Sharply Lower Demand Causes Concern in Asia Storage Supply Chain

This is an executive brief of Trendfocus Information Services.

The Trendfocus, Inc.‘s team was in Asia over the past 10 days to discuss the recent sharp cuts to flash and HDD storage demand with vendors and supply chain clients.

For the HDD supply chain, the big questions are “why” and “when will it get better”? Most of our meetings involved explaining, at length, to clients the combination of economic factors that have prevented the slower-than-expected consumption of inventory across OEM.

More importantly, significant component supply constraints at major hyperscale companies along with excessive inventory buildups at some cloud customers, irrespective of component shortages, have forced suddenly steep cuts in orders – conditions that have already caused Seagate and Western Digital to provide reduced guidance compared to what was given during last quarter’s earnings calls.

Exacerbating the hyperscale inventory position is the recent use of ocean shipments to reduce freight costs. Prior to the past few quarters, hyperscale companies all utilized air freight for HDDs to quickly obtain supply, but significant increases in air logistics have motivated even cloud companies to accept sea shipments to avoid additional freight surcharges. This move unfortunately results in a large, slower-moving bubble of in-transit inventory that didn’t exist previously, further weighing on order reductions.

As indicated in our pre-travel Executive Brief, HDD build plans for the just completed 3CQ and current 4CQ22 quarters were trimmed to the mid-30 million range, implying that the 2022 HDD shipment TAM could fall to nearly 170 million.

During the trip, the component suppliers finally witnessed cuts to build plans by one hold-out HDD company that maintained relatively steady nearline build expectations up until last week. As a result, current 4CQ22 HDD industry combined builds have slipped further, falling to around 33 million units.

The HDD suppliers themselves do not appear to be holding much previously built inventory, which could be a bright spot for a future rebound in component and HDD demand once HDD customers work through current inventory and system component supply issues. However, many HDD component companies are planning to or have already triggered factory shutdowns into October to deal with degraded market demand for HDDs.

Higher energy and raw materials costs along with falling currencies vs. the US dollar have impacted HDD component costs.

In addition, newer advanced HDD designs have also resulted in more complex and costly components. In general, while the HDD supply chain remains under pressure by HDD companies to manage pricing, invariably, component pricing continues to inch up in many cases. Combining this factor with a very weak end market, HDD vendors will need to carefully resist customers’ demands for price cuts in order to preserve gross margin in order to weather the next two quarters of market weakness.

While US cloud demand will rebound, likely in 2CQ23, with inventory digestion completed and system component availability improved, the broader market for storage will be at the mercy of large, difficult to control macroeconomic factors, including the now widespread assumption that a global recession is looming. The depth and duration of a global economic malaise will depend upon the resiliency of the US economy to weather higher unemployment until inflation rates make measurable sustained reductions in the face of continued aggressive interest rate hikes by the US Federal Reserve. Adding to the uncertainty are potentially devastating actions Russia may take to retaliate vs. western nations’ support of Ukraine following Russia’s invasion of that country in early 2022. China’s zero-Covid policies and ongoing housing crisis have cut growth in the world’s second largest economy in half for 2022, with the slowdown expected to drag well into the first half of next year.

Longer-term, the HDD industry faces the dilemma of when to invest in component capacity expansion given the near-term demand weakness. The exceeding of production capacity for components such as media, substrates and heads are still forecast by sometime in 2024, either requiring investment decisions in 2023, or allowing component supply constraints to manifest into a situation for suppliers to gain leverage over customers in terms of pricing and availability. Adding to long-term component constraints is the all-but-certain move to 11-disk HDDs over the next couple of years. The potentially good news for 11-disk designs is that the current implementation of 0.5mm thick aluminum-based substrates used for new 10-disk HDDs will also work for drives that add the 11th disk. Ongoing sampling and development of even thinner aluminum substrates is now under consideration for the potential of adding a 12th disk, possibly to support CMR capacities at or above 30TB (likely not to occur until 2026 or 2027).

Industry chatter also points to some solid progress in the development of HAMR HDDs, although Seagate’s pronouncement of shipping 30TB HAMR HDDs sometime in 2023 appears more like a next step on the way to eventually mass producing HAMR drives, rather than a rapid transition to HAMR. Seagate has publicly stated that transitioning to HAMR as a mainstream HDD technology will depend on yields and scrap rates of the HAMR process, so while technology capability is progressing, some additional work may be required over the next couple of years to prove profitable volume manufacturing. However, if a successful and meaningful increase in areal density enables HDD capacity gains without resorting to more than 10 disks, that could be a game changer for the industry and hyperscale customers at large.

On the NAND flash front, suppliers were in a similar mood as the HDD industry, ruing the plunge in demand and the significant increase in inventory; however, unlike the HDD industry which apparently maintains relatively little finished goods inventory in-house, plenty of NAND and NAND-based products are sitting at suppliers and customers alike. Both Kioxia and Micron have announced actions to reduce bit output to allow for the inventories to correct and re-balance to lower demand over the next few  quarters at least, but NAND and SSD prices will continue to plunge due to excess inventory and lack of demand in every market segment.

For the NAND industry, a domino effect has occurred that started at the beginning of the year when it was clear that pandemic-driven consumer PC sales stalled, followed by weakening mobile NAND demand in 2CQ22 and slowing enterprise system OEM demand extending into 2H22. Commercial PC spending has also fallen due to economic headwinds while hyperscale customers are moving solidly into a period of inventory digestion, wiping out any hope of supporting SSD shipments last 2 quarters of the calendar year.

As cloud companies consume a large portion of WW SSD NAND demand, the digestion phase currently underway will slow bit absorption possibly into 1CQ23, a longer cyclical slowing compared to historical norms. With every NAND end market down, and despite production adjustments by Micron and Kioxia, which will most likely be followed by others very soon, we can anticipate double-digit price declines over the next 2 quarters. The general feedback is that by mid-2023 after NAND vendors offer up nearly 40% to 50% per-bit price declines, the flash industry will no longer offer further price reductions following what will be a year of market softening. In the end, macroeconomic factors will determine the 2023 outcome for a NAND market that will continue to suffer with weak demand across all market segments.

After nearly 3 years of virtual calls with Asia-based clients during the Covid pandemic, the return to our first face-to-face contacts in Korea and Japan was refreshing and the familiarity of formerly frequent visits quickly returned. The Covid-19 pandemic created what felt like a time warp, where no travel and changed work environments felt like time was suspended in the intervening years. Landing in Asia with significant paperwork and other logistical hoops to jump through was a bit different this time, but experiencing Korea and Japan again felt like we had visited just months prior, rather than way back in 2019. As restrictions and quarantine rules ease further throughout much of Asia, the Trendfocus team looks forward to expanding our face-to-face encounters in the coming months and into 2023.