The flat-panel display sector is reeling from the effects of oversupply and anemic demand for consumer electronics.

Taiwanese manufacturers of liquid crystal display (LCD) panels had a rough year in 2015 as their profits were pinched by a supply glut and falling consumer electronics sales.

The net profit of AU Optronics (AUO), the world’s No. 2 maker of monitor panels, plunged 74% year-on-year from NT$18.07 billion (US$537.8 million) to NT$4.84 billion (US$144.6 million) while its shipment volume fell to 26 million units from 27.3 million units a year earlier.

Innolux, which is owned by contract electronics manufacturing giant Hon Hai Precision Industry (Foxconn), fared even worse last year. The company’s net income fell more than 50% from 2014 to NT$10.8 billion (US$327.3 million). In the fourth quarter of 2015, Innolux reported a net loss of NT$6.7 billion (US$203 million), its worst performance in more than three years. Innolux’s monitor-panel shipments also contracted by 28% year-on-year, falling to 25.5 million units from 35.5 million units in 2014. As a result, Innolux slid to third place globally behind AUO in monitor-panel shipment ranking, according to Taipei-based research firm TrendForce.

Taiwan’s panel makers are squeezed between Korean industry leaders and aggressive Chinese upstarts. Korea’s Samsung Electronics and LG Display – the top two LCD makers globally – benefit from vertical integration. Those companies sell their own branded consumer electronics products with LCD screens, including everything from smartphones to television sets. Chinese manufacturers are buoyed by robust state support and a huge domestic market.

Even as global demand flags for consumer electronics, Chinese LCD panel makers are ramping up production capacity. According to research firm IHS Technology, Chinese manufacturers held a 19% share of the global LCD panel market in 2015, up from just 4% in 2010. IHS predicts that China will become the world’s top producer of LCD panels by 2018, comprising 35% of global capacity.

Beijing’s drive to increase capacity “has threatened Taiwan’s entire LCD industry,” says Brian Chen, an LCD analyst at the government-backed Market Intelligence & Consulting Institute (MIC). “The Chinese government has also insisted on boosting China’s utilization rate of panels, so more of their domestic vendors have been using China-made panels [instead of those from Taiwan] in their products.”

That’s bad news for Taiwan’s panel makers. AUO and Innolux each depend on China for 30% to 40% of their business, experts say. For tier-2 firms CPT and Hannstar, China accounts for 70% to 80% of their business.

“Costs are similar for all panel makers. When prices crash, nobody can make money,” says David Hsieh, director of analysis and research at IHS and an expert on the LCD sector.

China thinks big

In October 2015, Beijing rolled out a massive state-backed expansion plan to boost capacity in its LCD sector and reduce dependence on Korean and Taiwanese manufacturers, who currently supply 70% of China’s LCD panels. The plan entails an investment of US$27 billion over the next three years to develop large-scale production facilities in seven locations across the country.

China’s mammoth investment in the LCD sector derives from its model of state capitalism, notes IHS’s Hsieh. Beijing has been encouraging provincial governments to support the building of LCD fabs to achieve the central government’s objective of increasing domestic panel supply, he explains.

Meanwhile, the larger panel supply benefits local government coffers as “revenue from a new fab is equivalent to revenue gains from business taxes or the value-added tax (VAT) for local governments,” Hsieh says.

Given those factors, “government support and subsidies for flat panel display investments will not end any time soon,” Hsieh says. “Quite the opposite, panel makers are using these factors as leverage to facilitate new fab investments in China.”

Indeed, China’s BOE Technology Group plans to spend US$16 billion over the next three years to build new LCD panel factories. The added capacity will allow the company to diversify its product lineup as it accelerates production of screens for smartphones, televisions, and car dashboards.

In December 2015, BOE began construction of a massive government-backed LCD factory in the Anhui provincial capital of Hefei. U.S. specialty-glass maker Corning, long a leading foreign investor in Taiwan, will invest US$460 million to build a glass substrate manufacturing facility nearby the Hefei plant that will supply Gen-10.5 glass substrates to BOE. BOE will also continue purchasing glass substrates for Gen-8.5 sizes and below from Corning.

“Corning is pleased to extend its close relationship with BOE and to demonstrate our continued commitment to China – the world’s largest TV market,” said James Clappin, president of the Corning Glass Technologies group, in a December statement.

The Hefei plant will enable BOE to surpass Japan’s Sharp as manufacturer of the world’s largest and most advanced LCD panels. For more than six years, Sharp has led in generation technology with its flagship Gen-10 fab in Sakai (a city near Osaka), notes Eric Chiou, a senior research manager at TrendForce. BOE’s Gen-10.5 fab will produce LCD panels for TVs with a display of 65 inches or larger and will have a capacity of 90,000 glass panels per month, he adds.

“If you want to know how important the LCD industry is to China, consider that the Hefei factory was the first place [Chinese President] Xi Jinping visited publicly this year,” Hsieh says.

By 2018, BOE will have greater flat-panel display capacity than any producers besides Samsung and LG, according to IHS. BOE’s 14% share of the global market will put it ahead of Innolux’s 13% and AUO’s 11%, who will fall to fourth and fifth place respectively, IHS forecasts. Overall, IHS expects that by 2019 China will have 11 thin-film transistor (TFT)-LCD panel factories in operation, another 10 under construction, and eight more in the planning stage.

Not nimble enough

Korean panel makers have moved faster than their Taiwanese counterparts to meet the challenge from China. In the past two and a half years, both LG Display and Samsung Display have set up large fabs in the PRC. Production within China has boosted their bottom lines, as imported LCD displays are subject to a 5% tariff.

LG will increase capacity at its Guangzhou plants from 90,000 substrates a month to 120,000 in the middle of this year to meet demand from Chinese vendors, according to Taipei-based research firm DigiTimes. The fabs will manufacture large-size TV panels mostly in the 40-inch and 50-inch segments.

Korean panel makers will further benefit from a free-trade agreement (FTA) with China that came into force in December 2015. Under the terms of the FTA, the 5% import tariff on Korean LCD panels will be scrapped after the agreement enters the 10th year. By contrast, Taiwan’s top panel makers AUO and Innolux have minimal production capacity in China and there is no agreement in place to remove Beijing’s 5% tariff on imported LCD panels.

How did Taiwanese panel makers end up in such an unfavorable situation? As Korean manufacturers began local production in China, the Taiwanese government did not allow Taiwanese firms to follow suit, notes Chen of MIC. “We are afraid Taiwanese firms may have missed the best opportunity to supply LCD panels in China,” he says.  “Korean panel makers have started to eat away at Taiwanese panel makers’ share in the Chinese high-end panel market.”

Nevertheless, Taiwanese panel makers believe they still have a chance to strengthen their position in China if Beijing is willing to eliminate import duties on Taiwanese LCD panels. Beijing and Taipei are currently in the late stages of negotiating a cross-Strait trade-in-goods agreement covering a wide range of industries.

In recent months, Taiwanese panel makers have stepped up their lobbying efforts to urge the government to move the negotiations along. “The government should toughen its position…in talks with China to bring down the import tariffs on Taiwanese panel makers to zero,” Innolux said in a December 2015 statement. Innolux encouraged the authorities to secure more favorable terms for panel makers than those received by South Korea.

In a January statement, AUO noted that Taiwan’s low-margin panel business is highly sensitive to China’s 5% import duty. Given that the panel industry supports the employment of more than 100,000 people in Taiwan, the government should “protect the livelihood” of those people by persuading China to drop the tariff, AUO suggested.

New product possibilities

Compared to their Korean and Chinese competitors, Taiwanese panel makers focus more on controlling costs – to the extent of hindering them from making crucial new investments in technology that could benefit their businesses. “Investing more in technology could be highly beneficial for Taiwanese panel makers,” says Daniel Tseng, president of Corning Taiwan.

In that regard, the Taiwanese industry could learn from the Koreans. Last November, LG Display announced it would invest US$1.59 billion to build the world’s largest organic light-emitting diode (OLED) panel plant in Paju, just south of the demilitarized zone near North Korea. OLEDs are more expensive to manufacture than LCD panels, but have a technological edge. They are thinner than LCD panels, feature better picture quality, and are easier to shape. The next generation of OLED panels is expected to be flexible, making it possible to roll up the displays.

Consumers have been slow to embrace OLED televisions thus far, but there are signs the market is picking up. LG Display said nearly of its half of its 2015 sales of 400,000 OLED panels for televisions came in the fourth quarter. IHS forecasts that the global OLED panel market will triple to US$29.1 billion in 2022 from US$8.7 billion in 2014.

LG’s foray into OLED also represents a hedge against China’s LCD panel deluge, which is pummeling the Korean manufacturer’s bottom line. The company recorded a net loss of 13.5 billion won (US$11.2 million) in the fourth quarter of 2015, compared to a profit of 389 billion won (US$322 million) during the same period a year earlier.

Up until now, Taiwanese panel makers have focused more on reducing the cost of doing business in China than on developing game-changing LCD technology. But that could be changing. In January, Innolux’s parent company, Foxconn, made an offer to buy Sharp for US$5.3 billion (the bid has since been increased to nearly US$6 billion), in what could be one of the largest foreign takeovers of a Japanese company.

If the deal goes through, it would be Foxconn’s largest acquisition since its 2009 takeover of Chi Mei Optoelectronics that merged the display company with Innolux.

Foxconn has previously tried to acquire Sharp. In 2012, it agreed to purchase a 10% stake in the Japanese electronics maker for about US$800 million, but the deal fell through after a steep fall in Sharp’s share price. That prompted Foxconn chairman Terry Gou to instead invest US$840 million through a personal investment vehicle to take a 38% stake in one of Sharp’s display panel factories.

Some analysts are skeptical as to whether Sharp is worth top dollar. The company booked a net loss of ¥222 billion (US$1.95 billion) in the fiscal year ended March 2015. Since then, Sharp has continued to perform poorly, recording an operating loss of ¥25.2 billion (US$221 million) in its most recent half-year results.

Yet Sharp remains an industry leader in LCD technology, notably Indium Gallium Zinc Oxide (IGZO) panels. IGZO panels have many advantages over other LCD technology, as they boast higher resolution and better touch detection, use less power, and emit almost no electrical noise. With the largest IZGO capacity in the LCD sector, Sharp supplies smartphone and tablet panels to Apple using the technology.

Foxconn is keen to tap the Japanese company’s display and manufacturing acumen, experts say. Foxconn would acquire Sharp with the intention of leveraging the Japanese company’s “next-generation LCD technology [IGZO] to further consolidate its partnership with Apple,” says Chen of MIC.

On February 25, the Sharp board announced it had approved Foxconn’s offer. But just a few hours later, Foxconn said the takeover deal was being put on hold as the Taiwanese electronics maker needed time to review potential financial liabilities of nearly ¥350 billion ($3.1 billion) which Sharp had disclosed a day earlier.

Even if Foxconn’s bid for Sharp falls through, some industry experts say Taiwanese LCD panel makers will find a way to meet the challenge from China and Korea. “I am not pessimistic – because the Taiwanese are so flexible in finding their value proposition,” says Corning’s Tseng.

Still, “Taiwanese manufacturers should keep in mind that cost advantages won’t make you a success – they will only allow you to survive,” he adds.