Illustration picture of semiconductor chips on a circuit board
Semiconductor chips are seen on a circuit board of a computer in this illustration picture taken February 25, 2022. Reuters

Chinese missiles flying over Taiwan and naval drills in the Strait in August that simulated a blockade by China have jolted the semiconductor industry into contemplating what once seemed a remote possibility: war over the major chip-producing island.

From drafting contingency plans to inquiring about manufacturing capacity outside Taiwan, some companies are now weighing how to respond if China attacks or restricts access to the democratic island, according to 15 semiconductor executives interviewed by Reuters.

While Taiwan has lived under the Chinese threat for decades, with occasional spikes in tensions, the war games in early August following the visit of U.S. House Speaker Nancy Pelosi to Taipei rattled nerves, said the executives, who asked for themselves and their companies not to be identified due to concerns over relations with China.

China claims Taiwan as its own territory. Taiwan's government rejects China's sovereignty claims.

Taiwan produces the vast majority of the world's most advanced chips and is home to Taiwan Semiconductor Manufacturing Company Ltd (TSMC), the world's largest contract chipmaker and supplier to major companies like Apple Inc, U.S. chipmaker Nvidia Corp and chip designer Qualcomm Inc.

Chips are crucial for building everything from iPhones and washing machines to cars and fighter jets.

The executives said it would be hard to wean the world off its reliance on Taiwan's hi-tech chips quickly but geopolitical challenges confronting the industry are increasing.

"Everyone is currently talking about business continuity plans," said Terry Tsao, president of the SEMI Taiwan industry group. "A small portion of companies have only started to make these plans recently. From what I've heard, most are foreign companies." Forty percent of respondents polled by the American Chamber of Commerce in Taiwan the week after Pelosi's visit said their companies were revising or about to revise their crisis contingency or continuity of operations plans in Taiwan.

One chip executive at a large foreign firm with operations in Taiwan said his company was asked about its business continuity plans by its customers and had in turn asked their suppliers in Taiwan the same questions.

"No-one really ever highlighted any kind of military action in their business continuity plans and now they are," he said. Unsettled by the Chinese drills, which showed how easily Taiwan could be blockaded, management had launched efforts to plan for disruption in supplies and other scenarios, he said: "I don't think anybody believes the political environment is going to get any better."

Some say the presence of chipmakers provides Taiwan with a 'silicon shield' - making China less likely to attempt to take the island by force and the United States reluctant to allow it to fall into Chinese hands. While the government in Taipei has downplayed this theory, it is keen to avoid any weakening of its economically vital semiconductor sector.

Later in August, officials from Taiwan's foreign ministry, economy ministry, and top military think tank made their case for the island remaining a safe place for chip investment at a closed-door AmCham event.

Sebastian Hou, senior investment analyst at Neuberger Berman in Taipei, said that after the U.S.-China trade war began many Taiwanese non-chip tech companies had reshored manufacturing or relocated to Southeast Asia because they were asked by their clients in the United States or Europe to diversify away from China. However, following Pelosi's visit, "customers in the Western world expressed their concerns about being too concentrated in Taiwan", Hou said: "There's no immediate action requested by their Western clients, but some discussion is already underway." INDISPENSABLE ISLAND One foreign chip executive with factories outside of Taiwan said more companies contacted him after Pelosi's visit to discuss options, but those meetings have not yet translated into new orders. He declined to name the companies involved.

"People are looking at: 'If I have choices, where else can I go to ensure that my device - my supply chain - does have alternatives if missiles do start flying?" the executive said.

These are customers seeking chips made with older technology because, when it comes to the bleeding-edge, there are no alternatives to TSMC with the production capacity to serve leading firms, the executive said.

Executives told Reuters it will be difficult to replicate the efficiency of Taiwan's semiconductor industry, with chip giants and hundreds of their suppliers arranged in clusters along the western coast of the island - especially given higher costs in countries such as the United States.

An executive at another major foreign chip company with operations in Taiwan said that - while the drills were forcing a closer consideration of the risks of future investment there - withdrawing was not on the table.

"It is still the business or financial terms that have a much bigger say," he said.

Kung Ming-hsin, minister of Taiwan's National Development Council, told reporters last month that major chip companies, including foreign ones, will invest around $210 billion in Taiwan over the next five years on advanced manufacturing.

German chip materials giant Merck is redoubling its investment. Last year, Merck announced a 500-million-euro investment in Taiwan over the next five to seven years. John Lee, managing director of Merck Group in Taiwan, told Reuters after Pelosi's visit that it has no plans to change course because the demand for chips is growing exponentially and Taiwan remains the world's largest semiconductor materials market. 'BEYOND OUR CONTROL' One executive at a major Taiwanese tech firm said it started to produce daily geopolitical reports following the drills to assuage foreign clients that it was taking the issue seriously - rather than because it was concerned about the risk of war. "Taiwan is used to this but if you are sitting in the C-suite overseas, it's much more alarming," the executive said.

A senior executive at another Taiwanese chip company said, however, that his firm has yet to receive significant pressure from foreign clients because of the military tensions. "They understand no matter how hard they twist our arm, there's very little we can do," said the executive. In recent years, Taiwanese chip companies have ramped up investments abroad, but the planned capacity is still only a fraction of their overall output, executives and analysts say.

When asked whether cross-strait tensions would affect his business, Miin Wu, the chairman and CEO of Taiwanese chipmaker Macronix International Co Ltd, told reporters last month: "Of course we worry about it". But he added that worrying did no good.

"Rather, we just continue to invest and come up with better and better products," he said.