The measures taken by the Trump Administration against Chinese technology firms go far beyond Huawei. The latest casualty is SMIC, China’s flagship semiconductor fabrication firm. China’s semiconductors industry is now having difficult times. The US-China dispute has morphed into a commercial embargo against Chinese semiconductors industry. It involves non-Chinese and non-US companies, first and foremost Taiwan’s TSMC and Korea’s Samsung. It could have far reaching consequences, leading to a new restructuring of this global industry.
Let us start with a global perspective on the semiconductor industry in order to better understand the challenges and stakes associated with the US-China tech war in this critical sector. Starting from the 1970s, the global semiconductor industry has gone through a gradual fragmentation of its value chain, resulting in increased division of labour and specialisation. While being global in scale, the industry is concentrated within a dozen countries. It is structured around the (almost) “fabless” chip designers like Intel, Qualcomm, Apple, and Huawei’s subsidiary HiSilicon which are serviced by three major types of players: chip fabs or manufacturers, design software makers (also known as Electronic Design Automation or EDA tools), equipment manufacturers. Since the 1990s, the US semiconductor industry has been the global sales leader with an almost 50% market share.
More precisely, US firms continue to enjoy dominant market shares in Logic and Analog semiconductors, while Korean firms (Samsung, SK Hynix) and European firms (Infineon, ABB) hold leading positions, respectively in the Memory and Discrete chips market segments. The continued US leadership in the two core chip markets has been possible thanks to innovative industry-wide “coopetition” schemes and sustained levels of CAPEX and R&D expenditure. According to the US Semiconductor Industry Association (SIA), American semiconductors firms spend on average on R&D 16.5% of their revenue, slightly above European firms (15% of sales) but 50% more than Taiwanese firms (10% of sales) and twice what Japanese, Korean and (Mainland) Chinese firms (8% of sales).
In addition, three US firms dominate the market for EDA tools, with a combined market share of 80%. US semiconductor equipment makers also have the upper hand with only a few meaningful foreign competitors such as Dutch company ASML. When it comes to fabrication however, US firms have gradually lost ground to Taiwanese and Korean firms, with Taiwan’s TSMC and Korea’s Samsung Electronics enjoying dominant positions in this concentrated market. The latter have been the real winners of the irresistible urge for chip makers to “go fabless”, in order to reduce their costs, improve their profit margins and concentrate on the most value-added part of the value chain. TSMC and Samsung Electronics have invested heavily and they have benefitted from the scale economies associated with ever increasing external orders – especially from 3G/4G chips made for smartphones. As a sign of this new reality, Intel, the leading US Integrated Device Manufacturer (IDM) has voiced earlier this year its intention to outsource its chip manufacturing after encountering growing difficulties to produce in-house its 10 nanometer chips and further delays before it can produce the 7 nanometre chips, contrary to TSMC and Samsung.
What about China?
The Chinese Authorities have supported the establishment and growth of an indigenous semiconductor industry since the 1980s. However, a number of structural constraints have hindered for decades the development of homegrown chip makers. Among these obstacles, we can cite the almost total dependence on foreign EDA tools and manufacturing equipment alongside a dearth of locally trained engineers in this highly knowledge-intensive industry. But perhaps the most important constraint back in the 1990s and early 2Ks was the lack of demand for locally designed and manufactured chips, which could have enabled the nascent Chinese chip makers to achieve scale returns and to become competitive. Over the last two decades, the situation has however dramatically changed, thanks to a combination of factors including the spectacular rise of China’s electronic Original Equipment Makers (OIM) – the likes of Huawei and ZTE -, the boom of the smartphone market and an unprecedented amount of government support.
In June 2014, China’s State Council published the “National Integrated Circuit Industry Development Guidelines”. This led to the creation of the first national investment fund dedicated to the semiconductor industry – the Big Fund – which raised RMB 138.7 billion from the Ministry of Finance and China Development Bank Capital, as well as several other state-backed enterprises. In 2019, China set up its second semiconductor-focused investment fund, raising RMB 204 billion (around $28.9 billion). It has become clear to the Government that this industry is critical for its ambitions to achieve tech catch-up with foreign powers – first and foremost with the United States. However, as mind boggling as they look like these figures should be put in perspective and compared with the total expenditure on R&D by US semiconductors firms, which currently exceeds $40 billion per annum. This explains why there is a need to channel more private funding to the semiconductor industry, and why the Chinese government has been so keen to organise the national VC and fund raising ecosystem, with the emphasis put on Shenzhen ChiNext Board inaugurated in 2009 which currently boasts a market cap of around RMB 9.5 trillion and Shanghai’s STAR market with a market cap of RMB 2.8 trillion as of August.
As a matter of fact China’s most prominent integrated circuit designer, HiSilicon, Huawei’s chip making subsidiary, did not rely directly on government support. It was nurtured internally and scaled up as a result of a SWOT analysis of the competitive landscape by Huawei’s management. On the other hand, SMIC, China’s tentative response to TSMC and Samsung Electronics in semiconductor fabrication has greatly benefited from the Chinese State’s industrial policies and initiatives to boost the innovation funding ecosystem.
In May 2020, in support of the country’s Made in China 2025 program; the China National Integrated Circuit Industry Investment Fund and the Shanghai Integrated Circuit Industry Investment Fund invested a combined US$2 billion, gaining, respectively, 23.08% and 11.54% ownership of SMIC. In July 2020 SMIC issued 1,685,620,000 shares at 27.46 yuan per share on the STAR Market of the Shanghai Stock Exchange, raising 46.28 billion yuan ($6.62 billion). Earlier this year Huawei shifted its Kirin chip order from TSMC to China’s SMIC. In order to accommodate for SMIC’s limited manufacturing capabilities, it had to replace the original Kirin 710 design based on 12nm nodes with a 710A version using 14nm nodes. The Huawei huge order is now in jeopardy as SMIC has fallen under additional US export restrictions which effectively cut it off from critical American suppliers. As reported by the FT, “the most advanced equipment Chinese suppliers can offer is for its 90 nanometre chips, many generations behind cutting-edge manufacturing technology and several behind what SMIC needs to keep expanding.”.
Does the latest US move and export ban signal the end of China’s fledgling semiconductor industry, as some analyst and commentators have rushed to conclude? Probably not. TO BE CONTINUED.