Taiwan vs. the “Red Supply Chain”

The key question is how long can Taiwan’s IC industry hold off its Chinese competitors?

Taiwan’s semiconductor sector faces a formidable challenge from China as Beijing moves aggressively to build homegrown chip-making giants. The Chinese government announced a US$20 billion fund last year for that task, and says it will invest a total of US$161 billion over the next decade in a bid to make China less dependent on imported chips.

The Made-In-China 2025 plan, announced in May, calls for the Middle Kingdom to become a technology juggernaut within 10 years. A key part of that plan rests on Chinese vendors mastering the entire integrated circuit production process, from IC design and wafer foundry operations to packaging and testing services.

The Chinese government announced a US$20 billion fund last year for that task, and says it will invest a total of US$161 billion over the next decade in a bid to make China less dependent on imported chips.

“China intends to implement Made in China 2025 – which will change it from being just a big production country to a very powerful production country,” said Chinese Vice Premier Ma Kai, speaking at CeBit, the world’s largest ICT trade fair, in Germany. “Support for ICT, and innovative breakthroughs in ICT, will be an important link in this chain.”

Beijing aims to develop a “red supply chain” that will compete with one of the pillars of the Taiwanese economy. The island’s semiconductor sector is valued at US$70 billion and is expected to grow 5.5% this year to reach more than US$75 billion, according to the Industrial Economics and Knowledge Center (IEK), an arm of the state-backed Industrial Technology Research Institute (ITRI).

Market insiders are divided as to the degree that China’s ambitious plans directly threaten Taiwan. “China’s increasing importance as a designer and manufacturer of ICs will not necessarily displace other semiconductor centers of excellence,” says Christopher Thomas, co-head of consultancy McKinsey & Company’s Asia semiconductor practice.

“Chinese semiconductor makers are nimble, responsive, and with rapid design cycles, a good fit for the fast-moving mobile phone and consumer electronics markets.”

But Chinese IC firms enjoy important advantages, such as state support and proximity to a big mainland customer base, says Thomas. They are also “built for speed,” he adds. “Chinese semiconductor makers are nimble, responsive, and with rapid design cycles, a good fit for the fast-moving mobile phone and consumer electronics markets.”

Morris Chang, chairman of Taiwan Semiconductor Manufacturing Co. (TSMC), the world’s largest contract chipmaker, said at the company’s annual general meeting in June that the technology of Taiwan’s IC firms is better than ever. “If Taiwanese firms keep making progress in technologies, it won’t be easy for them [Chinese competitors] to catch up,” he said.

 

Enormous ambitions

But Taiwan’s superior technology alone will not stop China’s steady ascent in the semiconductor sector, analysts say. The PRC’s market share of global sales by fabless IC firms increased to 9% in 2014, compared with 5% in 2010, according to research firm IC Insights. Rising sales among those firms led to an overall 26% increase in revenue at Chinese semiconductor manufacturers last year, the highest in the world.

China’s top fabless IC firms, HiSilicon and Spreadtrum, are channeling the country’s budget smartphone boom by supplying chips to Chinese handset makers, according to IC Insights. In 2009, HiSilicon was the only Chinese semiconductor firm to be ranked among the world’s top 50, but by 2014, nine Chinese firms were on the list.

“China is determined to develop the entire IC supply chain domestically,” says an analyst at a local brokerage in Taipei, who spoke on condition of anonymity for compliance reasons. “We can expect them to continue acquiring companies to close the gap with their competitors, which will pose a real challenge to Taiwan’s IC firms.”

Why is Beijing intent on becoming a semiconductor superpower? For one thing, demand is tremendous. China buys more than half the semiconductors sold annually, but not one of the world’s top 10 chipmakers is Chinese. As a result, last year China’s IC imports exceeded its petroleum imports, notes Chaoyin Chi, a division director at ITRI.

The ruling Chinese Communist Party has also grown wary of depending on foreign IC suppliers since former National Security Agency contractor Edward Snowden divulged how the United States used hardware produced outside China to spy on the PRC’s political leadership and businesses. “There are always rumors that IC products have a monitoring function embedded,” Chi says. “When the chipset is made by Qualcomm, the Chinese can’t be certain about security.”

In mid-July, Tsinghua made a US$23 billion bid for U.S chipmaker Micron Technology Inc., a top producer of DRAM and NAND flash memory chips. If the deal does go through, it will be the largest takeover of a foreign firm by a Chinese company.

In the past two years, Beijing-based Tsinghua Unigroup has emerged as a leader in China’s quest to strengthen the domestic IC sector. It has steadily built China’s largest semiconductor firm on the back of two key acquisitions: the purchases of Chinese chipmakers Spreadtrum and RDA Microelectronics, while forging partnerships with Intel Corp. and Hewlett-Packard Co.

Then in mid-July, Tsinghua made a US$23 billion bid for U.S chipmaker Micron Technology Inc., a top producer of DRAM and NAND flash memory chips. If the deal does goes through, it will be the largest takeover of a foreign firm by a Chinese company.

Thomas Zhou, associate research director of IDC China, says he does not expect Tsinghua’s bid to be successful. “Micron holds many patents in memory technology, so the Committee on Foreign Investment in the United States is unlikely to approve this acquisition,” he says. But if the deal were to be completed, Tsinghua would become one of the most important providers of DRAM and NAND flash in the world, and their memory technology in China would be enhanced, he adds.

Taiwanese DRAM makers, meanwhile, would face a formidable new challenger with access to both the strengths of China’s supply chain and Micron’s memory technology.

 

Taiwan’s advantages

Despite China’s rising strength in the IC sector, Taiwan retains many important advantages, experts say. Top Taiwanese semiconductor firms leverage their proximity to the design centers of major OEMs and ODMs to build strong customer relationships, notes Thomas of McKinsey. “They are globally focused, aggressive, and invest heavily in R&D and product development. These are strong advantages,” he explains.

Taiwan is currently the No. 2 fabless IC maker in the world behind the United States, with an 18% market share – double that of China’s – according to IC Insights.

Of the top 10 semiconductor foundries by revenue, four are Taiwanese, more than any other country. These include first-place TSMC (53.7% market share) and number-two United Microelectronics Corp. (UMC) with a 9.9% market share. Both companies enjoyed double-digit growth in 2014, while their closest Chinese competitor, Semiconductor Manufacturing International Corp. (SMIC), the world’s fifth-largest foundry with a 4.2% market share, saw its revenue contract by 4.8%.

Last year, Hsinchu-based TSMC’s revenue totaled more than US$25 billion, up from US$20 billion in 2013 and almost 13 times SMIC’s US$1.97 billion. TSMC increased its revenue by US$5 billion in just one year because of the success of advanced process technologies of 28 nanometers (nm) and 20 nm, according to Gartner. Among TMSC’s hundreds of clients are Qualcomm Inc., ARM Holdings PLC and Apple Inc.

TSMC has been able to build a strong global customer base because of its reliability and fast cycle time – the ability to get wafers out quickly – says Samuel Wang, chief analyst of Gartner’s semiconductor manufacturing team. “Their technology is superior, but technology doesn’t win you customers by itself,” explains Wang, a 35-year veteran of the semiconductor industry. “TSMC always delivers on time and is very transparent with its customers. Because of that, TSMC is trusted.”

 

If you can’t beat ’em, join ’em?

Another key reason for TSMC’s success is its team of able engineers, notes Stephen Su, general director of IEK. That engineering talent, along with state-of-the art technology and an innovative outsourcing business model, has put the company in a strong position to fend off Chinese competitors, he adds.

“Industry experts and insiders have told us that China’s talent issues are acute, especially among senior technical personnel: architects with long-term systems experience who can envision, define, and execute an end-to-end technical recipe for an IC or a process technology,”

Wang of Gartner agrees that TSMC’s engineers – and indeed those at Taiwanese semiconductor firms in general – have the edge over their Chinese counterparts. “Chinese foundries have a strong foundation to compete with Taiwan, but what they need are [talented] people; they don’t have that right now,” he says.

“Industry experts and insiders have told us that China’s talent issues are acute, especially among senior technical personnel: architects with long-term systems experience who can envision, define, and execute an end-to-end technical recipe for an IC or a process technology,” says Thomas of McKinsey.

McKinsey expects Chinese semiconductor firms to attract engineering talent by purchasing companies or R&D teams outside their home country, poaching top talent from multinational firms operating in China, and luring “technical leaders of the Chinese diaspora to return to the mainland.”

What should Taiwanese IC firms do when Chinese competitors try to poach their all-star engineers? Fortunately for Taiwan, money may not be enough to lure the top talent away, Thomas says. Senior technical experts are rare in the semiconductor industry and do not typically move from one company to another, he notes, adding that they are more motivated by the opportunity “to do ‘cool stuff’ and work on the most leading-edge technology” than financial rewards.

Some Taiwanese IC makers are taking a different approach, opting for closer integration with China to expand their market share. In November 2014, UMC announced plans to invest US$1.35 billion in a three-way joint venture with the city government of Xiamen, Fujian Province, and Fujian Electronics & Information Group. The new venture intends to invest US$6.2 billion in a 12-inch-wafer plant in Xiamen, which is expected to begin operation in late 2016 at the earliest. The plant will produce 500,000 12-inch wafers a month on 40-nanometer or 55-nanometer process technology.

Since UMC’s investment involves deploying advanced IC technologies in China, it requires approval from the Investment Commission of Taiwan’s Ministry of Economic Affairs. The review process is likely to be lengthy, experts say.

Meanwhile, market insiders are urging the Taiwanese government to more proactively support the local semiconductor industry. Paul Wang, chairman of Internet communications device supplier Sercomm Corp., has suggested that the government establish a NT$100 billion (US$3.23 billion) fund for that purpose.

Governmental financial support for the capital-intensive IC sector would be beneficial, concurs Wang of Gartner. But even without it, Taiwan’s semiconductor’s firms will retain their edge over China for a while, he says. “The Chinese still have so much to learn,” he concludes.

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