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China’s Semiconductor Revolution

24/08/20 Adam Walker Director

China recently unveiled tax incentives to encourage innovation in its domestic semiconductor industry with semiconductor design, packaging, and testing being tax-exempt for the first two years.

This move is the latest approach to increase investment in the key battleground in the technology war between China and the USA.

The Shanghai STAR market has been the preferred venue for many of China’s new and fledgling semiconductor companies, with the SMIC raising $7.5B in July alone.

For two decades, China has been known as the world’s centre for volume and low-cost production of electronics equipment built by the largest electronic manufacturing service (EMS) providers such as Foxconn, Flextronics, Jabil, Sanmina, New Kinpo, etc. These companies such as Foxconn build for notable original equipment manufacturers (OEM’s) producing the likes of the iPhone, iPad, Kindle,  Nintendo 3DS, Xbox and PlayStation. It was estimated back in 2012 that Foxconn built 40% of all consumer electronic

But China’s recent investments in semiconductor manufacturing is changing the perception as it competes directly with the USA, South Korea, and Taiwan for a major share of the global chip market.

As part of a 10-year plan announced by the Chinese government in 2014, about $150 billion was to be invested by the government and equity firms in the Chinesesemiconductor industry which is now starting to deliver returns. In 2018 slightly more than 15% of China’s total semiconductor consumption was supplied by China-based production.

Thus, developing and strengthening the industry was a high priority for the Chinese government. China wants to move “up the value chain” from assembling final products from often imported components to creating advanced technology in China itself.

This drive for semiconductor prowess will ensure that a procurement professional is likely to be spending more time in China as it becomes a significant player in the global semiconductor industry.

According to Chinese media, from the second quarter of 2020 to July, there were 77 semiconductor related financial activities (a total of 72 companies) with capital investment in the chip industry showed nearly a ten-fold increase from the previous year.

The growth of the Chinese semiconductor industry has been brought about by the government incentivising companies to locate and expand in China whilst lowering the barriers for foreign participation in China’s semiconductor production and moves adopted by Taiwanese investors relocating manufacturing and senior executives to the country.

China already has the largest market for semiconductors since 2005. Annually, China consumes more than 50 percent of all semiconductors, both for internal use and export. However Chinese manufacturers are reliant on external supply as its current capacity is less than 30% of their internal demand. To rebalance China’s semiconductor capability, they have been calling upon leading digital businesses to improve domestic semiconductor manufacturing capabilities with the likes of Huawei Technologies taking a lead.

The growing demand for smartphones, tablets, digital televisions, wireless communications, computers is continuing to stimulate global demand and thus increase China’s consumption.

China’s State Council 2014 “National Integrated Circuit Industry Development Guidelines” set the goal of becoming a global leader in all segments of the semiconductor industry by 2030. Also, the Made in China 2025 initiative maintains the research and application of the technology are vital for China’s future. By adopting this approach China aims to reduce semiconductor imports, shrink the sizeable deficit, and achieve self-sufficiency for its semiconductor needs. Their goal is to create champions in every semiconductor market, such as memory, microcontroller, analog, CPU and AI chips etc.

China is already becoming more competitive in the semiconductor memory arena but has much greater difficulties in manufacturing CPU based technology and other more specialised chips. They currently rely on major US suppliers who have built up skills over many years in advanced manufacturing and design. China is dependent on foreign expertise, particularly from Taiwan and the United States. Imports of both semiconductors and technology will be the norm for many years to come.

Though Chinese firms lack worldwide market share, the semiconductor industry has a long presence in the country. China’s control in the global electronics value chain has led semiconductor firms to establish back-end assembly, test, and packaging facilities to take advantage of labour costs and the proximity to the Chinese EMS facilities.

Semiconductor manufacturing requires, ownership of (or access to) a substantial amount of intellectual property (IP), managerial skills, highly skilled employees in semiconductor IC design and process engineering, and a close connection to scientific research. Currently, the United States leads in semiconductor design, followed by Taiwan.

Though China has attracted major players to locate facilities such as ON Semiconductor, NXP Semiconductor, Infineon Technologies, and ST Microelectronics. By pushing ahead with the development of its own chip industry is causing political concerns in the US, with the likes of Huawei facing the threat of losing access to American technology they have sought home-grown supply.

Experts believe that China is at least a decade from catching up with US technology. Still, if China successfully develops its own semiconductor industry, that could severely hurt US companies that have reaped profits in the country for many years.

With Chinese technology giant Huawei placed on the United States blacklist, American firms are now required to obtain government permission to sell to the company. This sanction has remained a significant problem for the company.

Huawei, 2020 was always set to be a tough year the company warned in its New Year message to employees, and nothing that has happened since has suggested those warnings were wrong. Smartphone sales had become the leading driver of Huawei’s growth and profitability before the blacklist, and now that is narrowed further to phone sales in China. This is a serious over-exposure, and it will not reduce any time soon.

Until May, the issue for Huawei’s smartphone sales—outside China, where Google is banned—was that loss of US software and services. But the blacklist was extended in May, on its first anniversary, and now Huawei is facing restrictions on the cutting-edge semiconductors inside its flagship products as well. Beyond smartphones, this has hit Huawei hard in the 5G equipment market. Here Chinese consumers cannot make up the difference. And while Huawei is guaranteed the lion’s share of 5G network kit sales in China, it is losing sales elsewhere, most notably in the UK All down to that US blacklist.

This incident between Huawei and the US government has stimulated evermore interest in China developing its domestic semiconductor industry. Huawei has its own “KIRIN” series of processors for its smartphones and even a 5G mode. Huawei’s semiconductors are designed by its subsidiary HiSilicon, which has stated it is prepared for such a move by American and can weather the political turmoil.

Lumentum, a Huawei supplier, said sales to the Chinese firm accounted for over 15% of total revenue for the three months that ended on March 30. Lumentum also revised its revenue guidance lower for the uncertainties.

China’s other technology giants are also said to be considering their own silicon. Xiaomi and Alibaba are both rumoured to be working on AI processors.

One of the biggest challenges for China will be finding and developing new suppliers if American sources remain off-limits or have certain sanctions applied. Under pressure from the US administration, the Dutch government last year blocked ASML from shipping a EUV scanner to SMIC. Without access to the state-of-the-art semiconductor processing equipment in lithography, the Chinese foundry will never be able to catch up market leader TSMC.

Though not easy if China is able to acquire the right professional talent, companies, and partnerships, it will be on track to create a large homegrown semiconductor industry in the next decade to compete aggressively with US businesses.

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