeah, I think when I was at SK Hynix, which was the job that I had previous to CHIPS, I would joke with people that I had a team that was based in Seoul South Korea, Silicon Valley, and Washington DC, and so there was never a time in which I was not working and so I had to craft my own time with family and others, and it was not too dissimilar when I was at CHIPS. It was intense.

But to Hassan’s point, what I found amazing was that there was this group of people that truly believed in what we were trying to accomplish, and they all brought their special skill sets, whether it be financial professionals, folks like Hassan and I that had deep industry expertise, people that knew risk, people that knew environmental policy, people that knew national security policy and others, and the scrutiny on us was pretty intense. We knew that from day one, we knew that we would be subject to congressional oversight, that all the communications that we have, every decision that we made to a dollar was going to be scrutinized, that there was going to be litigation risks, that there were going to be oversight risks.

We also knew that we were living in an era of, “Hey, let’s not repeat Solyndra” — for those that don’t know what Solyndra is, it was a loan that received a lot of attention because of how it potentially, it went negative at the time. It sort of became a poster child of what happens when government makes a bet and it doesn’t go well, and we weren’t just going to do one, we were going to do lots of bets, and every decision would be scrutinized. We knew that, but we had to go fast, so we couldn’t be paralyzed because of the scrutiny that was on us.

But the people were very impressive, the companies were very engaged with us, and I think they found the team to be very talented, and that they were not going to just bulldoze their way into getting the funds they wanted, and that became very clear.

CHIPS Challenges

Let’s zoom up to a high level. You said a phrase, you mentioned in passing, “What we were trying to accomplish”. What were you trying to accomplish?

DK: So Hassan, if you don’t mind, let me take a stab at this. I joined CHIPS because I showed up at the signing ceremony of the CHIPS Act being passed by the President, and someone at the Commerce Department found me and said, “We need to talk to soon”, and he had this look on his face like, “Hey, we are now going to have this money and we’re going to have to actually execute this thing”, and the government hasn’t executed anything like this in several generations.

Really explicit industrial policy.

DK: Correct, and focus on one industry with known players with emerging technologies. By the way, ChatGPT wasn’t a thing at the time, and so AI really wasn’t something that was on a lot of people’s radars.

So what were we trying to accomplish? When I was trying to make the transition from the private sector to the government, the first thing they asked was, “We need to have a vision paper out there that explains what we are trying to accomplish and what does good look like”, so that’s the first thing they asked me to do is come in and actually publish a Vision for Success paper. And so we published that and we essentially told the world, “Here’s our North Star and here’s what we’re trying to accomplish, here’s what good looks like for us”. Because it’s not just about building capacity, building fabs, it’s about building those types of technologies and fabs that I think would be maximizing to economic and national security. What does all that mean? We had to spell it out.

What’s the distinction there? Give me the summary of what you came up with.

DK: Hassan and I talked about this a lot, about how we were going to evaluate companies. But not only how are we’re going to evaluate companies, but how would we strategize in terms of making tradeoffs and so let me take it from a company’s perspective and then sort of mash it with how we came up with our framework, just between Hassan and I. I can’t speak for everyone at CHIPS, but let me just open this up real quick.

Is this the 4 C’s framework? What’s the framework?

DK: I’m going to get into the 4 C’s framework.

Okay, give me the 4 C’s framework.

DK: All right, so if you’re a company, there are many factors that determine your success. But here’s four that I think are really important. First, is achieving cost competitiveness. Can you do it at a competitive cost? And that’s primarily determined by the economies of scale that you can achieve.

Right. And when you say companies, you’re talking about companies that are doing the actual manufacturing of chips.

DK: Correct. That’s right. So these are the foundries, these are the IDMs that are actually building the fabs and operating them.

Secondly and relatedly, can you achieve technical superiority, and therefore combined with economies of scale, market power? Can you sell into the market and can you create modes? Thirdly, can you shape favorable relationship with customers, suppliers, and competitors in a way that is favorable to you? And fourth is the problem of resource allocation and positioning yourself for disruption and growth waves. If you don’t get all of those four primary factors right, and again there’s others, but if you don’t get all those four right, if you fail at one of those things, then you’re not in a comfortable place as a company and how you’re competitive.

So in a similar way, Hassan and I thought about, well, what are mirroring factors as an industrial policy organization at CHIPS for us to define what good looks like? And we called it the 4 C’s. Now this is sort of reflected in the notice of funding and how we did it, but between Hassan and I, we refer to it as the 4 C’s, and these are the four: Capacity, Capability, Competition, and Criticality.

So one is Capacity. Can we allocate resources to build significant production scale to make a difference in this country to actually close the cost gap between a North America and East Asia?

And what is the fundamental driver of that cost gap?

DK: Yeah, that’s a good question, I would break it down into two aspects. One is that what we found is that the manufacturing ecosystem in this country, particularly when it comes to semiconductors, had atrophied quite a bit over the past three decades or so, and so everything was a little bit inefficient and that contributed to higher operating costs, that was partially due too because of labor cost differences between East Asia and here. We would have anecdotes of experiences where there was a lack of specialized plumbers, immediate availability. When you need to fix something in Taiwan or South Korea, you can call them at 3AM and they would come immediately and fix that thing so that your fabs could operate.

And literally every minute that a line’s not running is costing you a tremendous amount of money.

DK: Exactly right. And in the US, that’s not necessarily the case. Plus, the US is a very big place, so you have to create an ecosystem within a limited geography that has all your suppliers at an efficient scale, has all that labor and talent at an efficient scale. There are some advantages in the US, especially that the energy costs tend to be lower than it is in East Asia, but the labor costs are higher, everything is a bit slower. The equipment themselves, which if you’re building a new fab just to get it up and running, somewhere between 60 and 70% of a new fab, the equipment themselves will be the same. But the cost of installing it actually might be higher because of the labor costs and the service contract you have to enter into on top of that.

HK: And the timeline to get those up and running is a major cost driver. So even if you’re buying the same tools, the fact that our fabs, everything that Dan said about the ecosystem being weaker, that compounds during the construction phase, and every additional day in the construction phase blows up your CapEx budget. And you saw that I think most acutely in some of the first fabs that were coming online, they were very publicly known to take much longer than the rest of the world.

One of the data points that’s maybe less obvious, I think, to folks on how the ecosystem is maturing in a lot of the ways that Dan pointed out, is you don’t hear as much noise now as firms like TSMC is on its second fab, Texas Instruments is moving its Sherman complex forward, because they’ve trained up the workers and they’re building replicas of the last ones, they’re moving faster.

How much is it training the workers versus importing the workers?

HK: Well, I think for construction it’s a lot of training because you want that workforce. But for a lot of the talent to run the fab, there’s a portion of, you need to get that talent in and Dan can probably speak to that more.

DK: Yeah, this is a good question. Especially when it comes to foreign companies building in the United States, yes, there’s a lot of companies that are working at a company like TSMC or Samsung or SK Hynix, but there’s a select group of people within that company that is actually doing process engineering, integration engineering, that makes up for the very special and very secret sauce that differentiates that company versus everywhere else. That’s not something that you can replicate immediately in a different place, especially in a foreign country, and so to some degree you have to be able to import specialized knowledge and that could only be done with people that are coming here and that they need then to be able to train folks.

This is something that Hassan and I thought about a lot, which is can we create an ecosystem in which those people come here and can train people in the United States, they can then do N+1, N+3 generation iterative innovation and this is something that of course Pat Gelsinger talks about quite a bit in that, “Are you doing actual R&D here?”.

The Foundry Revolution

Was it a real challenge that the US has had some semiconductor manufacturing, but it is almost all historically been the IDM type of manufacturing, where there’s a margin embedded in the whole process, whether it be an Intel or a Texas Instruments or whatever it might be, whereas the foundry model, because you’re just the one layer, you’re driven by cost control, and so this motivation to do it fast, to maximize efficiency, to not have any downtime, is inherent to your profit model in a way it’s not for an IDM. So was it not just that skills had atrophied in the US, but there actually was a fundamental skill set and mindset that straight up did not exist?

DK: Yeah, so let’s go level up a little higher. When we were signaling to the industry and to the world what good looked like, it also required Hassan and I to think about what got us here in the first place and this is what you’re getting at, which is we missed the foundry model revolution. What I would tell people is that the most important innovation in the industry that we’ve had in the last generation isn’t necessarily EUV technologies or the FinFET transistor or any of the technical things, it’s actually the invention of the manufacturing as a service business model that was perfected by TSMC.

In fact, when the general counsel of CHIPS came to me when I first joined and said, “Hey, I need to get to know more about chips, what can I read?”, the first thing I told them was, “Actually go read Ben’s blog because he talks about this and his conclusion would be that this is TSMC’s world and we’re all living in it and here’s why” — and so we missed that. Trying to recover from that, “Can we do it?”, is an interesting question.

Then we also, in some ways, purposely let go of the memory consolidation that has so much capacity attached to it, that all went to Japan and South Korea.

What we mentioned earlier, that is the industry that just in the very structure of the industry is a total priority on efficiency because so much is out of your control.

DK: Correct. So there is a business model innovation that we missed out on, and then there’s the efficiency, brute force efficiency and scale game that we purposely let go, in a sense. When you miss those two things, that’s two thirds, three fourths of the total capacity there is in the world if you add up memory and foundry. By the way, when you mature a foundry fab, then you have all the current and mature technologies that serves hundreds of customers, not just the leading edge, so we missed out on a lot of that. When we had to diagnose what went and wrong here, the easy answer that an industry association gave was, “Oh, it’s because foreign governments subsidize their production and that’s why it went elsewhere”, and I think that told a very incomplete story as to what happened.

No one in the US wanted to do a foundry. That was the whole reason why TSMC had a market opening.

DK: Correct, yeah. And so because of that, we needed to think about what business models should we support and what kind of capacity do we need to build? And so that’s the first C, Capability.

No, that’s good. That was a very, I think, fruitful discussion. And the feeling with the CHIPS program, was foundry capability the top priority?

DK: It was among the top priorities, and if you read our notice of funding carefully, there is actually a very explicit statement in there that says that there is a priority for business models that can serve multiple customers. What else could it be other than a foundry model that can serve multiple customers?

Of course being able to serve multiple customers not only gets you scale, but to your point about the difference between IDM and foundry is that the inherent advantage of a foundry is that all your customers are now invested in the success of your process and so they have engineers there that’ll fly over to your fabs, that’ll meet with your teams and iterate and so if you’re an IDM and you’re no longer competing against a foundry, you’re competing against that foundry and all of their customers that are invested in that process.

Yeah, it’s a shelling point for everyone to invest in the next process, which is getting astronomically more expensive.

DK: Correct. Because of that, it lowers the risk on everyone too. So from the foundry’s perspective, you have customers who are buying corridors ahead of time, but also who are invested in the success of that, so to break into that actually is very challenging.

Hassan, you wanted to follow onto that?

HK: I was going to just add, when Dan talked about the preference for the foundry model, remember too, we were writing this right after the COVID crisis where the emphasis on supply chain resilience came back and said, “We really want you to be able to service a range of customers and make that capacity available broadly”.

And actually another comment that I realized after Dan brought this up, I think the point that he made about ecosystems and your customers investing in your processes is the biggest overlooked advantage that TSMC had over Intel. Intel was fighting at one point — it continues to fight — an ecosystem, and that’s another value add of why you want to have the entire ecosystem invested in here. If you just built fabs for the four or five IDMs that continue to operate here, you would not get the global ecosystem to be investing alongside them to make them a success.

Supply Versus Demand

This is one of the biggest questions, you gave me a segue to Capability, the second C. I’m going to come back to that in a moment. But this to me is the biggest issue and it’s not a critique of you, it’s a zoom out. I’m also not sure how to fix this, which the key here is the demand side, and you guys are on the supply side. The problem for Intel is a lack of buyers, and some of that is on Intel, some of it is just the historical development of the reality that you’re not fighting TSMC, you’re fighting TSMC plus Apple, plus Nvidia plus Qualcomm plus everyone else in this ecosystem. Is that just an intractable reality that you couldn’t address because that wasn’t your remit? How did you think about this balance between supply and demand? And actually spurring, “We’re not just going to give money one time, but we’re going to have a virtuous cycle that helps us achieve our goals”?

HK: I think there is a real challenge for those. I think those firms, all of them, if you gave them truth serums would say, “We love TSMC and we are afraid of our full reliance on them”. Not just from a geopolitical perspective, but from a pure business perspective, you don’t want your entire business hinging on one supplier, right? The same way TSMC feels that discomfort regarding ASML and the reliance on EUV for all these advanced nodes.

Well, I think that’s underappreciated, about the whole thing with the semiconductor equipment manufacturing is it used to be all these equipment manufacturers did one thing and they were different parts of the chain, and TSMC basically said, “No, you all have to learn how to do everything,” so they can set you off against each other. But it’s happened because they’ve had the most power, but everyone depending on TSMC feels the same way, but has had less leverage.

HK: But go back to the fabless firms, and I know Dan had thoughts on this too, but at the end of the day, they have to be able to make a bet, it’s a minimum $500 million bet and they have to be able to go look their shareholders in the eye and say, “I’m going to spend $500 million taping out a chip with a foundry that’s not TSMC”, and they’re going to ask them why.

Well, I mean Apple tried. They had a generation where customers were looking, “Is this a Samsung chip or a TSMC chip?”, an unacceptable outcome to them. Nvidia’s tried more than anyone, they’ve tried to balance, and that ended up costing them because they weren’t a favorite customer of TSMC because TSMC’s like, “Oh, you want to flirt with Samsung? Not so good”.

HK: And Dan will tell you, we had these conversations, and I think the tension is here. Our remit was to create, exactly as we talked about, the capacity needs to be economically sustainable and viable so we can’t then go beat people over the head and say, “Hey, you need to go invest in a foundry that you can’t look your shareholders in the eye that you say that is not there yet”, which they were public. But I do think it put us in a tough spot of saying, we all looked around in the room and said, “These efforts aren’t going to be successful if other firms don’t buy in”, and we were trying to create the conditions to reduce their risk. But at the end of the day, that’s on the firms to deliver that technology and for them to get comfortable with each other.

Is this the bit where, you guys come in after the law is passed, and if you could wave a magic wand and actually reshape the law, and maybe this gets into the broader industrial policies perspective, my critique is that the law only addressed the supply side. There wasn’t a generation of demand, whatever that’ll be, I feel like spending billions of dollars to buy chips that you throw in a landfill would actually be tremendously beneficial because it’s a guaranteed buyer to get this stuff on the lines. Was that just a real hole in this whole program?

DK: That’s a good question. You’re right that we focus on supply because that was our responsibility in our remit.

That was the law, right. But if you could go back and there was a different law?

DK: That was the law, but we grappled with demand quite a bit, and that was one of the factors that we absolutely required companies to prove to us that there was a business case to be made. Meaning who are your customers? Are they bought into this? Is the government essentially investing in a space in which you have no hope of a customer, in which case the funds wouldn’t be given?

One of the many things that our amazing investments’ office, these finance and other professionals were doing, was doing a lot of due diligence into reaching out to customers to the extent that we had permission to do that and saying, “Okay, what is your plan to use this company and this fab?”, and you can think of it in terms of calling an Apple or the Nvidia’s of the world, and of course all of that had to happen and that’s not a secret.

But take a small MEMS producer, of course we’ve had those in our portfolio as well, we’ve had to contact their customers to say, “What’s your long-term plan with this company?”, and so we had to do that. In some ways then yes, we were only focused on supply, but what we found is that just by calling the customers from the US government’s perspective saying, “We are willing to give money to this supplier if you are willing to take on them as a customer”, did so much to put that potential customer at ease and buy into that corridor.

So what I’m trying to say is that this is an untapped power that we had if we were given more authority to do that.

To give them security that they should take the risk of getting the supplier.

DK: Right. But we have to be careful here too because at some point how much a government should be dictating what demanders should be doing, is a really tough question.

Believe me, I’ve been thinking a lot about this.

HK: We’re living it out in real life.

DK: One thing that I think was really interesting was when I observed a very savvy, very professional and noteworthy Secretary Raimondo doing, is when she would be engaging with the demanders, she had to encourage saying, “Hey, what is your willingness to take on this foundry or this company?”, without crossing the line into, “The government is requiring you to do this”. Because as soon as you get into that territory, then we’re not even in the territory of picking winners and losers on the supply, but then dictating demand as if the government is better at getting to a more efficient or better outcome. Now, you’re going to have lots of different opinions about this.

No, but to me, I actually put this at the end. I wanted to conclude on this point.

DK: (laughing) Okay.

I think it’s the critical question that I’m thinking a ton about. I have this general theory that, and I am obviously mostly focused on tech, but I think it probably applies economically generally. We’ve been in the economic era, decisions are made according to what is best economically, and what we’re facing is the reality of things that can’t be measured, of tail risk, of what happens when you follow the economics and it ends up with you being completely dependent on an island off the coast of China that they think is theirs. Obviously not an ideal situation, but to your point, how do you actually introduce a cost signal into the supply chain such that an Apple or an Nvidia or whatever would say, “Oh, we need to dual source, we need to build up another supplier”, and you pencil it out for those companies? Apple is probably the most extreme example where the rational thing for Apple to do is a China-Taiwan conflict would be so destructive to their business, it’s actually rational to just assume it’s not going to happen. Because if it happens, you’re screwed anyway and basically every dollar that you spend to relieve it is going to be a wasted dollar if it doesn’t happen, and so you’re stuck here.

My sense is we’re moving. I thought this for a while, but the timing was off, that’s always the issue with timing, we’re moving to the political era where the political era is actually governments start making suboptimal decisions economically that, for various reasons, and Dan you wrote this to me in an email:

Fundamentals are changing before our eyes due to industrial policies and it will be disruptive, in addition to the ways that Clayton Christensen theorized disruption, the market will be shaped by it, it will crush companies and CEOs, countries and governments of those who do not understand both sides, geopolitical disruptions can move in the opposite or similar direction of market forces.

At what point is holding on to, “Yes, it’s bad for us to centrally plan to tell companies what they should or should not do”, actually end up in you saying, “We’re going to end up in the messy middle, which is actually worse, where we’re going to try to shape it, but we’d be better off just telling them what to do, knowing it’s going to be inefficient because at least we’re going to get done what needs to get done”?

DK: Yeah. I think there are degrees of this, right? Ben, I don’t disagree with you.

Oh, there’s nothing to agree or disagree with. I think about this constantly every day.

DK: Yeah, so I think there is this corner solution in which the government has to step in and say, “The markets aren’t getting this right and therefore we’re going to dictate customer relationship here more than the industry would ever feel comfortable and do it by fiat”.

Which by definition is going to be economically inefficient and destructive to value.

DK: Sure, you could go that way, and then there is almost a middle ground solution, it doesn’t necessarily have to be as messy. So you can essentially say, “Well, then let’s envision a tax credit, for example, like an incentive-based structure in which if you are utilizing a US-based fab that you otherwise would not, there is a tax credit attached to that”, you could try to think of it that way. I’m just trying to describe, there’s a gradient to this that you could imagine to try to shape it, because you may not want to end up in one direction or the other. At the same time that you’re describing all the geopolitical and concentration risks that is associated with one dominant foundry, the benefits of that has been so fruitful to the industry.

That’s exactly it. It’s very rational that we ended up where we are.

DK: I could talk for another two hours about this particular story, but let me boil it down to a very quick one. Believe it or not, my daughter’s life was saved by a semiconductor technology at birth, while we were negotiating with TSMC, Intel and Samsung. She was born in December 2023, and so we were really in the thick of it, and the only way that her life was saved is that there was a new pacemaker that came on the market, on an emergency authorization, that was miniaturized enough to save premature infant babies with heart troubles, and I knew that if there’s anything to do with miniaturization of any electronic device, it has to do with the semiconductor technology, there’s nothing else that’s going to drive it.

So I contacted the manufacturer of this electronic device and I said, “I want to know everything about that semiconductor technology,” which is not something that parents usually ask, but because I was in CHIPS, I wanted to know, how did you do it? Who makes it for you? What are your options? Can you make it in the US? Did you have a shortage of this during COVID? How can we fix this? Because it really distilled for me in a really tangible way, in a personal way, what we were trying to accomplish. Not just, “Can we make iPhones?”, and “Can we make server chips?”, but, “Can we make a life-saving device that’s using the latest technology that can get there?”.

They explained to me that they had searched everywhere for a foundry partner, because they themselves could no longer go down the innovation cycle of chips themselves, they have their own fab, but it’s outdated, so they needed a foundry partner. No one would take them on except for TSMC. Why? Because they knew how to do the 3D packaging. They had fully depreciated six inch, eight inch fabs, and they were so maniacally focused on serving their customers that they didn’t mind taking on 1,000 devices, not wafers, 1,000 devices. Morris Chang himself apparently said, “We need to do this for this company to save these kids”, when nobody else would take it on.

That’s the kind of foundry we’re talking about here. And so we could talk about abstractions, about whether the foundry model is superior and IDMs, and there are clear superiorities and differences in business models, but I think we are talking about a very unique company and the culture that they have that have allowed the world to be served by it and served so well, but now we are exposed to the risks of it.

Now we come back to the question that you’re asking, which is, “How do we now de-risk that, not only through supply chain, supply-based policies, but is there demand-based policies that we could get to?”. My hunch is that there absolutely are demand-based policies to get at that, and there is a hunger for it from the customers’ perspective. To Hassan’s point, we have heard so much glowing feedback from TSMC’s customers about how good they are at delivering, they under-promise and over-deliver. It’s the theme that we hear over and over, and over again from the customers and they’re saying, “But if they can build in the US or if there could be US alternatives, of course we will take a look at it because we are not stupid, we know the risks here”.

So if you look at the enthusiasm for the Arizona fabs at TSMC, I think that tells you what you need to know about that company and what company is willing to do, but it’s not a complete de-risking. As an economist, I would have to say, if you’re looking for an insurance policy that completely de-risks, then that’s a very expensive insurance policy, almost too expensive for the world to handle.

It’s too expensive. A friend and I looked into how would you de-risk the risk of a China-Taiwan thing and the costs of the hedge are so astronomical as to make it completely non-viable.

DK: One other thing I would add, I would encourage your listeners to think not in terms of Apple and Nvidia, and AMD, and Qualcomm, who have significant market power as customers and demanders, they have such volume and such margins that they can dictate along with a TSMC or Samsung or an Intel, whoever their fab partner might be now or in the future, where there could be dictated. Think about customers that have no such power to do that. What kind of policies would you design that could essentially enable even a company like a Ford who is a huge company, but in terms of foundry customers-

Doesn’t matter.

DK: They’re really not going to move the needle as much as an Apple would do. So, what do you do when one fab is serving 1,000 customers? None of which have power.

Well, the problem is how do you actually incentivize a customer service culture? That’s like anathema to government funding. Go ahead, Hassan.

HK: There’s a RAND study that was done, I think, back pre-pandemic where they actually essentially looked at this question. They table topped a war games exercise and there’s an invasion of Taiwan. Actually, I think the premise is Taiwan goes under Chinese control, forget how, that part, just it goes under Chinese control and they asked US government participants and private industry participants, “What do you do?”. And the US government basically all responded, “Well, we got to get those fabs out of Chinese control one way or another”, and the private companies all basically said, “Well, we’ll learn how to work with the Chinese Semiconductor Manufacturing Corporation”.

This comes back to the uneconomic decision. I think there is a real tension within government, where there’s this urgency and this anxiety that we feel about what feels inevitable, and a lot of private firms do not match that urgency on this question, which does come back to this, “What are the incentives?”, and we’re seeing it play out. The President has basically said, “Do it or you’re in my bad graces”, and I think that there was a question of could previous administrations have taken a different stance and what would it have changed? I don’t think the calculus was ever, “No one was ever willing to accept the economic costs”, but the problem has continued to grow in the background and now you have to ask yourself, when does that trade-off change?

The Role of Government

Well, you guys weren’t in chip controls, but this is the basis of my opposition to them, which is, actually we underrate how good TSMC is and the Chinese firms would become just as dependent on TSMC as we are if we would let them or continue to let them and that’s actually a better hedge — it’s Mutually Assured TSMC destruction. You could comment if you want, it wasn’t your purview, but is there some grain of truth there where, even in the face of government dictat of build up SMIC, build up domestic, the reality is Chinese firms have competitive pressures as well, and TSMC just really is that awesome?

HK: You know what China’s going to pursue, you know that they’re going to pursue building up a fully indigenous ecosystem, and I think a simple game theory approach that it comes back to of like, “How do I maintain leverage as they try to go and do that?”, and if you cut them off, the flip side is you are not empowering them in some ways to make progress, say, on AI, but now you’ve also lost your leverage. So, you have to weigh that. Where are the cases in which maintaining some leverage is important enough that I’m eating that cost?

I don’t have an answer to that calculation, but I do think you raised the question of, “Do you want to maintain that leverage or not?”, and you see it happen, the Chinese basically said, “Okay, we won’t buy Boeing airplanes anymore during the trade war”. That’s an area of leverage that the US government is now losing vis-a-vis the Chinese.

Or the rare earth thing. We can easily solve the rare earth problems if we say actually, okay, you want to take out Chinese ability to flood the market with rare earths and make mines and processing uneconomical, the government could fix that. And once we fix that, China won’t have that point of leverage anymore. Just to sort of use an alternate examples. What do you think, Dan?

DK: Well, what I found to be really interesting is going all the way back to my first service in the government, in the entire US government, excluding the Defense Department and the intelligence agencies, my understanding was that there were two people in the entire government that was focused solely on commercial side of semiconductors. So, that was myself and that there was another gentleman, his name was Travis Mosier at the Commerce Department in the International Trade Administration, and that was it, this is 2015. It’s kind of ridiculous to think about now, to think about all the folks that are focused on semiconductors on the expert control side as well as the promote side, the chip side, the R&D side, there are teams and teams of this on it, and I think what was interesting for me to observe is that there was no obvious mechanism in which those different teams and agencies were coordinating with each other. There didn’t seem to be an obvious watchtower or a czar, if you will. Because right now, if you look at the way that the White House is structured now, there is an AI czar, I think. Is that right, Hassan?

Yeah, David Sacks.

HK: David Sacks.

DK: Right. When so much equity is at stake when it comes to semiconductors from a variety of angles, whether it be trade, promotion, defense, it might’ve made sense to create a semiconductor czar, if you will, to say, “Okay, what are we doing in terms of, what are critical technologies that we’re focused on to building out that capacity and capabilities in?”. Are we having a matching expert control posture? And if not, why not? And is it coherent? And then are we also then investing in the R&D capabilities from the government side that is sort of coherent to all of this?

I’m not sure if I’ve been part of discussions where all the stakeholders came together with one mandate to say, “Okay, here’s our semiconductor strategy as a nation and here are all these different aspects of it and here’s how we’re going to execute it”. I’m guessing, it feels to me that a government like China would have something like that, it didn’t feel like that to me when it comes to the US government.

That would be my critique of it in that, Hassan and I went into this thing on the supply side and just put our heads down and try to execute on the chip side. Then every once in a while we would have opportunities where I would get a ping of email from someone at BIS [Bureau of Industry and Security] saying, “Hey, we have this technical question for you, do you have anyone on your team that can answer questions about high bandwidth memory?”, and we would say, “Yes, of course we do, and we could tell you all about it without divulging any private information that we’re getting from our applicants”. We have lots of data, we have lots of information, we have have subscriptions to all these places that can make us smarter, and as soon as we were able to do some informal educating of each other, we were all better for it. It did make me wonder, “Gosh, we would be so much better off if we’re formally coordinated in all this”.

The interesting counterpoint though, just to sort of raise it, and this goes back to your, “We don’t want to have centralized control”, and of course it’s a spectrum and a gradient, but it’s very easy to sit here, particularly as pundits or people sit in the outside, and you see this with technocrats all the time, sort of looking lustfully at China and say, “Wouldn’t it be nice if we could have the control like they do?”, and yet at the end of the day, just to take your personal example, we did end up with this incredible technology where you could get a miniaturized pacemaker that could save your daughter’s life. In that view, the complete hands-off nature actually worked beautifully and the incredible advancements that have happened, did it happen despite the lack of government involvement or because of the lack of government involvement? I agree with your points, and it’s problematic given the national security concerns, we haven’t had any sort of strategy, but I do think in these discussions it’s always worth, that’s why I loved your example so much, it’s always worth remembering, you do get better, more efficient, faster economic growth without the government’s involvement, and we shouldn’t forget the massive gains that have come from that.

DK: No, you’re right. Again, these are corner solutions, if you will. And if I didn’t believe that there were some government intervention that was necessary, then I wouldn’t have joined CHIPS. I’m not here to suggest that the market’s always going to get right, but I also recognize that the government’s not always going to get it right either. The primary point that I think I would like to convey here on this aspect is, if we are going to do industrial policy, if we are going to do heavy-handed intervention in terms of export controls, promotion of supply, get into the commercial demand-

If we’re going to do it, can we at least do a decent job of it?

DK: Yes, let’s do it right, and let’s do it correctly. And coming full circle, if you’re going to do it that way and be really fully committed to it, then you better know how to speak the language of companies and the companies now better know how to speak the language of government as well.

That gets to your point before, yeah.

DK: I still see miscommunication between the two, and so when I talk about those factors that companies deal with, Hassan and I tried our very, very best to make sure that when we were thinking about our industrial policy and its outcomes, it was mirroring those two things, because we could not exist in a vacuum in which the government says, “Here’s what we want, you better go do it”, and then watch it happen. We couldn’t really do that. We had to say, “Okay, what moves you and here’s what we think where we want, here’s what you’re capable of, where can we meet even if it’s halfway to get to a better place?”.

Leading Versus Trailing Edge

Well, I’m going to give Hassan, sorry, this is very mean to you since, I know we’re already going a little long, but is this where the rest of the 4 C’s come in? I think we only got to Capacity. We have Capability, Competition, and Criticality. How do those fit into this balancing act and trying to be translators between a government obsessed with national security and companies that are trying to innovate?

HK: Very naturally the government’s going to have a different objective function than a firm. A firm’s simple objective function is going to be to maximize profit, keep my shareholders happy, go home.

But we were tasked with a far broader set of evaluation criteria, and so when we’d look within those 4 C’s, you come back and say, “Can you tell a story of why this project moves the frontier for US capabilities within those buckets in a way that perhaps is more valuable to us than it is for the market?”. So, we’ve spent a lot of time talking about the leading edge, and it was obvious why we care about, say, being able to build AI chips in the United States.

That is somewhat obvious, but there’s a host of these other technologies that didn’t fit into the capacity bucket because they serve niche markets and enable niche capabilities that are crucial for emerging industries. We talked about autos. Autos, perhaps you want to win the race for EVs globally and you want to have the best power electronics ecosystem. If you want to do that that’s not something the industry cares about at a macro level because it doesn’t move equipment sales, it doesn’t move the top line for TSMC or any of the major firms.

Right. No one’s going to build a trailing edge fab when you could just repurpose ones that already exist.

HK: But that matters to the government because we want to have that technology available to the Fords and GMs of the world. It also has a bunch of national security applications.

And a bunch of political concerns, the auto industry is a huge thing when it comes to getting votes.

HK: Absolutely, you come back and you say, there are parts of the supply chain — we spent, because ChatGPT came out in November of 2022, the conversation very rapidly shifted from this conversation on resilience to technology leadership with respect to AI. But those other 3 C’s, what they really told a story on, there’s a whole industry that’s not just on building the most advanced chips, and it certainly benefits from that broader ecosystem as Dan laid out before, when you have capacity in the US, the whole ecosystem gets stronger.

But things like Datacom transceivers that are being made on indium phosphide, if you want to build mega AI data center clusters that can communicate across campuses, you need to be able to push the frontier on indium phosphide technology. That’s a couple $100 million investment to move up to a six-inch wafer. That doesn’t grab headlines, but it’s one of those key linchpin technologies for being able to build something that really does matter to the government if you want to be able to deploy the best AI models.

Well, to me, this has been one of my biggest critiques of CHIPS, in that I felt it was too focused on the leading edge, when the single biggest contrast between national security or resiliency concerns and economic incentives was the trailing edge. The reason we have trailing edge is it used to be leading edge a long time ago, so it was economical because these are fully depreciated assets. It’s impossible to rebuild that economically because you have to pay off your equipment costs, and you’re competing with fabs that don’t, and China can do that because they have to move their way up the learning curve, and so they’re going to dominate all this trailing edge. TSMC has that because they already built it, even they in the response to China are specializing all their trailing edge fabs too, because just general purpose, 28nm chips or 90nm chips or however back you want to go, China’s just going to inevitably flood the market there. There is no one that can solve this other than the government, the economics never pencil out otherwise. How much did you think about that and how did you balance this? You mentioned Hassan, ChatGPT takes the world, everyone’s thinking about AI, but actually where the government can arguably we have the biggest impact is in this area.

HK: I think the most debates that we had on portfolio construction were essentially around the question of how much to reserve for the trailing edge, because the big guys came in early and we knew what their asks were and their asks, and the Secretary said this, if you looked at just the Big Four, they totaled more than the $39 billion that we had. So there’s a version of it where we could have just said, “Hey, you all get your ask or something close to your ask and we’re all going home”.

We chose not to do that, but we then did have a long set of conversations on how much do you reserve. The problem, Ben, was the firms in the projects they were proposing, their assumption was there’s no world in which the economics of a new build here are going to work, unless the government is willing to lean in at such a level, almost the majority comes from the CHIPS program on a $10 billion plus fab. But there was also, we had given guidance that our expected funding ranges were in the 5% to 15% plus the 25% ITC [Investment Tax Credit]. So, a lot of these firms read the tea leaves.

So, this was sort embedded in the law. The law itself didn’t really allow for it, because a trailing edge project needs 100% government funding. That’s just the reality of it.

HK: And I think it was sort of anticipated that there was not an appetite for the government to lean in and basically say, “We are building this fab”, unless the DOD wants to do it on special circumstances, which is a separate case than what the Commerce, how people viewed our authority in the Commerce Department. It was to go fund facilities that would be economically viable with dollars on the margin, coming from the federal government.

Is this a big change you would’ve made to the law, Dan? To go back to my question earlier.

DK: So, I think one way that you could have done it, I’m just thinking out loud, I need to think about this a little bit more, the economics of leading edge and economics of trailing edge is almost completely different, to your point. The margins are much smaller. “How do you compete against a fully depreciated fab?” is something that we heard over and over again.

Particularly when more supply is uneconomically coming online in China.

DK: Right, so the market can’t really absorb a lot of it right now either. And while the export controls are focused very much on the leading edge chips, the tool sets that we have to make sure that over supply and flooding of over subsidized, non-market based supply from China, the tool sets are actually very limited if you think about it.

So, take tariffs for example. We could try to do a component-level tariff, whereas if your end-use device like a phone, like a PC or server, if it contains, say, a Chinese-made chip, then we would tariff a certain amount. You could do that and you could design it in a way that would essentially zero out Chinese-made goods in the United States. It would be very hard to do, but you could try to imagine that happening, right, Ben? And I believe there are discussions about that at various parts of the US government.

But you’re talking about tariffing a 25 cent, or even cheaper, component.

DK: Well, right. So, you could think of it as, so for example, right now USTR [Office of the United States Trade Representative] is doing a, what’s called a 301 investigation on over supply of legacy chips from China, and the remedy that they have available isn’t necessarily just tariffs or tariffs of that component or the value of that component. You could tariff if you choose to tariff a portion of the final end good if you want to. I don’t think they’ve ever tried this, but you could have a quota if you would needed to.

The remedy is, I’m speaking out of turn maybe because I’m not quite sure what the legal aspect of this is, but you could imagine designing something that essentially zeroes you out from Chinese oversupply to protect, say, a GlobalFoundries or a Texas Instruments or a Polar Semiconductor, whatever it might be, the different size of companies. But that only addresses 25% of the global market for chips.

And it’s a fungible market.

DK: And so how do you contain oversupply within China itself to, in a sense, let it implode there? I don’t think there is a mechanism that we’ve envisioned to do that unless there is a huge amount of coordination that is a result of a lot of goodwill and forcing mechanisms I suppose. That is something that we haven’t figured out.

We’re doing a great job building that now, so it’s all good.

DK: (laughing) The economics of legacy chips is something that we thought about a lot. Congress did try to do this though, if you remember, it was supposed to be $50 billion. It ended up being $52 billion because $2 billion was earmarked specifically for legacy chips. So we actually had a mandate out of our $39 billion, $2 billion out of that had to go to what we defined as legacy chips and we sort of defined that in our notice of funding.

But to your point Hassan, was it actually hard to spend that because it’s still un-economical?

HK: I think what we found was it was early on when we started to get applications, to be honest, I think we were expecting a lot more large scale, mature node fabs. We were expecting people to come and say, “We want to build some mature node capacity here”, and I think there was a moment of us looking at the applications we got, “Okay, they’re not going to do that”. What do we do now?

What we actually, I think, stumbled upon that gave me some solace, was a lot of firms that had existing manufacturing capacity came and said the CHIPS Act is an opportunity for us to upgrade our facilities. So we take a facility that’s fully depreciated and we’re going to bring in automation, updated process equipment and that’s how you compete — you let them go take on all the debt.

You’re more efficient, yeah.

HK: And you just get more efficient. So you can add automation to facilities that were built in as far back as the 60s and 70s, like they have at GlobalFoundries in Vermont, and you’re equalizing the playing field because they’re going to bring on uneconomic capacity, but you’re going to keep your most economic capacity at or as close to the productive frontier as you can. And I do think those upgrades were meaningful, but they don’t move the needle on, yes, you’re right, we’re not going to have a large portion of the 45 to 65nm capacity globally because we’re not going to match what China’s doing, but we probably have enough capacity for critical use cases.

We can still make bombs!

HK: For critical use cases, and then it requires other coordination. Our firms keeping the right level of strategic inventories, which is a thing firms have been paying more attention to. But we’re not going to have, to your point, we’re not going to be able to go back as the government and say, “We are mandating across these thousand critical products that you maintain 150 days of inventory”, that’s not an approach that we’re going to be willing to take in a sort of economic decoupling, but we are going to say, “Firms, you go figure out what your strategy is and we’ll on the margins help you build up more local capacity”.

DK: And Congress did mandate the $2 billion, and I would say just to push back a bit on your criticism, Ben, that Hassan and I and the team went beyond that to say we recognize the criticality of current and mature chips. Despite the fact that the economics were really difficult, we pushed really hard. For every company that was capable of making those chips, we pushed hard for them to propose something to us, and sometimes they proposed something to us that was very realistic that we couldn’t possibly fund because it would’ve required something like a 60 or 70% level of funding for them to break out even.

So if I had to design a new CHIPS program, I would say that the secret sauce might be how you do investment tax credit. I would think really creatively about the level of investment tax credit, depending on the end use goods that you’re providing, I would think about investment tax credit for demanders as well, to create a both supply and the demand side to get at something very clear. I would think about how to coordinate that with Europe as well and other parts of Asia in which you don’t want to get to a race at a bottom situation with subsidies. But I think you could have a really coordinated effort, and I think one thing that we saw was a lot of countries came to us and said, “Hey, if there are investments that you guys think is good but you don’t have funding for, we’ll take it”.

I think to that extent, I think the concern about oversupply from China and everything else, I think these are shared concerns. I know I’m sort of ignoring the politics of now, but I’m imagining a system in which everyone recognizes that this is a critical sector and that supply and demand to the degree that can be fixed towards resiliency by the government, there could be better coordination. So yeah, I would think about the ITC quite a bit.

Is one of the takeaways from the CHIPS Act that actually it was the tax portions that were way more useful and flexible and should be leaned into more as opposed to just the dollars and cents?

DK: I think that’s part of the answer. I would say because we had the 25% tax credit, that was the blunt instrument. The ITC was the blunt instrument that allowed us to be a little surgical on our end because if we had no tax credit available, then our choices would’ve been a lot more stark, then we really had to make a strategic choice as to say, “Gosh, do we lean in on the leading edge altogether”, or do we, because peanut buttering it may not have worked, but the ITC did the peanut buttering for us in a substantial way, 25% fully refundable tax credit that if you start construction by 2026 or 27, I forget which year.

HK: 2026.

DK: Yeah, then you get get continuous credit for that for several years thereafter. If you’re a company listening to this, please check with your tax attorneys about how that works. If you break ground and you’re continuing to building out, that is eligible for you, that actually makes it really economical to start building in the US, particularly as we start building out the upstream supply chain around the US, I think it becomes a really compelling place to build.

So I think definitely keep the tax credit aspect of it, I think you will find at the end of the day that the Treasury will have done a lot more and in a non-competitive way, meaning that you didn’t have to compete for those dollars against other applicants.

Everyone gets it if they build.

DK: That’s right. And so if you’re going to do it in the future, but I would also say that if you are going to do it in the future, then you have to remember that we have to have institutional muscle and capability within the US government to actually think deeply about these things, and dole them out to make sure that you understand what the first set of CHIPS team thought about and did. What did they accomplish, what did they not do? We knew we weren’t going to get it all perfectly and companies weren’t going to get it all perfectly either, and things are shifting around us.

The Future of CHIPS

What advice do you have for the folks that are doing this now? This comes back to the fourth C, which is Criticality. This matters. To your point, we didn’t have any of this capacity in the US government. You guys put together a team, but now we have a new administration and everyone, you guys are talking to me, sorry, you’re stuck with Stratechery. There’s a fifth C here, Continuity. How do we accomplish that?

DK: Yeah, I’ll say something, and Hassan, I’ll let you have the last word on this one. So if the CHIPS team is listening to this, anyone at CHIPS team is listening to this, I recognize that there has been a heavy reduction in the team, and that it almost seems unrecognizable from just a few months ago, that this is a different place and that they’re operating under a different political environment. My advice is continue to remember that the work that you’re doing is one of the most important things that the government is doing right now. It may not feel like it right now, but it really is, and it’s always been the case for public servants to hang in there and look at the long-term and to quietly execute and do your best.

I would also say that from my professional experience and public experience, this is by far the best team that I’ve ever seen work by far. In terms of talent, in terms of dedication, that I would say just quiet out the noise and continue to do and can make sure that actually you write some things down. One of the reasons why we wanted to do this podcast with you is to at least try to preserve some of the lessons that Hassan and I had learned. We thought that you would be a really good communicator between us to try to push us to actually get at the points that we learned.

I’ve willingly gone along. I feel like there’s so many details to dive into. Is there anything that specifically we should have said that we didn’t?

DK: We could do this for another three hours if you like, Ben. I would say I think we’re living in an era of government intervention that may not be as predictable as we have liked, and so the era of uncertainty and unpredictability is here now, and we have to get used to it. CEOs are going to have to get used to that, government policymakers are going to have to get used to that and there’s going to have to be need for it. There’s going to be need for continuous translating between the two constantly now for the next foreseeable future.

Hassan, what’s your perspective?

HK: I’m not going to be able to give the folks at CHIPS as rousing a speech as Dan did. But I do think it’s worth remembering that at a high level, I think there’s actually a fairly strong bipartisan consensus on the urgency for these matters, and I hope that given there’s a bipartisan consensus, there’s opportunity to take the good ideas from each other and build upon them as opposed to focusing on executing one side’s ideas over the other.

Because I think back to an earlier comment that you had about focusing on the demand side versus supply side, the President has come out and he’s very willing to nudge on the demand side, and I think if we are going to move from one-off industrial policies toward a coordinated industrial strategy, it’s going to require taking ideas from both sides, because there’s things certain sides are comfortable with and other sides are no,t and there is probably a lot of good on both those sides, and that I think is a path towards sort of a coherent strategy. It does not mean it’s command and control by any means, but it’s at least, “Hey, let’s get the various levers talking to each other and working in unison towards the goals that we want to”.

That’s exactly what I was thinking. I think in general, the right is more comfortable thinking about the demand side, the left is more comfortable thinking about the supply side, if you want to put a partisan lens on it. This is why it’s hopeful, to your point, Hassan, that there is bipartisan concern about this. It’s frustrating that there is a wildly veering back and forth in terms of prioritization, in that the assistance of one or the other and actually you do need both. I think to many extents, the weaknesses in the program and the frustrations you guys ran into was in part because of that missing other side and the consideration of that, and yet that doesn’t mean that your side should have been thrown out, so let’s do both.

HK: Exactly. I see there are ways in which the President has made it very clear that he wants a lot of high-tech goods made in the US, and going and saying to these firms, Nvidia, Apple, “Why are you not building in the US?”, and using his bully pulpit is I think accretive to the goals that we had in the CHIPS program. So I would love a, “Hey, we started with this and now we can take out some of the ideas that we think aren’t working anymore, but we’re going to add to it”, that is I think a valuable approach.

I think you came off as more optimistic than Dan actually, Hassan, I think you underrated yourself.

HK: I really do believe both sides share an earnest belief in the urgency to address the problem, and I think if we can recognize that shared earnestness to address it, I am more optimistic. Our system feels more chaotic, but to your point, amidst the chaos, very smart capable people pull the good ideas to the forefront and they make them work. And so we may seem more chaotic and less organized than say the rest of the world, but that’s kind of simultaneously our superpower.

That is the US in a nutshell, absolutely.

HK: It is a little our superpower because some weirdo comes out with something that no one considered and turns out that’s a more viable disruptive path, and I do think that noise, you’ve got to kind of be able to be zen about it at some level and say something good may yet come hopefully.

DK: Our program director used to say, Ben, at our all hands meetings, and we kind of found it a bit comical, he said, “If he would’ve told me this is where we would be when we started the program, I would’ve taken it a hundred out of a hundred”, so amidst all the churn, all of the ups and downs, when I left the program about a month ago, in terms of all the announcements and all the awards and everything else that we did, of course things could have been more efficient. Of course things could have been for the better in a sense. But if you were to take it in a vacuum and say, “Were we successful?”, I think I would’ve taken it a hundred out of a hundred as well. Realizing that we had no playbook that was given to us, we had to create it. We had no process that were given to us, we had to create it. We had no formal mechanism for us to do interagency coordination, to do all the things necessary to get funding out, we had to create all of that. We had to create a team from scratch, we had to engage with every company.

And by the way, Hassan and I could have come up with the best strategy ever, and if the companies didn’t want to play ball, then it doesn’t really matter. Everyone has the best strategy in the world, but if you get punched in the face, then your strategy’s gone. I think I butchered that quote from Mike Tyson.

Close enough!

DK: Given all of that, I think it was a wildly successful program. If we take it as the first foray into industrial policy of something that we could build upon and learn from and do better as we go on, that we will take these lessons and improve ourselves and get to a better place and improving place, I think is wildly successful.

The last thing I would leave you with this, Ben, is this thought that I think about this every day as I listen to my daughter’s heartbeat, I talked to the chip designers at the medical device company. They’re called Medtronic, you might’ve heard of them, they have life-saving devices. I asked them about what node they’re made on, how it’s packaged, what fab it’s made from and everything else and they gave me all technical details. And the lead designer of that just kind of paused and said, “I just want you to understand this device, this pacemaker detects your daughter’s heartbeat, how it wants to beat. If she’s sleeping, it knows that. If she’s trying to walk or run, it knows that. If it needs to speed up or down, it knows that, it’s intelligent”. And he said, “Right now, I know there’s a lot of focus on AI, but that device in your daughter’s heart that’s keeping her alive, that’s AI”.

A cynical analyst might come along and say, “Actually, no, that’s an IoT device, AI is really in language models”. But I took that to heart to say, “Right, the best of what America has to the world is in part innovation, technology innovation that enables all of us to live longer, to live better, to live more peacefully and with more safety and health in our lives”, that’s AI there, it’s not just language models. It’s that too, and semiconductors and manufacturing thereof is the foundational building blocks of all of that, and we should never forget that, and it’s something that we have given to the world that we’re trying to strengthen. So it shouldn’t be a zero-sum game, it should be something that we approach with a lot of enthusiasm, but with a lot of care.

Well, I want to thank you guys for coming on the podcast, first of all, but more generally, I do want to thank you for your service. Dan, I talked to you a while ago and like I said, you’re looking much better these days, I’m glad you’re on vacation, I’m glad you took time from your vacation to come on here, but I genuinely thank you both and you did good work and I agree. We’re in a better place than we were.

DK: Thanks, Ben.

HK: Thanks, Ben.

This Daily Update Interview is also available as a podcast. To receive it in your podcast player, visit Stratechery.

The Daily Update is intended for a single recipient, but occasional forwarding is totally fine! If you would like to order multiple subscriptions for your team with a group discount (minimum 5), please contact me directly.

Thanks for being a supporter, and have a great day!