Taiwan's semiconductor makers have been on a slow boat to the Mainland, thanks to Taipei's restrictions on investment. Now that journey could slow to a stall, with Beijing's recent enactment of the anti-secession law, the legal framework for using force in the event Taiwan declares independence.
Until that happened, Taiwan had considered relaxing its rules. One reform on the cards would have allowed them investors to move more advanced technology across the Strait – and move up from mature 200mm wafer equipment, and to invest in semiconductor packaging and test operations.
But now Chen Shui-bian's administration is on edge. Indeed, Beijing's harder line looks on one level like it precipitated a crackdown on allegedly illegal investment: recent bang-ups between Taipei regulators and island investors snared UMC, Taiwan's second largest contract chip manufacturer, or foundry, which was trying to cut a deal with "mainland" chipmaker He Jian Technology Co, a company actually started by UMC alums.
Trouble in March
March also brought the sledgehammer down on Semiconductor Manufacturing International Corp Founder and CEO Richard Chang, who earned his industrial spurs in Taiwan. His apparent crime (for which he was fined US$158,000 and ordered to retract his mainland investments within six months): investing in SMIC without Taipei's approval.
Taiwan has long been slow to loosen up, and not without reason. For a homegrown industry nurtured and subsidized by the government, its exodus to the Mainland threatens to carve off the very pinnacle of the island's industrial sector, draining intellectual capital and thousands of jobs.
In 2002, Taiwan partially lifted a ban barring tech transfers by allowing mature production equipment across the Strait, including those technology used to manufacture 200mm wafers. But any chip investment still had to have government approval (as UMC and Richard Chang were reminded) – often a long process taking months. And since delays can turn the best business plans upside down, Taipei can scuttle plans just by dawdling as it looks for the right stamp.
Today, the fabrication plant on the Mainland operating with Taiwan's blessing is Taiwan Semiconductor Manufacturing Co (TSMC), which invested US$898m in its modest Shanghai fab (Building one normally starts today at well over US$1bn).
But many chipmakers, along with venture capitalists, have slipped into the Mainland via Hong Kong companies, or offshore vehicles established in havens like the British Virgin Islands (BVI) and Bermuda. According to a report commissioned by the US Semiconductor Industry Association, as of September 2002, Taiwan chipmakers and investors had funded at least 19 foundries in the Mainland. "[Taipei] is largely concerned with symbolism – direct investment is restricted, but investments through the British Virgin Islands or Hong Kong are untouched," says Jim Lewis, a technology policy expert at the US-based Center for Strategic and International Studies.
Indeed, there are those who argue Taipei has actively promoted selected cross-strait chip investment. "For the last 20 years, the government has encouraged mainland investment through intermediary companies," says Tom Howell of global law firm Dewey Ballantine LLP, a principal author of the SIA study. But foundry investments, he says, may be one of the few exceptions. And while semiconductor assembly and test (A&T) are not allowed by Taipei, major Taiwan A&T houses, the so-called back-end wafer manufacturers like ASE Inc and ChipMOS Technologies, have established mainland operations reportedly dedicated to materials and substrate manufacturing.
The big lure
The Mainland is where the growth is. According to industry-wide estimates, mainland semiconductor companies can now only meet between 15% and 20% of the domestic demand, so the potential for growth is stratospheric. By 2010, Gartner projects demand will reach US$96.7bn, and even then, mainland chipmakers are expected to supply less than half that.
One Taiwan company drawn to the Mainland is design house ProMOS Technologies, which filed papers seeking Taipei's permission to invest US$900m in a mainland manufacturing plant to manufacture 200mm wafers. The company says it first applied in December, and at this writing, was still filing papers to satisfy information requests from various government agencies, though it remains optimistic its plans will be approved.
Big name Taiwan chipmaker Winbond Electronics Corp has invested an average of RMB20m (US$2.4m) annually in mainland activities for five years now, largely in R&D, according to a person familiar with the company. But it won't build a fab there until it sees more A&T infrastructure in place, he says. So for now it keeps its 90- strong operation in Shanghai focused on sales and developing wireless applications (more than half of the staff is in R&D).
In the capital-intensive chip manufacturing, equipment costs are the big issue, not labor which accounts for less than 5% of operating costs. But move over to the design side – the so-called fabless semiconductor companies and some areas of assembly – and labor starts factoring in big time.
Mainland engineers – generally judged inferior to Taiwan entry-level peers, but very quick learners – earn 40-60% of the money island engineers get. In that context, Winbond's decision to set up in Shanghai, where a Taiwan R&D chief supervises 50 mainland engineers, looks compelling. Other island chip companies, like Sunplus Technology Co, VIA Technologies and Macronix International Co, follow similar models, and for good reason: Taiwan's universities no longer apparently produce enough engineers. "Taiwan's higher ed system is a fully developed system," says Albert Lin, head of business operations at ProMOS. "There is no room to further increase Taiwan's supply."
The Mainland offered big perks to get the chip migration going – like the just discontinued 17% value-added levy on imported chips (it's 3% for locally made ones). Various government incentives like tax holidays still apply, but one of the biggest attractions is location: 70% of chip-hungry notebook computers, according to Toshiba official in the triangle, are now made in a wedge bounded by Shanghai, Suzhou and Hangzhou.
There could be some new and powerful cross- Strait combinations if both sides simply let market forces play out. Cross-bred companies like SMIC and He Jian are already approaching global standard, says IDC analyst Betty Lin. SMIC, for instance, has moved up to advanced 0.13 micron technology, while Taiwan's TSMC mainland operation still putters along at 0.35 micron and is prohibited by Taipei's rules to proceed to line-widths finer than 0.25 micron – although a TSMC spokesman says the company is now seeking permission, and expects approval, to go to 0.18.
Wafer size is another no-go area for islanders: while SMIC continues to increase its revenue on the back of more advanced, premiumpaying 300mm (12-inch) wafers, TSMC must settle for working with 200mm (8-inch) technology on the Mainland.
Now the rules are coming back to haunt: He Jian, the UMC-groomed chipmaker founded only two years ago, has already reached the point of turning out 30,000 wafers a month, compared to TSMC's current output of 5,000 – though it says it will be ramped up to 15,000 wafers per month by year-end.
That may not be fast enough: by Lin's estimates, SMIC is poised to become the world's no 3 foundry this year, after docking in the no 4 slot for the last two. Is Taipei really going to wait till SMIC threatens foundry leader TSMC, its pride and joy?
For some, like Lewis of CSIS, that scenario presents a skewed picture, since Mainland and Taiwan operations are often one and the same to begin with. "Taiwanese actually own a large percentage of the IT industry in China," Lewis says. "The Taiwanese bring business skills and technical expertise that the Chinese do not have."
But they must restructure, he says. "As they shift lower-end processes there, they have to find a way to move up to higher end functions, such as design. The issue is not competition with mainland companies – [but] with Japanese and American firms that have dominated the high end," Lewis says, adding that he expects some to do well.
Dewey Ballantine's Howell argues Taiwan can retain R&D, design, finance, logistics, marketing and training. "It's an approach they have taken with other industries, like printers and electronics."
Lewis agees: "President Chen's call for Taiwan to move from manufacturing to knowledge-based services is the right idea," he says, adding that Taiwan isn't really hollowing out anyway. "The problem is not hollowing out but how to manage economic integration with China and how to move up the value chain."