Through a combination of government support, industry investment and export growth, China has become a major producer and consumer of semiconductors. Industry estimates suggest China's appetite for integrated circuits (ICs) will grow 11%, to US$34bn+ in 2005, pushing Chinese consumption ahead of the United States and Japan, two thirds of it going into electronics exports. If IC Insights estimates prove correct, China will consume about 25% of global IC production by 2008, up from just 8% in 2001.
Most consumption is satisfied by imports. China's manufacturing capacity is growing, but the gap between what it produces and consumes has been widening – from US$5. 7bn in 1999 to US$20.8bn in 2003, according to PricewaterhouseCoopers.
With industry data suggesting China is capable of meeting only a fifth of requirement, Beijing has been looking at options. One, PwC says, calls for pushing up capacity aggressively – increasing it by 40% a year through 2010. But that rate looks hardly sustainable. A more moderate growth path would see capacity increase by 28% annually, raising China's portion of worldwide capacity from 5% now to 11.5% in 2010.
The fear is how dramatically China's increasingly prominent role impacts pricing and shakes other manufacturing centers around Asia and elsewhere. Although IC industry structure has changed considerably since, memories of South Korea's rout of Japan in memory chips (DRAMs) production still reverberate.
All this expansion will necessarily take place as the highly cyclical chip industry peaks and troughs – and as chip making continues its shift away from the do-it-yourself model to the outsourcing model where work is farmed out to contractors, or foundries. Notes IC Insights: "After growing twice as fast as the total IC market in 2003, pure-play foundry sales are forecast to increase 52% in 2004 to $17.17bn. This compares to a 31% increase forecast for the total IC market in 2004." IC Insights defines pure-play foundries, like Taiwan Semiconductor Manufacturing Co (TSMC), as those who make little else but chips on contract.
Outsourcing trends favor China, which is focused on building foundry capacity and scoring contracts by under-pricing everyone. IC Insights sees the competitive arena shifting, noting that while business boomed for Taiwan's TSMC in 2004, enough foundries had either expanded or started up to whittle down its share. Mainland China's fast-expanding Semiconductor Manufacturing International Corp (SMIC) was one. In 2004 it was projected to almost treble sales, to US$1.1bn – while TSMC was projected to grow a record 37% year on year, but still drop another 5% share. Between 2002 and 2004, TSMC kept growing while it watched its global foundry sales share drop from 54% to 47% – while SMIC, now the world's fourth largest foundry, increased its share from 1% to 6%.
But China's chip industry is still in a fledgling state. Given the US$1bn-US$2bn+ investments required to build fabs, and the blinding pace of design changes – often calling for new production line investment – China has had to pursue a strategy of courting the global semiconductor giants. All of the world's top 10 chip companies have operations of some sort in China, whether full fabs or packaging and assembly and test plants.
Incentives to beat all
To spur growth, the government has established accommodating regulatory policies which augment China's advantages of low costs and a huge domestic market. Preferential terms mirror incentives other Asian economies used to get their IC industries off the ground in earlier days. Producers enjoy a five-year zero income tax advantage followed by another five years at half of China's already low tax rates. Beijing has promised a continuation of incentives, which some argue already beat Taiwan's.
In a bid to boost local industry – a move that roiled US and other exporters – chip imports were subjected to a 17% value-added tax (against a VAT of only 3% for domestic chipmakers). A WTO ruling ended that in January, but it allowed China's domestic producers to make significant headway. And last December, Beijing increased rebates on IC exports to 17% from 13%.
Practically everything now has chips in it, from winking running shoes toddlers wear to chip-set-rich dashboards on A-380s. There is more electronics in products and chips account for a larger portion of electronics value, explaining why IC growth outpaces general electronics growth – rising from 4% on average in 1965 to 19% in 2003, according to IC Insights; in communication electronics, ICs accounts for nearly a quarter today. Consumer and industrial consumption is booming, from mobile handsets and DVD players to "intelligent" appliances and cars, now packed with electronics.
China may be dominated by foundries, but design houses and so-called fabless firms are springing up. Industry association data showed 463 by yearend 2003, but the numbers are disputed: one source quoted by PwC maintains China only has 500 "qualified" IC designers – and some of those have to be working for new arrivals, like Samsung, a vertical player which makes as well as designs its own ICs. (Samsung and Synopsys both announced China research centers in 2004.) iSuppli says China graduates 400 chip designers a year, hardly a flood.
China's advancement is hampered by other factors, too, not least weak intellectual property protection, which makes big players reluctant to introduce their top thinner-line chips – and big 300mm wafers from which more sophisticated IC devices are sliced and diced. Bigger wafers are crucial from a competitive standpoint because they offer bigger yields where savings really kick in. (Though SMIC and Shanghai neighbor Grace Semiconductor both claim 0.13 submicron technology, China is awash in secondhand small-wafer kit offloaded by companies like Chartered Semi who want to move on.)
While China's big problem remains enforcing laws that increasingly meet international standards, a promising sign came in December when SMIC agreed to pay US$175m to TSMC to settle pending patent and trade-secret issues.