The demand for chips has never been greater, with high-performance computing (HPC) now dictating where the silicon flows. At the same time, there’s massive pressure on the leading chip foundry, Taiwan Semiconductor Manufacturing Company (TSMC), to remain resilient despite capacity constraints.
The giant is now doubling down on its most advanced chip technologies, even as the shift to 2-nanometre(2nm) production begins to weigh on margins. This is being viewed as an early sign of how the transition to 2nm will reshape both demand and profitability in the semiconductor industry.
For Q1 2026, TSMC reported revenue of $35.9 billion, up 40.6% year-over-year, driven by demand for leading-edge chips. Advanced technologies, including 7nm and below, accounted for 74% of total wafer revenue, highlighting the company’s increasing reliance on cutting-edge nodes.
“Moving into second quarter 2026, we expect our business to be supported by continued strong demand for our leading-edge process technologies,” said CFO Wendell Huang in the earnings call.
HPC accounted for 61% of TSMC’s revenue in Q1, up from previous quarters, while smartphone demand declined sequentially. This shift reflects a deeper change in the semiconductor market. AI workloads are driving sustained demand for advanced chips, especially at 3nm and below.
“AI-related demand continues to be extremely robust,” said CEO CC Wei in the call. “The shift from generative AI and the query mode to agentic AI and the command and action mode is leading to another step up in the amount of tokens being consumed.”
That rise in compute demand is pushing customers to adopt newer nodes faster. In the first quarter, 3nm alone contributed 25% of wafer revenue, while 5nm accounted for 36%. Together, these nodes form the bulk of TSMC’s business.
The company is responding by expanding capacity across regions. It plans to add new 3nm fabs in Japan, Taiwan, and the US over the next few years, even though the node has reached maturity, as AI workloads continue to drive demand. North America accounts for 76% of the company’s revenue.
2nm Arrives But Brings Costs
At the same time, TSMC has begun ramping its next-generation 2nm process, N2. The node entered high-volume manufacturing in late 2025 and is now scaling across sites in Taiwan.
The executives noted that the demand for 2nm is already strong. “N2 is ramping successfully in multiple phases at both Hsinchu and Kaohsiung sites, supported by strong demand from both smartphone and HPC/AI applications,” Wei said.
However, this transition is not without trade-offs. The company expects the early ramp of 2nm to dilute gross margins by 2–3% in 2026. That pressure comes as TSMC continues to invest heavily in new capacity. The company plans capital expenditure at the higher end of its $52–$56 billion range this year.
The financial impact of this shift is already visible.
Inventory levels have risen as the company prepares for 2nm production while meeting strong 3nm demand. Margins remain strong for now. Gross margin stood at 66.2% in the first quarter, supported by high utilisation and cost improvements.
Still, executives signalled that newer nodes will weigh on profitability in the near term.
They also flagged potential cost pressures from rising prices of key materials and geopolitical uncertainty. They cited the recent situation in the Middle East, which could drive up the cost of chemicals and gases critical to semiconductor manufacturing.
The company said it has built supply resilience through multi-region sourcing and inventory buffers, but warned that higher input costs could still affect margins. “Based on our current assessment, there may be an impact on our profitability, but it is too early to quantify the impact,” it said in a statement.
Bet on Advanced Nodes
TSMC is managing a balancing act between growth and profitability. While demand for advanced chips is rising, the cost of scaling new nodes is also increasing.
“We expect the N3 gross margin to reach and cross the corporate gross margin level in the second half of this year,” said Huang.
That improvement will help offset some of the pressure from 2nm. However, the broader cost structure is changing. Overseas fab expansion will also dilute margins in the early stages, adding another layer of pressure.
At the same time, TSMC sees demand remaining strong for the long term. “Our customers and customers’ customers, who are mainly the cloud service providers, continue to provide us with their very strong signal and positive outlook,” Wei said.
This demand outlook underpins the company’s aggressive expansion plans. TSMC is building capacity not only to meet current demand but also to support future growth in AI and computing. The company also expects its full-year 2026 revenue to grow by over 30%.
For now, TSMC is prioritising scale and investing in 2nm and beyond, even if margins take a temporary hit.
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