China's semiconductor, or integrated circuit (IC), market grew 32% to US$40.8 billion in 2005, accounting for 21% of global IC consumption. In doing so, it surpassed both the United States and Japan to become the world's biggest, according to IC Insights, a US-based IT consulting firm. As recently as 2000, China only accounted for 6% of global consumption, and was one-fifth the size of the US market.
While demand is hot, domestic production is not. With only US$2.6 billion worth of semiconductors produced domestically in 2005, China's tech exports are largely built using chips imported from elsewhere. In a bid to rectify the imbalance, and capture the lost profits, the government has established preferential regulations to mimic conditions that have seen the semiconductor industry flourish elsewhere in Asia.
Chip producers enjoy a five-year zero income tax advantage followed by another five years at half of China's already low tax rates. Officials have promised a continuation of this favorable regulatory environment and reiterated their commitment to the industry's development despite the unpredictable nature of the market.
A research fund has been set up to subsidize the semiconductor industry, something that could well prove more financially beneficial to the industry than the tax breaks. On the R&D front, China is following a typical developing world path by courting global semiconductor giants to form partnerships rather than engaging in the more expensive and time-consuming practice of constructing its own independent research base.
The world's top 10 semiconductor enterprises all have operations of varying scales in China. Getting in early and establishing good relationships with the government is seen as essential to securing a solid share of the burgeoning market.
Production centers tend to be found in and around the large eastern cities, especially Shanghai, where Intel, TSMC and equipment provider Applied Materials have all set up shop.
Cities in the surrounding Yangtze River Delta region are also popular, with both Samsung and Fairchild based in Suzhou. Other foreign operators can be found in Beijing and Tianjin in the north and Guangdong's Guangzhou and Shenzhen.
But there is some activity inland too. Infineon has a design center in Xi'an, in addition to production bases in the Yangtze River Delta. Philips began operating a plant in northeastern Jilin in 2004 and Intel opened a US$375 million facility in the western city of Chengdu in 2005.
China's chip industry still has a long way to go, but its efforts are paying off to a certain extent. IC Insights forecasts that chip production will be worth US$12.1 billion by 2010, which equates to annual growth of about 36%. However, given the low base, this will only represent 4% of the expected US$319 billion worldwide production in 2010. Furthermore, it will only meet about 10% of domestic demand, which is likely to be worth US$124 billion.
The advancement of China's chip industry is hampered by its poor record in intellectual property rights (IPR) protection. Although Beijing issued laws in 2001 addressing IPR in the semiconductor industry, foreign companies are still reluctant to release valuable technologies into the country. This is a major stumbling block with Taiwan, the global home of the semiconductor business, whose government imposes severe limitations on the transfer of semiconductor processing technology to China.
Despite this foreign reluctance to share information, China is making progress. The future of its semiconductor industry lies in its high quality design houses, which have been driven by increased investment in research, design, raw materials supply and other support industries. Several of China's major semiconductor enterprises have made impressive advances in their bid to reach international standards.
A recent survey by EE Times-China showed that 45% of China's IC design companies – the so called "fab-less" semiconductor companies – chose 0.18 micron for digital IC design in 2005, an increase of about 7% from 2004. Meanwhile, 14% developed chips using the 0.13 micron process, an increase of 8% from the previous year. The move from 0.18 micron to 0.13 micron is expected to escalate with most local houses believing there are no technical barriers to the shift.
In a vote of confidence for the domestic industry, the survey also found local foundries were the top choice for IC design houses, with nearly 60% preferring the mainland for fab processing. The number opting for Taiwan fabs decreased by about 6%, attributed to the growth of local manufacturing and the apparent cost advantage.
This preference for home-grown products and services has trapped the industry in a positive feedback cycle that augers well for the future. Many of the newest fabs being constructed on the mainland were originally planned for Taiwan, but have been lured to China not only due to lower costs, but also due to enhanced local sales potential.