Silicon squeeze: AI’s impact on the semiconductor industry

Profitability and growth dynamics in the semiconductor industry have shifted dramatically in recent years. The industry as a whole has experienced impressive economic profit growth, rising from $38 billion in the 2000–09 period to $450 billion in 2010–19, according to McKinsey analysis. In October 2024, the McKinsey Global Institute noted semiconductors as one of 18 industries poised to transform the future business landscape, with anticipated value of between $1.7 trillion and $2.4 trillion by 2040.¹“The next big arenas of competition,” McKinsey Global Institute, October 23, 2024.

While AI’s technological requirements are funneling a significant amount of investment and demand to the industry, the resulting gains are largely concentrated among a handful of key suppliers and distributors. Meanwhile, economic value generated by the remaining industry players is increasingly squeezed along with their growth prospects as dynamics shift with the proliferation of AI and expansion of Chinese market players. In fact, the top 5 percent of companies generated all of the industry’s economic profit in 2024, while economic value generation for the remaining 95 percent of companies declined sharply.

In aggregate, the semiconductor industry has largely been viewed as having recovered from its 2022–24 downturn.²State of the U.S. semiconductor industry 2024, Semiconductor Industry Association, 2024. However, a more detailed analysis reveals a very different and more nuanced view. With the exception of the few top players in terms of economic value, the industry’s recovery has been much slower than expected or has yet to transpire. Meanwhile, the Chinese semiconductor market continues to expand, evolve, and exert pressure on market share in the global industry. To navigate this growing environment, semiconductor companies in all industry sectors will need to find ways to use AI-driven opportunities, expand into adjacencies, boost productivity, and build resilience to geopolitical shifts and other industry disruptions.

Value creation in the semiconductor industry is increasingly concentrated

Economic profit growth (returns that companies in the sector generate over their cost of capital) in the semiconductor industry has been strong. Relative to other industries in the top 30 for average economic profitability, the semiconductor industry has progressed dramatically, going from 15th place in 2000–04 to fourth place in 2016–20 and third place in 2020–24.³Ondrej Burkacky, Marc de Jong, Ankit Mittal, and Nakul Verma, “Value creation: How can the semiconductor industry keep outperforming?,” McKinsey, October 15, 2021.

In its first decade, the semiconductor industry generated a relatively modest economic profit value of about $38 billion, most of which was contributed by Intel, according to McKinsey analysis. Aside from Intel, other industry players generated minimal or negative economic profit. The maturing industry consolidated significantly and scaled up the foundry model in its second decade; the emergence of new technologies such as smartphones created new avenues for growth beyond computers. Consequently, profitability increased dramatically, and the industry generated $450 billion in economic profit between 2010 and 2019.

Between 2020 and 2024, the industry generated an aggregate economic profit value of $473 billion—more than it created during the entire decade prior (Exhibit 1).

Image description: A stacked column chart shows economic profit and loss in the semiconductor industry from 2000 to 2024. The aggregate economic profit from 2000 to 2009 was $38 billion, with a margin—aggregate economic profit divided by revenue—of 1.3%. From 2010 to 2019, the aggregate profit and margin were $450 billion and 8.0%, respectively, which is less than the $465 billion profit and 9.6% margin from 2020 to 2024. Notably, the chart shows that economic losses were significantly larger in 2023 and 2024 than in previous years, at -$70 billion and -$40 billion. Notes: Figures may not sum, because of rounding. Economic profit is calculated as net operating profit less adjusted taxes (capital charge, where capital charge is invested capital including goodwill at previous year multiplied by weighted average cost of capital); based on a sample of approximately 410 companies over 2000 to 2019, about 310 for 2020 to 2021, and about 300 for 2022 to 2024. Source: McKinsey Value Intelligence; McKinsey analysis End image description

This spike in economic profit is primarily due to the explosive growth in AI and new applications for semiconductors in markets such as automotive and industrial. It is also partly due to some abnormally high profits generated during pandemic-driven product shortages.

Recently, however, the sector has seen a divergence in value generation. In 2023 and 2024, respectively, the top 5 percent of industry players—led by Nvidia, TSMC, Broadcom, and ASML—generated $121 billion and $159 billion in economic value, while players in the bottom 5 percent of economic value generation lost $45 billion to $70 billion, according to McKinsey analysis. Nonetheless, the current state of the semiconductor industry in aggregate cannot be explained solely by examining the outsize impact of the top economic value generators in the earliest and most recent market phases. A much deeper analysis is needed to identify and address widespread industry issues.

For example, viewing economic profit in terms of industry players in the top 5 percent, middle 90 percent, and bottom 5 percent of economic value generation brings industry dynamics into sharper focus: In 2024, the top 5 percent of companies generated $147 billion in economic profit, the middle 90 percent generated only $5 billion, and the bottom 5 percent lost $37 billion. The power curve in the semiconductor industry has become exceptionally steep, and power is increasingly concentrated among the companies in the top 5 percent of economic value generation (Exhibit 2).

From 2021 to 2022, the middle 90 percent of the industry experienced a sharp rise in economic value generation linked to pandemic-related shortages. However, the effects of the pandemic on the middle 90 percent of companies were temporary; by 2024, their economic value generation had fallen from a 2021 average of $130 million per company to below prepandemic levels at $17 million (Exhibit 3).

Image description Two charts with eight columns each show sharp declines in total and average economic profit for the middle 90% of companies in the semiconductor industry from 2021 to 2024, as measured by revenue for the period from 2017 and 2024. Total economic profit fell from $33.5 billion in 2022 to $10.3 billion in 2023, and $4.5 billion in 2024, while average economic profit fell 88% in the same period, from $130 million in 2021 to $16 million in 2024. Note: Based on a sample of approximately 410 companies for 2017 to 2019, about 310 for 2020 to 2021, and about 300 for 2022 to 2024. Source: McKinsey Value Intelligence; McKinsey analysis End image description

This is a tale of two industries. A small part of the industry is riding the value creation boom and generating economic profit at unprecedented levels. But most of the industry is facing a very different reality.

Inventory and revenue trends signal that the industry has not fully recovered

Viewed in the aggregate, the industry appears to be recovering from its most recent downturn relatively quickly, similar to its recovery following the 2008 downturn, when peak revenue levels were reached in 2010. However, if Nvidia (the number-one player in the top 5 percent of economic value generation) is removed from the calculation, the industry’s overall performance picture changes substantially. The recovery trajectory since the downturn that began after May 2022 resembles the longer duration seen in the wake of the 2000 downturn: an elongated climb back to peak revenue levels in 2004 (Exhibit 4).

Image description A line chart shows timeframes for semiconductor industry returns to peak sales levels following significant downturns in 2000, 2008, and 2022. One line shows it took about 18 months to recover from the 2008 downturn, and another line shows it took 4 years (48 months) to recover from the 2000 downturn. A line that plots semiconductor industry sales from the peak in May 2022 to November 2024 shows that if Nvidia’s sales are included in the aggregate’s total, it appears that the industry recovered quickly, within around 24 months, and by November 2024 had exceeded peak sales levels by around 10%. However, excluding Nvidia’s numbers from aggregate, the industry remained 10% below peak sales levels for 30 months after the 2022 downturn, following a trajectory that resembles that of the 48-month recovery from the 2000 downturn. Source: Semiconductor Industry Association; World Semiconductor Trade Statistics; McKinsey analysis End image description

Since 2000, spikes in inventory as a share of next-quarter revenue have been associated with downturns in the semiconductor industry: As the industry recovers, inventory levels drop. This holds true for all segments of the industry, including suppliers, distributors, and manufacturers (OEMs, original-design manufacturers [ODMs], and electronic manufacturing services [EMSs]). When an industry downturn began in May 2022, for example, inventory as a share of next-quarter revenue in the supplier and distributor segments spiked to 75 percent (from about 55 percent in the first quarter of 2022) and to 49 percent (from about 40 percent) in the manufacturer segment.

The world has learned to live with higher levels of semiconductor inventory. In fact, it’s recognized that it needs to do so to avoid future supply shortages. But current levels are quite high, comparable to levels seen during earlier industry downturns. And although they have begun to decline, especially for semiconductor customers such as OEMs, ODMs, and EMSs, high levels persist for semiconductor suppliers and distributors. In another sign that the path to recovery will be longer than anticipated, supplier inventory assessments that exclude Nvidia (69 percent) are 11 percentage points higher than those that include Nvidia (58 percent) (Exhibit 5).

Image description

A line chart shows inventory levels for three segments of the semiconductor industry, measured as a percentage of next-quarter revenue. The chart reveals that between 2022 and 2024, inventory levels have only declined in the OEM, original design manufacturer, and electronics manufacturing services industry segment, while levels for the distributor segment remain high (at 78% in Q3 2024) and levels in the suppliers segment appear to be declining (down to 58% in Q3 2024 from around 63% in 2023) if Nvidia’s numbers are excluded from the total. When Nvidia numbers are included, supplier inventory levels are rising, at 69% in Q3 2024.

Notes:

1. Includes 329 public semiconductor companies made up of independent design manufacturer, fabless, foundry, microcontroller, and packaging and assembly companies. Excludes electronic design automation, capital equipment, memory integrated devices manufacturer, and intellectual property companies.
2. Includes 5 of the largest public distributor companies.
3. Includes top 121 public OEM, original design manufacturer, and electronics manufacturing services companies.

Source: Source: S&P Global Market Intelligence; McKinsey Value Intelligence

End image description

Industry dynamics shift further as the Chinese market expands and evolves

Globalization was a dominant force behind the industry’s growth between 2010 and 2019. Global semiconductor companies expanded their presence in China, and this accounted for an increasing share of their revenue. Consider, for example, the regional revenue split of key semiconductor equipment players: Mainland China increased its share of sales from 6 percent in 2010 to 25 percent in 2020 and 38 percent in 2024 (Exhibit 6).

China’s revenue share for 2024 could be an outlier, representing potential stockpiling of semiconductor equipment to mitigate the impact of potential future trade restrictions. Nonetheless, a clear trend indicates that Mainland China market players are increasing the country’s share of semiconductor equipment. Between 2010 and 2024, declining shares were most pronounced in the Taiwan and Japan markets. The Taiwan market is building fab capacity outside of Taiwan in the United States and Europe, and a limited number of new fabs have been built in Japan—two factors that could be contributing to this trend. Meanwhile, market players in Korea; the United States; and Europe, the Middle East, and Africa have maintained their historical shares.

The period between 2010 and 2019 marked the emergence of local Chinese semiconductor players with per annum growth rates of 21 percent. However, a rapid decline in the revenues of leading Chinese player HiSilicon (following US sanctions on Huawei) stunted growth between 2019 and 2023.⁴“Gartner says worldwide semiconductor revenue grew 26% in 2021,” Gartner, April 14, 2022. Excluding this single player, the semiconductor industry in China grew at 9 to 10 percent annually between 2019 and 2023. Going forward, a strong 9 percent per annum growth rate is anticipated for local Chinese players.

Semiconductors are essential components for expanding industries such as electric vehicles (EVs) and commercial drones, and Chinese players have demonstrated an intent to build an outsize presence in these areas. Globally, for example, 60 percent of new EV registrations in 2023 were in China.⁵“Electric vehicles,” International Energy Agency, accessed April 4, 2025. Meanwhile, mounting geopolitical considerations have strengthened the impetus for China to develop its domestic semiconductor ecosystem.

These conditions have potentially far-reaching implications for the industry because ongoing imbalances could exacerbate shortages in critical materials, disrupt supply chains, and squeeze margins for companies in all industry segments around the globe.

Bold actions are needed to drive industry growth as pressure builds on multiple fronts

Between 2019 and 2023, the segment of the semiconductor industry that deploys components for AI applications had a CAGR of 21 percent. Companies benefiting from the AI boom include fabless, foundry, and capital equipment players that help supply components such as logic chips—GPUs and data processing units (DPUs)—and microcomponents such as microprocessors (MPUs) and microcontrollers (MCUs). During the same period, CAGR for the overall semiconductor industry was 6 percent; excluding memory players, industry CAGR was 9 percent. Meanwhile, growth for companies based in Mainland China was largely flat, and non-AI companies in the rest of the world grew by 8 percent per annum.

By 2030, the semiconductor industry could reach $1 trillion in revenue. Gen AI expansion has the potential to contribute an additional $300 billion, for a total of $1.3 trillion. And these prospective revenue numbers are somewhat conservative; continued investments in AI and gen AI could further accelerate growth in the semiconductor market.

But growth prospects through 2030 differ greatly from what the industry experienced between 2019 and 2023. CAGR for companies with exposure to AI could be strong at 18 to 29 percent. Benefiting from its exposure to data center tailwinds, the memory segment could see CAGR rebound to 17 to 23 percent. As the Mainland China market matures, CAGR for local players could be 14 to 20 percent. However, companies in other geographies and industry sectors may experience a sharp decline in CAGR to about 2 to 3 percent—less than a third of historic CAGR for this segment of the industry (Exhibit 7).

Most players could find growth increasingly difficult as their market share gets squeezed by AI-centric companies and the emergence of at-scale market players in Mainland China. Thus, the dynamics that have shaped the semiconductor industry over the past decade may not persist through the next decade. The geopolitical environment will continue to be complex, offering both challenges and opportunities, so players must consider how they will identify and enable the right opportunities and become better at navigating challenges.

For the semiconductor industry to fully recover and achieve widespread growth in the future, companies must reimagine their business models and seek new opportunities for growth—for example, in adjacent segments or perhaps expanding vertically beyond the confines of the semiconductor industry as part of a solution play. Some companies are already exploring new options and trying to differentiate themselves. Some may spin off and reorient themselves, perhaps entering new partnerships or significantly changing their operations or organization. Without innovation and new sources of revenue, some companies may not bounce back from their current levels.

Companies should also reevaluate their product portfolios and aim to strengthen their solution plays via further consolidation. Companies that lack exposure to AI will need to establish how they will enter and participate in an increasingly AI-driven industry, and agility and speed are essential to compete and grow. Technology innovations should focus on creating a more productive, healthier, and more sustainable world. Value realization should go beyond creating AI applications, adding value on top of AI, and benefiting the global economy.

At the same time, players must be able to use AI to reimagine, or rewire, their businesses and how they run them, improving on execution while finding new and different ways to operate.⁶See “Rewired: The McKinsey guide to outcompeting in the age of digital and AI,” McKinsey on Books, accessed April 4, 2025. There has been a great deal of consolidation in the semiconductor industry, but many companies have not yet been able to transform their systems or processes, missing out on opportunities to gain productivity alongside their increased scale. Deploying AI and gen AI use cases in key domains such as product development, sales, and manufacturing can unlock significant productivity gains while reducing time to market and improving customer engagement.

Finally, the semiconductor industry must determine how it will enable the next frontier in operational productivity at a time when talent is growing increasingly scarce. The average worker age in certain critical areas of the semiconductor industry is increasing as the generation of workers with the most experience prepares for retirement, and AI is not quite ready to fill the void.

Ultimately, the growth that characterizes the semiconductor industry must be harnessed and channeled into innovation. AI can help companies realize greater efficiencies while unlocking new capabilities and avenues for growth. Rising to meet these challenges is vital, not just to ensure that players worldwide have access to what they and their markets require but also to buffer the combined impacts of continually shifting geopolitics, material and talent shortages, supply chain disruptions, and a juggernaut of technological advances.